What Is a Joint Venture and How Does It Work?

joint-venture

As a small business owner, you need a collaborative mindset to succeed. You need to develop solutions with employees, business partners, and investors on a regular basis. Sometimes, you might have a great business idea that requires expertise or resources from another individual or company.

In this case, you might consider entering into a joint venture with that individual or company? What is a joint venture and how does it work? What are the possible benefits (and risks) of this kind of arrangement? We’re here to help.

In this guide, we’ll explain how a joint venture works, discuss the benefits and risks—plus, we’ll review a joint venture compares to other types of business entities, as well as how to start one for your business.

How a Joint Venture Works

Expanding upon our joint venture definition above, this type of agreement allows you to come together with one or more other individuals or businesses to carry out a specific project. Joint ventures are particularly common in the real estate, media, and technology sectors.

When it comes down to it, business owners enter into joint ventures to access new markets, tap into complementary skill sets, or combine resources. The concept of a joint venture can be confusing because there’s a degree of collaboration and independence.

Two or more people or companies come together in a joint venture for a specific purpose. However, the parties don’t have any legal responsibilities to each other beyond the scope of the joint venture.

Characteristics of a Joint Venture

Generally, a joint venture consists of each of the following characteristics:

  • The parties undertaking the joint venture are legally independent, with the exception of the work they do together during this collaboration.
  • The parties set out to accomplish a specific, mutually beneficial goal.
  • Both parties contribute resources, share ownership of the joint venture’s assets and liabilities, and share in the implementation of the project.
  • The joint venture is temporary (but can be short or longer-term), dissolving once the goal is reached.

Overall, the key to this arrangement is that both parties contribute to it and share in the opportunities and risks.

This being said, however, the contributions don’t need to be equal. For instance, one party might manufacture the product, and the other party might offer a distribution channel. One party might offer 70% of the money, while the other might bring just 30%.

No matter how you split contributions and profits though, each party is fully liable for anything that might go wrong with the joint venture.

As an example, let’s say two real estate developers launch a joint venture to build an apartment building. A bystander gets injured by construction debris that one of the developers leaves behind. Under the law of every state, both developers will share fully in the liability if the bystander sues, even though only one was responsible for the accident.

The only way to eliminate this shared liability is to form a legally separate entity for the joint venture (which we’ll explain below). Although a joint venture doesn’t require that you form a separate entity, many businesses choose to take this route.

Joint Venture Agreement

The terms of a joint venture should be documented in a written joint venture agreement. Although a written contract isn’t legally required to establish a joint venture, it’s the best way to ensure that each party is committed to the shared effort and knows what is expected of them.

joint-venture-agreement-sample
This is the first page of a joint venture agreement template created by the SBA. Image source: SBA.gov

The contract should specify what each party will contribute to the joint venture, each party’s rights and duties, and how much each party will profit from the venture, similar to a partnership agreement.

Overall, just like any type of business collaboration, without a written agreement, joint ventures can fall apart due to disagreement between the parties, and therefore, it’s worth taking the time to draft and agree upon a contract from the beginning.

Joint Venture Examples

Joint ventures can be useful in any situation where distinct companies have complementary resources and a shared goal. The examples of joint ventures you’ve read about might have been two mega corporations coming together, but small business owners can benefit from this type of arrangement, as well.

According to Washington, D.C.-based business attorney Joy R. Butler,

“If you think a joint venture is the exclusive territory of Fortune 500 companies, think again. Joint ventures offer the option of pooling resources with others, so you don’t have to go it alone. Your joint venture might be as straightforward as sharing a customer list for a combined marketing campaign… or providing original content for a website.”

Here are some joint venture examples:

  • Two mobile phone companies agree to share their network.
  • A transportation provider and network provider join forces to provide WiFi on the transportation platform.
  • Multiple real estate developers work together to build a shopping complex.
  • A restaurant teams up with a big distributor to get their products into supermarkets nationwide.
  • Two car companies pair up to conduct research about fuel efficiency.

These examples are all inspired by real-life joint ventures.

For instance, BMW and Toyota formed a joint venture in 2015 to develop a vehicle powered by hydrogen fuel cells.[1] And back in 2009, Vodafone and Telefónica joined hands to share their mobile network infrastructure across parts of Europe, a deal that allowed both companies to save millions.[2]

Joint Venture Alternatives

Although joint ventures may seem similar to other types of business arrangements—and sometimes the term “joint venture” is used interchangeably with terms like “partnership,” joint ventures are unique.

With this in mind, it’s important to understand how joint ventures differ from other business arrangements:

Joint Ventures vs. Partnerships

A general partnership is a specific type of business structure where two or more people govern a company together. The partners share in the profits and losses of the business.

Unlike a joint venture, a partnership is typically designed to last indefinitely. Joint ventures are usually temporary and initiated for a specific project, though they have more permanence than a simple licensing or distribution agreement, particularly when larger companies are involved.

However, there are some similarities between joint ventures and partnerships, the main one being liability.

“A joint venture is similar to a partnership, but courts typically distinguish between them by finding that joint ventures are usually for one single project or transaction, whereas partnerships typically are longer-lived,” explains Professor Michael Molitor of Cooley Law School at Western Michigan University. “But in any event, whether it is a partnership or a joint venture, the partners or joint venturers will be personally liable for the business’s debts.”

Joint Ventures vs. Franchises

In a franchise, the parent company grants a license to run a business using the parent company’s name, brand, and operating methods—some examples include McDonald’s, Subway, UPS, and other low-cost franchises.

Usually, a franchise is a long-term arrangement, and the franchisee pays an initial fee to the franchisor for the right to operate the business. Additionally, the franchisor exerts a certain degree of control over the franchisee’s business decisions. In a joint venture, neither party is in “control,” and both contribute toward a shared goal.

Joint Ventures vs. Licensing

Licensing is similar to franchising because the licensor permits the licensee to use the company’s name and logo. The licensee manufactures products and pays a royalty fee to the licensor for the rights to use the brand.

With joint ventures, on the other hand, both parties work together to reach a common goal and assume equal liability should something go wrong with the project.

Joint Ventures vs. Mergers or Acquisitions

In a merger, two companies combine to become a single business entity. Sometimes, two companies of similar size come together, like Exxon-Mobil.

Alternatively, a large company could acquire the assets of a smaller company. The purpose of a merger is usually to capture new market share, and an acquisition is often used to buy out a smaller competitor.

In contrast, the purpose of a joint venture is to achieve a common goal, and each party maintains its independence.

Joint Ventures vs. Qualified Joint Ventures

A qualified joint venture is a partnership that’s run by spouses, each of whom participates in managing the business.

For tax purposes, the IRS allows each spouse to file a Schedule C for their portion of the business income and losses, in the same way that sole proprietors do.

Benefits and Risks of a Joint Venture

Before we explain how to form a joint venture, you might be wondering about the benefits—and the risks—of such an arrangement. This type of collaboration seems simple enough, especially in comparison to the other business arrangements we listed, so, is there a reason why you wouldn’t agree to a joint venture with another business?

In short, there are two sides to consider before agreeing to a joint venture with another business or individual. Let’s start with the possible benefits:

Benefits of Joint Ventures

  • Your business can gain access to markets, resources, people, capital, technology, etc. that you wouldn’t have otherwise.
  • You can reduce competition—especially if you’re working with a direct competitor.
  • By working with another individual or business, you can more easily accomplish a goal or objective that would have been difficult on your own—which hopefully leads to an increase in profits.
  • You may be able to bypass time-consuming business license or regulatory requirements by working with a company that has already met those requirements.
  • You can designate a specific part of your business to work on a joint venture project with another business, without having to completely combine your organizations.

Risks of Joint Ventures

On the other hand, of course, there are possible drawbacks associated with entering into this type of agreement:

  • You may find it difficult to work with the other business and have to sort through disputes.
  • The joint venture could end badly and result in wasted time, effort, money, and resources.
  • The project or goal you’ve taken on through the joint venture could end up failing.
  • You can open yourself up to additional liability and other legal risks by working with another business (especially if you don’t create a separate entity for the joint venture).

As you can see, there are both advantages and disadvantages to forming a joint venture and you’ll want to weigh these points against one another before deciding if this type of arrangement is right for your business.

How to Form a Joint Venture in 5 Steps

As we’ve explained, companies or business owners commonly form a joint venture to access new markets, gain an edge over competitors, or tap into complementary resources. Therefore, if you think this type of arrangement may be a worthwhile opportunity for your business, here are the steps you’ll need to take to form one:

Step 1: Find a partner.

First, finding a joint venture partner (or more than one partner for larger joint ventures) starts with clearly defining your objective. For instance, perhaps you’ve developed a new product but lack wide distribution channels to get it into stores. You can ask fellow business owners what distributors they use and do some independent market research. Then, reach out to different distributors to gauge their interest in a joint venture.

This being said, you should evaluate the people who you’ll be working with both in terms of their skills or knowledge and their cultural fit. Obviously, they must be able to prove the reach of their distribution channels.

However, you should also assess how committed they are to the final goal. Can you trust the people in charge? What’s the financial condition of the company, and what are their financial expectations from the joint venture? Does the firm have any other commitments or conflicts of interest that would hurt this arrangement?

When trying to find a partner, you should be prepared for a lot of negotiation and back and forth in the process of forming your arrangement. You might need to exchange production schedules, customer lists, and other proprietary details with your would-be partner, and they’ll need to share their own information.

To protect the confidential information of everyone involved, it’s a good idea to prepare and sign a mutual nondisclosure agreement.  

Step 2: Choose a type of joint venture.

After you’ve found a partner, your next step will be to structure your joint venture.

As we’ve discussed, there are two ways to do this:

  • Form a separate legal entity for the joint venture, such as a corporation or limited liability company (LLC), with each party having an ownership stake in the new entity; or
  • Operate under a joint venture agreement without creating a separate legal entity. This is called an unincorporated joint venture.

Just as is the case with forming a joint venture itself, there are both advantages and disadvantages to the two structure options.

Forming a separate legal entity for your joint venture is the more expensive and complex option. If you form a corporate joint venture, for example, the joint venture will be responsible for filing and paying its own business taxes. However, having a separate legal entity also provides more legal protection if something goes wrong.

The faster, less expensive option is to get started with a simple contractual arrangement. In this case, the joint venture doesn’t report any profits of its own and doesn’t pay taxes on its own. The profits flow through to the respective parties’ tax returns.

If you’re exploring a joint venture for a narrowly defined purpose where liability isn’t much of a concern, it might be fine to get started this way. For a more complicated joint venture, on the other hand, it’s safest to establish a separate legal entity.

Step 3: Draft a joint venture agreement.

Once again, no matter what type of joint venture you create, you should draft a joint venture agreement that contains all the details of how it will be run. You can start with a joint venture agreement template, like the one shown above, to create your own agreement for your specific arrangement. Depending on the business you’re working with and the risks associated with the joint venture, however, you might also decide to consult a business attorney for assistance.

This being said, at a minimum, your joint venture agreement should contain the following information:

  • The purpose of the joint venture
  • Formation process (i.e. if the arrangement will be a separate entity or established by contract)
  • How the parties will allocate profits and losses, which need not be equal (though an outside claimant is free to sue either or all parties)
  • Each party’s contributions, which need not be equal
  • What duties each party is responsible for to ensure the joint venture’s success 
  • Meeting schedule to decide on important matters
  • Voting rights of each party
  • When the joint venture will end

Overall, when you’re drafting and signing the joint venture agreement, it’s a good idea for both parties to have legal representation as part of the process.

Step 4: Pay taxes.

As with any profit-seeking enterprise, you must pay taxes when you’re part of a joint venture. As we mentioned above, the taxation of your joint venture depends on how the arrangement is structured. 

If you form a separate legal entity, any profits of the joint venture will be taxed based on the entity type. For example, C-corporations pay a 21% flat income tax rate on business profits, and shareholders pay taxes again on dividends. LLCs, on the other hand, are taxed as pass-through entities, which means the business income and losses are reflected on each owner’s tax return.

Unincorporated joint ventures are similar to LLCs in terms of tax treatment. The profits of the joint venture flow through to the parties to report on their individual tax returns, in line with their respective share of the profits as outlined in the joint venture agreement.

If the parties to the joint venture are corporations, then each corporation reports the joint venture income on their corporate tax return. An unincorporated joint venture doesn’t itself complete a business tax return. 

Step 5: Follow other applicable regulations.

Finally, you’ll want to make sure you follow any other regulations that might apply to your joint venture at the local, state, or federal level.

For instance, if you’re “borrowing” employees from either company that is a party to the arrangement, you’ll need an employer identification number (EIN), and you’ll need to follow other labor laws. Depending on which industry your joint venture belongs to, you might need a business license to operate.

And if you’re considering a cross-border joint venture, a host of international regulations come into play that might limit your ability to operate in other countries. 

The Bottom Line

At the end of the day, joint ventures can be beneficial, even critical, to making a business idea a reality when you need someone else’s resources, market knowledge, or skill set to accomplish a specific project. This being said, however, a joint venture also opens you up to risks and liability, particularly if you don’t form a separate legal entity for it.

Therefore, as we’ve discussed, if you decide to enter into a joint venture with another individual or business, it’s important that you understand the possible risks, as well as draft a thorough agreement to help mitigate those risks, in order to put your endeavor on the best path to success.

Article Sources:

  1. AutoNews.com. “BMW Begins Tests of Fule-Cell Car Developed with Toyota
  2. NYTimes.com. “European Carriers Telefonica and Vodafone Will Share Networks in 4 Countries

Priyanka Prakash, JD

Priyanka Prakash is a senior contributing writer at JustBusiness.

Priyanka specializes in small business finance, credit, law, and insurance, helping businesses owners navigate complicated concepts and decisions. After earning her law degree, Priyanka has spent half a decade writing on small business financial and legal concerns. Previously, Priyanka was managing editor at a small business resource site and in-house counsel at a Y Combinator tech startup. Her work has been featured in Inc., Fast Company, CNBC, Home Business Magazine, and other top publications.

Read Full Author Bio
Disclaimer
JustBusiness strives to keep information up-to-date but, at times, information may be different on a product or service provider’s website. Additionally, while we are compensated by some marketing partners, these partnerships do not influence our opinions of the products and services available to small businesses. All partner products and services are provided without warranty from JustBusiness. Please review a product or service provider’s terms and conditions when evaluating such products and services.