It is the 21st-century way of doing business, especially in the global economy. A large U.S. company eager to develop cutting-edge technology will find a small, expert partner to start a joint manufacturing operation in Shanghai.
Even competitors may find that to maximize profits for both in a specific niche, it is useful to form a joint venture or a strategic alliance.
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Nortel and IBM have a joint venture. So do Sony and Ericsson. And last week, there was news of a potential joint bid by General Electric Co. and Financial Times publisher Pearson plc to take over Wall Street Journal publisher Dow Jones & Co.
But it’s not just big international firms handling matters like these. As joint ventures and strategic alliances become increasingly common, lawyers in Rhode Island are likelier than ever to tackle these complex deals in their own practices.
So at the Rhode Island Bar Association’s annual meeting this month, three partners at Edwards Angell Palmer & Dodge – Brendan J. Radigan, Mark N.G. Hichar and Patricia A. Sullivan – and Joseph B. White, a partner at Nixon Peabody, used a hypothetical case to illustrate for their colleagues the benefits, perils and key questions involved in such deals.
Smallco, a local tech firm that’s a market leader in IT for law enforcement – especially software – wants to team up with Bigco, a Texas-based, publicly traded, multinational corporation that has a division that competes with Smallco but is strongest in hardware.
Together, they want to develop next-generation technology for the law enforcement niche. Leaders of both companies have met and hashed out the basics of the deal: They plan to continue to market their individual products until the new technology is ready, at which point they will both switch to their joint creation. And they will continue to support their old customers. But moving forward, they will develop a joint clientele.
The case illustrates a key motivation for joint ventures and alliances, Radigan said: “to combine synergies,” as he put it, to make the most of each partner’s strengths and fill in the gaps in each of them. Smallco has the software expertise and the knowledge of its field; Bigco has the international reach, large-company resources and hardware expertise.
Yet the pairing is also lopsided, which is not uncommon, either, Radigan said.
“Smallco’s life as a corporation depends on the success of this joint venture, whereas Bigco, as a $23 billion corporation, may not really care,” he noted.
And in launching a joint venture, both partners are entering “a very open-ended relationship,” he said, that involves “a lot of risk” and could change dramatically over time.
To set up a joint venture that protects both parties properly and maximizes the chances of success, Radigan said, requires “a great deal of thought and care.”
When clients come to him with plans like these, he said, he starts by asking them a series of questions: How well do they know the other party? Do you trust the company? What is its track record with joint ventures? How stable is management? How balanced is each parties’ bargaining power? What would happen if one party’s interests in the venture were sold? Have they considered alternatives, such as an acquisition?
And fundamentally, “Have you considered everything that can go wrong?”
“That’s your job as a lawyer,” Radigan told his colleagues. “Often there’s a certain dynamic in these negotiations where parties early on are quite happy and enamored with each other and really don’t want to think about the bad side, the downside, the things that can go wrong. And inevitably things do go wrong, and they need to be anticipated.”
Setting up a new, separate legal entity for the joint venture – preferably a limited liability company or a corporation – is one important strategy to protect both parties, Hichar said. That’s “impractical” if it’s a very short-term endeavor, because it costs money and is onerous, but for the longer term – in Bigco’s and Smallco’s case, three years – it is worth it.
If the companies normally compete with each other, Sullivan said, it is crucial to bring in an antitrust law expert from the start, well before all the documents are drafted, confidential information is exchanged, or announcements are made.
“Really look hard at regulatory requirements, and not just in the United States,” she said, noting that companies doing business in Europe, Australia and many other places need to ensure they don’t get in trouble with anyone.
It is also essential to avoid sharing competitively sensitive information until it’s clear it will be OK, Sullivan said – and to the extent it is shared, it might be best to limit access to it, to for example, only executives who are not involved in designing and selling the products that compete. Or, hire a third party to review the information.
White stressed the importance of signing, early on, a confidentiality agreement and an agreement not to solicit each other’s customers and/or employees. And it is probably a good idea not to share the names of your top five or so accounts, he said.
Other key documents include a letter of intent – the first chance the lawyers will get to outline the terms of the deal – and an agreement on the financial aspects of the venture, which will help both parties focus on their respective contributions and expected revenue.
There also should be a clear definition of the scope of the venture, White said, including the activities involved, the time frame, etc. But avoid a very narrow scope, he said, because companies have found it reduces the likelihood of joint ventures’ success.
Also make sure to set up parameters for the resolution of disputes, Hichar said. One approach considered by Bigco and Smallco was to have an escalation procedure, so increasingly senior executives would address a conflict. That is a good idea, he said. Mediation is also good.
And set up “a very well-drafted, precise set” of provisions ending the joint venture, Radigan said. There should be a way for either side to buy the other one out, for example; an initial public offering might also be envisioned. Or there may be milestones that must be reached, or else either side can bow out.
