The hidden logic for holistically structuring exit terms in joint ventures.
Tracy Branding Pyle
FEBRUARY 2022 — All joint ventures come to an end. The median lifespan of a joint venture is 10 years — a time frame that has remained largely unchanged for decades. Some 65% of JV s end with the venture being bought out by one partner (Exhibit 1). The other 35% end in other ways, such as being unwound, dissolved, sold to a third party, or taken public.
" * " indicates required fields
© Ankura. All Rights Reserved.
Because JV s are not permanent, potential partners must think through the terms of the inevitable separation. Unfortunately, exit negotiations are often pushed to the eleventh hour and not fully considered. Too often, potential partners do not have a clear view on the exit rights they want, what rights are reasonable to give their partner, and how these rights will play out under different future scenarios.
This white paper will shed some light on how companies should address exit terms in joint venture negotiations. Specifically, we outline the costs of getting exit wrong, explain why exit terms are difficult to structure, and walk through a five-step process for defining an approach to exit in JV agreements. Our perspectives draw on benchmarking data on the exit provisions in 81 JV agreements and our experience structuring and restructuring hundreds of JVs. This paper is part of an ongoing series on JV dealmaking intended to bring structure, data, and perspectives to negotiating and structuring JV legal agreements. [1] For additional discussion on at-will exits, please see the 2022 Ankura White Paper: At-Will Exits in JV Agreements: Eject Buttons Often Come with Strings Attached, by Edgar Elliott, Tracy … Continue reading
Getting exit terms wrong in joint ventures can be costly. Poorly structured exit provisions can cause significant time delays — to get out of an underperforming or non-strategic business, to monetize initial investments and access trapped capital and other assets, or to execute broader strategic moves. Poorly structured exit provisions can also exacerbate partner animosity, trigger litigation, cause reputational damage, spawn high legal fees, and negatively impact exit prices. All destroy shareholder value.
Many JV exits illustrate these costs. Consider a 50:50 media JV in India between a global player and a local firm. The agreements committed each partner to use the JV as its exclusive vehicle in India for certain high-growth broadcast and streaming-related services. The business was underperforming in the fast-growing market and needed investment to maintain market share, let alone grow relative to competitors. However, the Indian partner was unable to invest, was unwilling to take on debt, and did not approve investments proposed by the partner or management team. The global firm made a fair offer to buy out its partner, but this offer was rejected. Perhaps the Indian partner realized the value to the global partner of owning the JV outright was greater than that implied by an external “fair market” valuation – a situation not uncommon for savvy partners to realize. In the end, the global partner paid a price 40% above fair market value to buy out its partner and regain its freedom to operate in India, a key growth market.
Or consider Fuji Xerox, a multibillion-dollar joint venture between Xerox and Fuji Photo Film, founded in the 1960s as a way for Xerox to access the Japanese market. In a complicated turn of events, when Xerox was in financial distress in the last decade, its potential attractiveness to a third-party buyer was impeded by exit terms in its Fuji Xerox joint venture. Specifically, the Fuji Xerox venture agreements provided that if Xerox was acquired by a third party, Xerox lost certain governance rights in the JV as well as the right to use critical intellectual property and trademarks in Asia for multiple years. This led Xerox to eventually agree to be bought by Fuji as other buyers were less interested in purchasing Xerox given its intellectual property in the Asia-Pacific market was tied up in the JV. Activist investors filed suit, and eventually Xerox terminated the merger agreement, which in turn led to Fuji filing suit against Xerox regarding such termination. Fuji and Xerox then negotiated a separate exit for Fuji Xerox under which Xerox sold its stake in the JV to a Fuji subsidiary. This debacle involved lengthy and expensive litigation among JV partners and shareholders that destroyed significant value.
Structuring robust exit provisions in joint ventures is challenging for all sorts of reasons. This is not just because partners often wait to discuss these terms until late in the game when there is pressure to sign the deal, though that certainly can be a contributing factor. It is also not simply because partners are excited about the momentum of the deal and do not want to detract from the romantic view of a new partnership with a potentially contentious debate about a future divorce, though this, too, can play a role.
It is also challenging because JV exit terms are inherently complex. Such terms are spread across many parts of the JV agreement, often appearing in sections related to transfer of interests, termination, breach of agreement, covenants, other provisions, and even in commercial agreements outside the shareholders’ agreement. Similarly, for senior executives and other non-lawyers, the combination of exit triggers, exit mechanisms, and potential valuation approaches may seem almost limitless. This can make exit terms hard to track and view holistically. The challenges multiply, and potential options proliferate, when a potential JV has more than two partners.
Adding to the challenge is uncertainty about the market or technology. JV s are often used in frontier businesses — i.e., new technology domains, new market segments, and new countries — for which the future is much harder for firms to predict than in core existing operations in which mergers and acquisitions (M&As) and organic investments tend to be favored. This makes it difficult to know when, why, or by whom an exit may be needed, and difficult to know what exit provisions will benefit or harm a particular partner.
In sum, structuring joint venture exit terms is complicated — and it requires strategic thinking that combines business and legal skills. But it is not five-dimensional chess. There is a way to think about exit in a structured way that allows dealmakers and lawyers to engage jointly, fully, and thoughtfully in shaping exit principles and contractual terms, and paving the way for smooth off-ramps in joint ventures.
A five-step process can help organize and simplify the thinking on JV exit terms (Exhibit 2). These five steps are: (1) review strategic considerations affecting exit, (2) define exit triggers, (3) determine the best exit mechanisms for each trigger, (4) define valuation approaches, and (5) address post-exit needs. Each step is detailed below.
