When multiple business entities make a decision to start a new business together as a cooperative arrangement, they form what is known as a joint venture. In creating a joint venture, each of the involved entities agrees to what assets they will contribute, how they are going to distribute income and share expenses, and how the new entity will move forward.
Before deciding to get involved in a joint venture, business owners need to carefully assess how they plan to proceed. It is essential that every detail of the new organization’s operations be thought out and addressed ahead of time, from its management and tax liabilities to how profits and losses will be distributed.
Forming a Joint Venture
Even though a joint venture represents a cooperative between two or more business entities, each of those original entities retails its original legal status, whether as companies or corporations or as an individual or group of individuals. Not all joint ventures involve the actual formation of a new business entity, but if a new entity is created it will be required to pay its own taxes. The tax liability will be based on the form of business that is adopted: if an unincorporated joint venture, the tax on profits will belong to the entities who originally joined the agreement, while as a corporation it will have its own tax responsibility.
A joint venture can exist solely as an agreement between the original cooperating entities. Whatever form a joint venture takes, it is best arranged via a detailed, comprehensive contract that specifies what assets each of the participating entities will contribute, how the new entity will be managed, who will be in control of important decisions and how the distribution of profits and losses will be accomplished.
Why form a joint venture?
There are numerous advantages to forming a joint venture, including combining distinct talent and background from two separate entities to create a novel product or service, or taking advantage of one entity’s strength in marketing with another’s innovation. A good example of a successful joint venture can be found in BMW Brilliance Automotive, Ltd, which was formed between BMW Group and Brilliance China Automotive Holdings. The two created a new entity to sell BMW vehicles in China, leveraging Brilliance China’s geographic presence to sell BMW’s products.
Among the reasons for forming a joint venture are:
- Leveraging the combined resources of multiple entities in order to strengthen the organization’s strength and viability.
- Leveraging the expertise of one or more of the original entities in order to create a better product or improve its delivery or marketing.
- To achieve economies of scale
Though many joint ventures are formed with an eye to the future, some are created to accomplish short-term goals and then quickly disbanded upon those goals being achieved.
How Does a Joint Venture Work?
A joint venture can take the shape of any type of business entity, including a partnership or corporation. Whatever type of entity the founding entities land upon, decisions need to be made regarding division of stock if a corporation, who will be on the board of directors, and how much responsibility for the new entity’s management each original entity will carry.
In some cases, a joint venture is established under a unique federal income tax arrangement called a qualified joint venture that allowed a married couple greater simplicity in filing their joint return than they would find if a business that they operate together were to be established as a partnership.
Though similar, a consortium is not the same as a joint venture, as it is a more casual business arrangement that does not involve the creation of a new entity. Rather, in a consortium, distinct entities remain separate but make the decision to cooperate.
Crafting a Joint Venture Agreement
Though it is conceivable that multiple entities would be willing to enter a joint venture on a casual basis or via an oral agreement and there is no requirement that a joint venture register with either a state or federal government, it is still better to involve an attorney who can craft a document requiring the signatures of all parties involved.
A well-formulated joint venture agreement may include:
- The names of all entities involved in the agreement
- The management structure being adopted in the formation of the joint venture
- The ownership percentage of each of the named members
- The percentage of profit or loss that will be allocated to each named member (also known as their distributive share)
- The name of the bank through which the joint venture will manage its funds
- The identities of all contractors and employees who will manage the day-to-day operations
- The resources being made available for the organization
- How financial statements and records will be created, dispersed, documented and archived
- Under what state’s laws the joint venture will operate
If you have any questions about joint ventures or business entities, please contact our office.