A joint venture agreement is a written contract outlining the circumstances of two parties pursuing a business activity or project. This agreement details the arrangement between separate entities (often with interrelated strengths) who combine their resources, capital, and expertise to accomplish a common goal.
Instead of creating a formal partnership or new legal entity, a contractual joint venture (JV) allows the parties to continue filing their tax returns separately yet still reap the financial advantages of a partnership, such as sharing resources and risks.
What to Include
- Parties or Co-Venturers: The two entities that have agreed to work together.
- Financial Contributions: The amount of money, property, and time each co-venturer will invest.
- Management Structure: The people responsible for the venture’s day-to-day operations.
- Purpose: The scope of JV activities and the reasons to join resources and collaborate.
- Profits: How the parties will distribute profits, either based on contributions or another formula.
- Term: Whether the venture is for a limited time or indefinite period.
- Assignment: Whether either party can assign their responsibilities to another entity.
- Confidentiality: Both parties agree to keep all proprietary information confidential.
- Exclusivity: Whether either party can perform business with other entities outside of the agreement.
- Termination: The conditions under which the joint venture will end.
Characteristics of a Joint Venture
Here are some defining characteristics of a joint venture:
- Legal Independence: Both entities are legally independent. They only work together to achieve their desired goal.
- Common Goals: Both parties agree to achieve a specific goal that benefits them.
- Shared Resources: Both parties share ownership of the venture assets, liabilities, and implementation. They both contribute resources, but their contributions might be unequal. For example, one party might contribute 60% of the necessary resources while the other party offers the remaining 40%. The parties can allocate profits accordingly.
- Temporary Relationship: The arrangement is usually short-term, ending once the parties reach their established business goal.
Why Might a Joint Venture End?
The involved entities might agree to end a joint venture when:
- One company buys the other.
- Market conditions change.
- One company develops new goals.
- The companies’ shared plans don’t apply.
- The companies are taking too long to fulfill their goals.
The Benefits and Risks of Forming a Joint Venture
Explore some of the benefits and risks of forming a joint venture:
Benefits
- Larger companies can gain access to research materials from newer companies working on innovations.
- Smaller companies can benefit from larger companies’ market presence.
- Domestic companies can learn about the social reality of a local area from a foreign company.
- Foreign companies can gain new relationships and expertise from domestic companies.
- Companies can experiment outside of their core business to develop new products or services.
- Companies can merge their wealth of knowledge in a specific niche.
Risks
- The involved parties may have unclear business objectives if they have poor communication.
- The parties may experience misunderstandings due to differences in management styles or culture.
- One party may bring a disproportionate amount of value compared to the other, resulting in an asymmetrical business relationship.
- The parties may not have the same viewpoints on how to share and distribute profits.
Joint Venture Agreement vs. Partnership
Without a joint venture agreement, the law may assume your collaboration is a legally recognized partnership and apply the default state laws for tax and liability purposes.
Here are just a few of the differences between a venture and a partnership:
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How to Form a Joint Venture
Explore the steps to forming a joint venture so you can decide if this path is right for your existing business:
Step 1 – Find a Suitable Partner
Find a suitable partner who complements your company’s existing structure. For example, suppose your business developed an innovative new product, but you don’t have adequate distribution channels. You might look for a business partner with established channels and a good industry reputation.
Contact different distributions to assess their interest in partnering with you. Ensure you trust the company leaders you choose by evaluating their skills, industry expertise, and cultural fit. Conducting this due diligence can increase your confidence in your chosen partner.
Here are some elements to consider about a potential partner:
- The company’s financial situation
- The company’s expectations from the venture
- Other partnerships the company may already have (conflicts of interest)
- The company’s expressed commitment to your proposed goals
Step 2 – Choose a Type of Joint Venture
Once you find a partner, you can negotiate with them to decide on the type of joint venture you’d like to start. Consider the two types:
- Contractual joint venture: A contractual joint venture is a business arrangement you enter with another company in which you both continue to operate separately. You only combine resources to strive toward common goals.
- Equity joint venture: An equity joint venture is a business arrangement in which you and another company create a new entity under which you conduct business. Each party will hold equity in the new company, and the new company will operate separately from the two parties’ businesses.
Creating a separate legal entity is more complex and expensive, but it can offer more legal protection if an issue arises. A simple contractual agreement allows for more flexibility, as the parties don’t have to pay taxes and report profits for an entirely new entity. Instead, the profits flow through to each party’s business.
Step 3 – Draft a Joint Venture Agreement
Use our builder to start drafting your own document. Tailor it to your and your partner’s needs and preferences. Negotiate with the other party to ensure you detail mutually beneficial terms.
While drafting and signing this document, you should have legal representation for each party. A third party with legal knowledge for each entity can ensure the document is fair and legally enforceable.
Step 4 – Pay Taxes
No matter what kind of profit-seeking business you have, you must pay your share of taxes. The same applies to owners of joint ventures. The taxes you pay for your joint venture will depend on how you structure your arrangement.
If you and your partner create a separate entity, all its profits will be subject to taxation based on the business type. For example, C corporations pay a tax rate of 21% on profits they earn. Alternatively, limited liability companies (LLCs) account for business losses and income on each owner’s individual tax return.
Contractual joint ventures don’t file their own tax returns. Instead, their tax responsibilities flow to each party’s respective entity.
Step 5 – Abide by Other Regulations
Ensure you abide by federal, state, and local laws for your joint venture’s activities. For example, if you plan to use the labor of another entity’s employees as part of your joint venture agreement, you must follow applicable labor laws.
Depending on the industry to which your joint venture belongs, you might also need to acquire a business license or permit to legally operate.
