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Crafting an alliance can be a difficult task for both lawyers and executives. This is because these two parties have different point of view in structuring an alliance agreement. Lawyer often want to limit risks, and they tend to favor alliances that are narrow in scope and long on contractual detail. However, executives tend to be more concerned with building successful businesses, and they are more focused on growth and demand for broad-based alliances with running room for scope of expansion.

Companies entering an alliance are often concerned about their share of economic ownership in a venture as:

A desire to maximize financial rewards The power in controlling or influencing critical

venture decisions

Many studies show that many ventures fail because of unclear decision-making right. However, 50-50 alliance can be unfavorable as both partners will have equal influence where the managing board of is composed of an equal number of directors from each corporate parent.

Yet, 50-50 alliance: 1. Has a higher successful rate than those with uneven

ownership2. Has a longer life span than those life span than those with

uneven ownership3. Partner are more likely to work harder4. They are typically more independent of the parents than

are majority-minority deals.

Lawyers usually do not recommend 50-50 joint ventures but recommending the client take majority position and management control in order to ensure clear decision power while also protecting the parent’s interests. However, when the ownership is split 50-50, lawyer will attempt to protect parent interests by drafting a detailed joint venture contract specifying that both partners will have equal seats on governance board.

The joint venture CEO will be given day-to-day operating responsibility, which the board will have to power to reject over a list of key decisions, including:

Acquisitions or divestitures The annual budget Capital expenditures in excess of a specified amount Strategic plans Changes in product or market scope Transfer pricing to and from the parents Appointment of the top two to five officers of the venture Designation of auditors

Most executives focus more on the decision-making control, for instance, by identifying a few key issues and agreeing how each will be resolved before the agreement is signed, but still there are some executives who try to maximize the ownership.

Since clear decision making lies at the heart of successful alliances, both partners can derive substantial benefits from combining the best of legal and business best practice. The ideal approach contemplates using five mechanisms:

1. Separate economic control from decision-making control.2. Seek the casting vote or veto power on certain decisions.3. Agree in advance on ten to fifteen key decisions.4. Develop a decision-making map.

5. Create conflicts resolution mechanisms.

1. Separate economic control from decision-making control.Normally, it can be assumed that economic control (what percentage of the venture the firm own) will be the same as decision-making control.

For example: In the energy industry, one consolidation joint venture

has a 65-35 split in terms of economic ownership but operated as a 50-50 partnership on all decision.

A joint venture in the office equipment business was 50-50 in economic control, but one partner operated the alliance and controlled all major decisions.

2. Seek the casting vote or veto power on certain decisions.It is possible to protect parent interests simply by having real influence over one or two decisions. By focusing on the control on a few decisions rather than control of the entire venture, firms will be more flexible in deal making and more successful in their alliances.

For example: One leading international oil company signed a 50-50 joint

venture in the Indian market after concluding that a casting vote on capital expenditures was enough to protect its interests.

Firms have focused on decisions that involve changed in the basic venture goals, quality control, and regulatory and fiduciary.

3. Agree in advance on ten to fifteen key decisions.

Sometimes it is both possible and advisable to reach agreement of the key factors that associated with capital expenditure plan before ever forming the venture, such as investments in product development, manufacturing, and new markets, for the first several years.

In scripting certain decision, both partners should uncover potential areas of conflicts which will help to speed up decision making process once the alliance is operational.

4. Develop a decision-making map.

Smooth decision making depends on a clear understanding of role in different decision. Partners should consider developing a decision-making protocol. This protocol will spell out which decision makers (e.g. JV CEO, JV board, and so on) will be involved in which alliance decisions (e.g. annual budgeting, spot discount to customer) and the nature of the involvement (e.g.

proposal, consult, decide) in those decisions.

5. Create conflicts resolution mechanisms.

Partners should include opt-out or wild-card provisions in the alliance agreement to avoid or resolve conflict after it rises. These are some decision making strategies that may prevent termination:

The JV agreement might allow one partner to fund investments while diluting the other’s ownership stake.

It might allow one of the partners to take on the activities within the initial scope of the alliance if the other parent does not empower the alliance to do so.

The alliance might be allowed to buy crucial inputs or sell its output on the open market if the parents fail to reach agreement on transfer prices.

The most basic level are a “newco” joint venture and a non-equity (contractual) alliance without new entity is created.

Joint venture is favored when the partners look for deep combination of tangible assets (factories, equipment, and technology).

Joint venture takes some time to form, start up, restructure, and undo. There are expected to last for several years and preferred when the alliance is stable.

On the other hand Non-Equity alliances are favored when

planned integration is less deep and it is generally center around intangible assets (ideas, brands, and so on). It is hard to value and often use in fluid situations or in short-term.

Lawyers tend to concentrate on four dimensions: liability, governance, tax, and regulation.

Traditionally, the main concern has been liability The concern about liability leads the company

favored joint venture form (corporate, limited liability, or limited partnership) which limit the company’s firm liability to the amount of its venture investment.

On the other hand, general partnership or non-equity alliance possibly will expose the assets of the corporate parent to the liability of the alliance.

Partners can attain limited liability even if they choose contractual joint venture or general partnership form. ◦ For example, if the partners choose the

contractual form, they can form new corporate subsidiaries if there are sufficiently capitalized and the venture participants stick to corporate formality then the corporate shield will protect the partners.

Management structures can be different from each other due to its entity◦ For example, partnership is managed by general

partners; a joint venture is managed by elected officer and there is overseen by a board of directors.

◦ Moreover, if the partners of 50-50 want to govern the joint venture with a group of four people, they can establish a corporation with a four-member

board of directors.

The key tax question is that whether the entity is taxed as a corporation or partnership.◦ For corporations, the owner will be subjected to

double taxation because there income will be taxed not when it earned by joint venture, but also when it distributed to the shareholders.

◦ On the other hand, for the partnership entity will not be subjected to double taxation, but it will be taxed at the partner level. These tax and corporate laws are being used in US only.

Partnership entities are taxed with more flexibility than the corporation due to the allocation of gains or losses.

For example, in the agreement may states that, one party will receive 50 percent of gains that are generated by the partnership, but 99 percent of the losses.

A venture partner may look for merger the joint venture tax or accounting purposes.

If the partner owns an 80 percent or greater equity interest in the venture it should be able to consolidate for tax purposes.

If the partner owns more than 50 percent equity interest it should be able to consolidate for accounting purposes.

Payments from a venture to the venture parent company might be treated differently for tax purposes. It’s depends on whether the joint venture is a corporation, limited liability company or partnership.

The formation is not reportable transaction when the companies are non-equity alliance, joint venture that is a general partnership, limited partnership, or limited liability partnership.

On the other hand, the formation of a corporate joint venture is reportable.

Executive have to spend more energy making a choice because they faced with many alternative structure.

Therefore, the partners should be flexible in terms of making choices and also help to consider the alternatives that will help them accomplish the business goals.

These are question that the executive should pay attention to:

Do they want an alliance that is an autonomous business or does the success of the alliance depend on integrating parent assets?

Do the parents plan to make additional capital investment?

If successful, will the alliance last for three or more years?

Is one partner likely to sell its interest to the other partner or a third party, or will the venture be spun off to public investor?

Step1: Concerns about the structure that should be address- For Example, Management or possibility of spin-off.- It provides benefit by helping the executive to determine whether the partner should form separate entity and how to govern the entity.

Step2: Lawyer should be asked to identify and look for the benefit of governance, tax regulatory and liability concerns.

Step3: Have to together to generate answer. The answer must address the strategic and managerial concerns to the executive and tax, liability and regulatory issues to lawyers

As stated above, the lawyers always want to make the scope narrow in order to reduce the risk that will occur in the future. For example, one US manufacturer had made a big contract signing, lasting for 20 years, with a single company in the region. It made the royalty fees as the percentage of revenue. So, when the partners perform not that well, the arrangement cannot be changed. The solution is that limiting the scope, signing the nonexclusive contract, and setting a short term.

However, there are some drawbacks in narrowing down the scope. First, it can interfere with the ongoing venture development if the license is too restrictive. Secondly, narrowing down the scope means that the alliance will use the resource of the parents in operation, so it will be a conflict in transfer pricing. Finally, it will limit the abilities of the alliance.

The executives seem to prefer the broader way than that of the lawyers. Their view is that they like to run the business on their own, but with the parent company supports. Even though the narrow scope can reduce risk, the likelihood in alliance will be reduced as well. There is a study showing that 65% of alliances facing the problems in the first year. Therefore, the best way is to narrow down the scope first and then just expand it after. This seems to be easy but it is actually time-consuming.

There are five ways to succeed in both views. Alliances should create growth and companies should select partners that are not competitors. Establishing the exclusive agreement when necessary is also important. They should anticipate the change in scope and negotiate them in advance.

1. Create Room for Growth – the partners should reduce the conflict in the business by giving the alliance the scope to grow. They should give time to the alliance and also restrict some right to engage in activities in that time.

2. Select Partner That Are Not Competitors – Collaborating with direct competitors is not the best way to succeed in business. There is the case that the company joining with the competitors. It is more likely to be failed more than succeed.

3. Establish Exclusive Arrangement Only when Necessary- partners should link the exclusive arrangement with the scope with the exclusive arrangement to performance requirements.

4. Anticipate and Negotiate Changes in Scope in Advance- partners should agree on the condition of the scope that will be changed.

5. Define How Parents Will Use Technology Created by The Alliances- there are many ways to do this, by geographic area, product category, or end-user customer segment.

There are many questions after structuring the alliances in valuation like how much each partner’s contribution are worth. This question is so important and complex

The lawyer view is to minimize the use of resource of the firm and maximize the share of profit in the future.

Some executives are more likely to advocate valuation solutions that create strong alliance.

But executives also understand that creating strong alliance makes sense only if the result is consistent with the goals of the company that is maximizing shareholder value for the parent company.

Hence, executives understand the value of careful analysis and aggressive negotiation on behalf of the patent.

They might provide a generous valuation to certain partner’s assets in order to create benefits such as partner trust. Executives may also be quiet willing to value assets (or set transfer prices) on favorable terms for alliance.

Executives desire to develop a strong alliance and the lawyer’s advocacy on behalf of the patent both have their place.

The real concern in revolving valuation issues is that it is difficult for dealmakers to advocate the alliance and at the same time negotiate on behalf of the parent.

Each company would have separate negotiating team, a group of executives and lawyers assigned to protect parent interest and analyze the alliance from the parent’s perspectives.

A third team would consist of executives from both sides. Its role is to protect the interests of the alliance, to develop a business plan and determine how the alliance can maximize synergies, including resource requirements such as cash, assets, technology and management.

Discussions about value and capital contributions are likely to be adversarial and disruptive, especially if these negotiations take place before the benefits of alliance are established and trust is built between the partners.

An alliance is rarely a permanent arrangement. McKinsey’s analysis shows that average life span of a joint venture is about seven years, with more than 75 percent of terminated joint ventures acquired by one of the partners. Given these statistics, even partners with a high degree of confidence in the longevity of their alliance should consider exit provisions to protect their interests.

Lawyers recognize the need to negotiate exit clauses and will almost always insist that these clauses be included in the alliance agreement. They will ask their clients to identify the events that will trigger a right to exit.

Lawyers will also ask their clients to discuss how the exit should be made once an exit right is triggered.

They may recommend that this transfer right to be subjected to a right of first refusal, under which the non-selling partner would have an option to acquire the interests of the selling partner before the selling partners may transfer its interest to third party. 

Finally, good lawyers will ask their clients to focus on termination-related valuation issues. If the partner is going to sell its interest to the alliance or other partners, what price should be paid?

Executives tend to approach exit provisions differently. Many want to defer detailed discussion on the grounds that such discussions can reduce trust

Executives may want to avoid discussion of exit provision for a second reason because it forces an uncomfortably blunt assessment of whether the parent is the natural buyer or seller of the assets.

Example: If the parent is the natural sellers say, because the business really does not fit the company portfolio but cannot be sold for an attractive price today. This can be embarrassing for the managers running the business.

Executives tend to approach exit provisions differently. Many want to defer detailed discussion on the grounds that such discussions can reduce trust

Executives may want to avoid discussion of exit provision for a second reason because it forces an uncomfortably blunt assessment of whether the parent is the natural buyer or seller of the assets.

Example: If the parent is the natural sellers say, because the business really does not fit the company portfolio but cannot be sold for an attractive price today. This can be embarrassing for the managers running the business.

Given the importance of exit provisions in determining the terminal value of alliance, the partners should consider them in details in the negotiations.

Recognizing the sensitivity of the issue, however, it makes sense to discuss exit provisions after the business team has confirmed the value of the alliance and the overall terms of the deal.

Moreover, it is best if a separate team consisting of financial and legal staff negotiate the exit provisions, using guidance from the business team.

Using this device to set alliance value upon termination has become quiet common in recent years. But it is appropriate only when each partner is just as likely to be the buyer or seller.

It is dangerous for a company that is likely to be the seller to agree to “buy-sell” provisions. Once the alliance is under way, it will be very difficult to conduct an open auction to sell the business.

The partner that is likely to be a buyer will be in a very strong bargaining position, because it will have had the opportunity to meet customers, absorb know-how, evaluate the true economic value of the business, capture much of its synergies, and learn how to operate the venture as a stand-alone theory.

It is often possible to anticipate which of the partners is likely to be the acquirer by looking at how closely the alliance’s business is connected to each partner’s core activity and at the ability of each partner to invest.

It also helps to consider which of the parents controls patents and technology and which of the partners control the customer channels. If the company is likely to be the seller, it should try to negotiate a valuation approach that either locks in the current value of the business as a floor price or sets a future valuation based on a formula.

Both lawyers and executives have much to offer in crafting alliance agreements. Best business practices suggest that some of the typical lawyers concerns

1. The desire to define scope precisely.2. The reactions against 50-50 joint ventures are

overblown. Similarly, the lawyers’ views on such issues as

exit mechanisms and structure can provide significant help to the executives. A good working relationship between the two parts of the negotiating team should increase the likelihood that the resulting alliance will be well designed and successful