Chapter 14
Joint Ventures, Partnerships, Strategic Alliances, and Licensing
Humility is not thinking less of you. It is thinking less about you.
—Rick Warren
Inside M&A: microsoft partners with yahoo! —an alternative to takeover?
Business alliances sometimes represent a less expensive alternative to mergers and acquisitions. This notion may have motivated Microsoft when the firm first approached Yahoo! about a potential partnership in November 2006 and again in mid-2007. Frustrated with their inability to partner with Yahoo!, Microsoft initiated a hostile takeover bid in 2008 valued at almost $48 billion or $33 per share, only to be spurned by Yahoo!. Following the withdrawal of Microsoft's offer, Yahoo!'s share price fell into the low to mid-teens and remained in that range throughout 2010.
Reflecting the slumping share price and a failed effort to create a search partnership with Google, Yahoo!'s cofounder, Jerry Yang, was replaced by Carol Bartz in early 2009. The U.S. Justice Department had threatened to sue to block the proposed partnership between Yahoo! and Google on antitrust grounds.
Microsoft again approached Yahoo! with a partnering proposal in mid-2009, which resulted in an announcement on February 18, 2010, of an Internet search agreement between the two firms. As a result of the agreement, Yahoo! transferred control of its Internet search technology to Microsoft. Microsoft is relying on a ten-year arrangement with Yahoo! to help counter the dominance of Google in the Internet search market. By gaining access to each other's Internet users, both firms hope to be able to attract more advertising dollars from companies willing to pay for links on Microsoft's and Yahoo!'s websites. With Microsoft's search technology believed to be superior to Yahoo!'s, searches requested through Yahoo!'s site will be implemented using Microsoft's search software.
Regulatory agencies in both the United States and the European Union had no trouble approving the proposal because the combined Yahoo! and Microsoft Internet search market share is dwarfed by Google's. Google is estimated to have about two-thirds of the search market, followed by Yahoo! at 7% and Microsoft with about 3%.
Yahoo! could profit handsomely from the deal, since it will retain 88% of the revenue from search ads on its website during the first five years of the ten-year contract. Microsoft will pay most of the costs of implementing the partnership by giving Yahoo! $150 million to defray its expenses. Microsoft also agreed to absorb about 400 of Yahoo!'s nearly 14,000 employees. Ironically, Microsoft may get much of what it wanted (namely Yahoo!'s user base) at a fraction of the cost it would have paid to acquire the entire company.
Chapter overview
For many years, joint ventures (JVs) and alliances have been commonplace in high-technology industries; many segments of manufacturing; the oil exploration, mining, and chemical industries; media and entertainment; financial services; pharmaceutical and biotechnology firms; and real estate. They have taken the form of licensing, distribution, comarketing, research and development agreements, and equity investments. What all of these arrangements have in common is that they generally involve sharing the risk, reward, and control among all participants.
The term business alliance is used throughout this chapter to describe the various forms of cooperative relationships common in business today, including joint ventures, partnerships, strategic alliances, equity partnerships, licensing agreements, and franchise alliances. The primary theme of this chapter is that well-constructed business alliances often represent viable alternatives to mergers and acquisitions, and they always should be considered one of the many options for achieving strategic business objectives. The principal differences in the various types of business alliances were discussed in some detail in Chapter 1 and are therefore only summarized in Table 14.1. This chapter discusses the wide variety of motives for business alliances and the factors common to most successful ones. Also addressed are the advantages and disadvantages of alternative legal structures, important deal-structuring issues, and empirical studies that purport to measure the contribution of business alliances to creating shareholder wealth.
Table 14.1. Key Differences among Business Alliances
A review of this chapter (including practice questions and answers) is available in the file folder entitled “Student Study Guide” on the companion site to this book (www.elsevierdirect.com/companions/9780123854858). The companion site also contains a Learning Interactions Library, which gives students the opportunity to test their knowledge of this chapter in a “real-time” environment.
Motivations for business alliances
Money alone rarely provides the basis for a successful long-term business alliance. A partner often can obtain funding from a variety of sources but may be able to obtain access to a set of skills or nonfinancial resources only from a specific source. The motivation for an alliance can include risk sharing, gaining access to new markets, globalization, cost reduction, a desire to acquire (or exit) a business, or the favorable regulatory treatment often received compared with M&As.
Risk Sharing
Risk is the potential for losing, or at least not gaining, value. Risk often is perceived to be greater the more money, management time, or other resources a company has committed to an endeavor and the less certain the outcome. To mitigate perceived risk, companies often enter into alliances to gain access to know-how and scarce resources or to reduce the amount of resources they would have to commit if they were to do it on their own. For example, in late 2004, General Motors and DaimlerChrysler, the world's largest and fifth largest auto manufacturers, respectively, agreed to jointly develop hybrid gasoline–electric engines for cars and light trucks. Neither corporation felt comfortable in assuming the full cost and risk associated with developing this new automotive technology. Moreover, each company would be willing to contribute the results of its own internal R&D efforts to the joint development of a technology to be shared by the two companies.1
Sharing Proprietary Knowledge
Developing new technologies can be extremely expensive. Given the pace at which technology changes, the risk is high that a competitor will be able to develop a superior technology before a firm can bring its own new technology to market. Consequently, high-technology companies with expertise in a specific technology segment often combine their efforts with another company or companies with complementary know-how to reduce the risk of failing to develop the “right” technology. Evidence shows that such alliances often do result in knowledge sharing between alliance partners.
Examples of technology JVs include the well-known Microsoft and Intel partnership in which the two cooperate to enhance the “Wintel” world, which combines Windows operating systems with Intel microchips. More recently, Chinese battery maker BYD Ltd. and German automaker Daimler AG, a leader in electric car technology, announced a 50/50 joint venture in mid-2010, headquartered in China, targeted at the Chinese electric car market.
Sharing Management Skills and Resources
Firms often lack the management skills and resources to solve complex tasks and projects. These deficiencies can be remedied by aligning with other firms that possess the requisite skills and proprietary knowledge. Building contractors and real estate developers have collaborated for years by pooling their resources to construct, market, and manage large, complex commercial projects. The contribution of Dow Chemical management personnel to a JV with Cordis, a small pacemaker manufacturer, enabled the JV to keep pace with accelerating production.
Reflecting the bureaucratic inertia often found in mega-corporations, large pharmaceutical firms actively seek partnerships with smaller, more nimble and innovative firms as a way of revitalizing their new drug pipelines. Such relationships are also commonplace among biotechnology firms. Small biotechnology firms are in fact likely to fund their R&D through JVs with large corporations, with the larger partner receiving the controlling interest.2
In mid-2006, Nokia, a Finnish firm specializing in wireless communications, and Siemens, a German company with a strong position in fixed-line telecommunications, agreed to pool their networking equipment divisions in a joint venture to develop integrated network products. In early 2009, Walt Disney Studios announced that it had entered a long-term distribution agreement with DreamWorks Studios to utilize its marketing skills to distribute six DreamWorks' films annually.
In 2009, Italy's Fiat acquired a 35% stake in U.S. car maker Chrysler in exchange for sharing products and platforms for small cars with Chrysler. The deal was designed to help Fiat boost its sales volumes to compete in the global auto market and to enable Chrysler to enter more foreign markets, gain access to fuel-efficient technology, and expand its small-car offering.
Sharing Substantial Capital Outlays
As the U.S. cellular phone market became saturated, wireless carriers fought tenaciously to increase market share in a maturing market. Increased price competition and the exorbitant costs of creating and supporting national networks contributed to consolidation in the industry. Regional and foreign carriers were encouraged to join forces to achieve the scale necessary to support these burdensome costs. Vodafone and Verizon Communications joined forces in 1999 to form Verizon Wireless. SBC and Bell Atlantic formed the Cingular Wireless partnership, which acquired AT&T Wireless in early 2004.
Securing Sources of Supply
The chemical industry is highly vulnerable to swings in costs of energy and other raw materials. Chemical companies such as Dow, Hercules, and Olin have used JVs to build new plants throughout the world. When shortages of raw materials threaten future production, these firms commonly form JVs to secure future sources of supply. Similarly, CNOOC, the large Chinese oil concern, has been busily trying to invest in oil and natural gas assets in highly diverse geographic areas to obtain reliable sources of supply. CNOOC's efforts have ranged from outright acquisition (e.g., the attempted takeover of Unocal in the United States) to long-term contracts (e.g., Canadian tar sands) to joint ventures in various locations in Africa (e.g., Sudan and Kenya).
Cost Reduction
In the 1980s and 1990s, retailers and financial services, firms outsourced back-office activities, such as information and application processing, to IBM, EDS, and the like. Others outsourced payroll processing and the management of benefits to such firms as ADP. More recently, firms entered so-called logistics alliances. These alliances cover both transportation and warehousing services and utilize a single provider for them.3
Companies also may choose to combine their manufacturing operations in a single facility with the capacity to meet the production requirements of all parties involved. By building a large facility, the firms jointly can benefit from economies of scale. This type of arrangement is commonplace within the newspaper industry in major cities in which several newspapers are engaged in “head-to-head” competition. Similar cost benefits may be realized if one party closes its production facility and satisfies its production requirements by buying at preferred prices from another party with substantial unused capacity. Other examples of competitors combining operating units to achieve economies of scale include Sony and Ericsson combining their mobile-handset units to compete with Nokia and Motorola in the late 1990s, as well as Hitachi and Mitsubishi forming an $8 billion-a-year semiconductor joint venture in 2000. In 2005, Canon and Toshiba created a new manufacturing operation to satisfy their requirements for SED displays for TVs by investing a combined $1.8 billion in a JV.
Gaining Access to New Markets
Accessing new customers is often a highly expensive proposition involving substantial initial marketing costs, such as advertising, promotion, warehousing, and distribution expenses. The cost may be prohibitive unless alternative distribution channels providing access to the targeted markets can be found. For example, in late 2006, eBay granted Google the exclusive right to display text advertisements on eBay's auction websites outside the United States, with eBay sharing in the revenue generated by the advertisements. Earlier that same year, Yahoo! signed a similar agreement with eBay for sites within the United States. Both Google and Yahoo! were able to expand their advertising reach without having to make substantial additional investments.
A company may enter into an alliance to sell its products through another firm's direct sales force, telemarketing operation, retail outlets, or Internet site. The alliance may involve the payment of a percentage of revenue generated in this manner to the firm whose distribution channel is being used. Alternatively, firms may enter into a “cross-marketing” relationship, in which they agree to sell the other firm's products through their own distribution channels. The profitability of these additional sales can be significant because neither firm has to add to its overhead expense or to its investment in building or expanding its distribution channels.
Globalization
The dizzying pace of international competition increased the demand for alliances and JVs to enable companies to enter markets in which they lack production or distribution channels or in which laws prohibit 100% foreign ownership of a business. Moreover, a major foreign competitor might turn out to be an excellent partner in fighting domestic competition. Alternatively, a domestic competitor could become a partner in combating a foreign competitor.
The automotive industry uses alliances to provide additional production capacity, distribution outlets, technology development, and parts supply. Many companies, such as General Motors and Ford, take minority equity positions in other companies within the industry to gain access to foreign markets. By aligning with Lenovo Group as a strategic partner in 2007, IBM has an opportunity to enlarge dramatically its market share in China. More recently, Nissan and Daimler announced in 2010 the formation of a partnership in which the firms would share the cost of developing engines and small-car technologies with projected savings totaling $5.3 billion. As part of the arrangement, each firm will buy a 3.1% stake in the other.
A Prelude to Acquisition or Exit
Rather than acquire a company, a firm may choose to make a minority investment in another company. In exchange for the investment, the investing firm may receive board representation, preferred access to specific proprietary technology, and an option to purchase a controlling interest in the company. The investing firm is able to assess the quality of management, cultural compatibility, and the viability of the other firm's technology without having to acquire a controlling interest in the firm.
Alternatively, a parent intending to exit a subsidiary may do so by contributing the unit to a joint venture and negotiating as part of the deal a put or call option with the other JV partners. A call option gives the partners the right to purchase the unit, and the put option gives the parent the right to sell the unit to the other partners. The price and a time period during which the options may be exercised are determined during the formation of the JV. For example, GE negotiated a put option with Comcast in 2010 when GE announced that it would be contributing its NBC Universal subsidiary to a JV corporation in which Comcast and GE would own 51% and 49% stakes, respectively (see Case Study 14.2 for more details).
Favorable Regulatory Treatment
As noted in Chapter 2, the Department of Justice has looked on JVs far more favorably than mergers or acquisitions. Mergers result in a reduction in the number of firms; JVs increase the number of firms because the parents continue to operate while another firm is created. Project-oriented JVs often are viewed favorably by regulators. Regulatory authorities tend to encourage collaborative research, particularly when the research is shared among all the parties to the JV.
Critical success factors for business alliances
Research suggests that the success of a JV or alliance depends on a specific set of identifiable factors.4 These factors most often include synergy; cooperation; clarity of purpose, roles, and responsibilities; accountability; a “win–win” situation; compatible time frames and financial expectations for the partners; and support from top management.
Synergy
Successful alliances are characterized by partners that have attributes that either complement existing strengths or offset significant weaknesses. Examples include economies of scale and scope, access to new products, distribution channels, and proprietary know-how. As with any merger or acquisition, the perceived synergy should be measurable to the extent possible. Interestingly, successful alliances are often those in which the partners contribute a skill or resource in addition to or other than money. Such alliances often make good economic sense and, as such, are able to get financing.
Cooperation
All parties involved must be willing to cooperate at all times. A lack of cooperation contributes to poor communication and reduces the likelihood that the objectives of the joint venture or alliance will be realized. Not surprisingly, companies with similar philosophies, goals, rewards, operating practices, and ethics are more likely to cooperate over the long run.
Clarity of Purpose, Roles, and Responsibilities
The purpose of the business alliance must be evident to all involved. A purpose that is widely understood drives timetables, division of responsibility, commitments to milestones, and measurable results. Internal conflict and lethargic decision making inevitably result from poorly defined roles and responsibilities of those participating in the alliance.
Accountability
Successful alliances hold managers accountable for their actions. Once roles and responsibilities have been clearly defined and communicated, measurable goals to be achieved in identifiable time frames should be established for all of the managers. Such goals should be directly tied to the key objectives for the alliance. Incentives should be in place to reward good performance with respect to goals, and those who fail to perform adequately should be held accountable.
Win–Win Situation
All parties to an alliance must believe they are benefiting from the activity for it to be successful. Johnson & Johnson's alliance with Merck & Company in the marketing of Pepcid AC is a classic win–win situation. Merck contributed its prescription drug Pepcid AC to the alliance so that J&J could market it as an over-the-counter drug. With Merck as the developer of the upset stomach remedy and J&J as the marketer, the product became the market share leader in this drug category. In contrast, the attempt by DaimlerChrysler, Ford, and GM to form an online auction network for parts, named Covisint, in early 2000 failed in part because of the partners' concern that they would lose competitive information.
Compatible Time Frames and Financial Expectations
The length of time an alliance agreement remains in force depends on the partners' objectives, the availability of resources needed to achieve these objectives, and the accuracy of the assumptions on which the alliance's business plans are based. Incompatible time frames are a recipe for disaster. The management of a small Internet business may want to “cash out” within the next 18 to 24 months, whereas a larger firm may wish to gain market share over a number of years.
Support from the Top
Top management of the parents of a business alliance must involve themselves aggressively and publicly. Such support should be unambiguous and consistent. Tepid support or, worse, indifference filters down to lower-level managers and proves to be highly demotivating. Middle-level managers tend to focus their time and effort on those activities that tend to maximize their compensation and likelihood of promotion. These activities may divert time and attention from the business alliance.
Alternative legal forms of business alliances
As is true of M&As, determining the legal form of a business alliance should follow the creation of a coherent business strategy. The choice of legal structure should be made only when the parties to the business alliance are comfortable with the venture's objectives, potential synergy, and preliminary financial analysis of projected returns and risk. Business alliances may assume a variety of legal structures, including corporate, partnership, franchise, equity partnership, or written contract.5 The five basic legal structures are discussed in detail in this section. Each has its own implications with respect to taxation, control by the owners, ability to trade ownership positions, limitations on liability, duration, and ease of raising capital (Table 14.2).
Table 14.2. Alternative Legal Forms Applicable to Business Alliances
| Legal Form | Advantages | Disadvantages |
| Corporate Structures | ||
| C Corporation | Continuity of ownership Limited liability Provides operational autonomy Provides for flexible financing |
Double taxation Inability to pass losses on to shareholders Relatively high setup costs including charter and bylaws |
| Subchapter S | Facilitates tax-free merger Avoids double taxation Limited liability |
Maximum of 100 shareholders Excludes corporate shareholders Must distribute all earnings Allows only one class of stock Lacks continuity of C corporation Difficult to raise large sums of money |
| Limited Liability Company (LLC) | Limited liability Owners can be managers without losing limited liability Avoids double taxation Allows an unlimited number of members (i.e., owners) Allows corporate shareholders Can own more than 80% of another company Allows flexibility in allocating investment, profits, losses, and operational responsibilities among members Life set by owners Can sell shares to “members” without SEC registration Allows foreign corporations as investors |
Owners also must be active participants in the firm Lacks continuity of a corporate structure State laws governing LLC formation differ, making it difficult for LLCs doing business in multiple states Member shares often illiquid because consent of members required to transfer ownership |
| Partnership Structures | ||
| General Partnership | Avoids double taxation Allows flexibility in allocating investment, profits, losses, and operational responsibilities |
Partners have unlimited liability Lacks continuity of corporate structure Partnership interests illiquid Partners jointly and severally liable |
| Limited Liability Partnership | Life set by general partner Limits partner liability (except for general partner) Avoids double taxation State laws are consistent (covered under the Uniform Limited Partnership Act) |
Each partner has authority to bind the partnership to contracts Partnership interests illiquid Partnership dissolved if a partner leaves Private partnerships limited to 35 partners |
| Franchise Alliance | Allows repeated application of a successful business model Minimizes start-up expenses Facilitates communication of common brand and marketing strategy |
Success depends on quality of franchise sponsor support Royalty payments (3–7% of revenue) |
| Equity Partnership | Facilitates close working relationship Potential prelude to merger May preempt competition |
Limited tactical and strategic control |
| Written Contract | Easy start-up Potential prelude to merger |
Limited control Lacks close coordination Potential for limited commitment |
Corporate Structures
A corporation is a legal entity created under state law in the United States with an unending life and limited financial liability for its owners. Corporate legal structures include a generalized corporate form (also called a C-type corporation) and the Subchapter S (S-type) corporation. The S-type corporation contains certain tax advantages intended to facilitate the formation of small businesses, which are perceived to be major contributors to job growth.6
C-Type Corporations
A JV corporation normally involves a stand-alone business. The corporation's income is taxed at the prevailing corporate tax rates. Corporations other than S-type corporations are subject to “double” taxation. Taxes are paid by the corporation when profits are earned and again by the shareholders when the corporation issues dividends. Moreover, setting up a corporate legal structure may be more time consuming and costly than other legal forms because of legal expenses incurred in drafting a corporate charter and bylaws. Although the corporate legal structure has adverse tax consequences and may be more costly to establish, it does offer a number of important advantages over other legal forms. The four primary characteristics of a C-type corporate structure include managerial autonomy, continuity of ownership or life, ease of transferring ownership and raising money, and limited liability. These characteristics are discussed next.
Managerial autonomy most often is used when the JV is large or complex enough to require a separate or centralized professional management organization. The corporate structure works best when the JV requires some operational autonomy to be effective. The parent companies would continue to set strategy, but the JV's management would manage the day-to-day operations.
Unlike other legal forms, the corporate structure has an indefinite life, since it does not have to be dissolved as a result of the death of the owners or if one of the owners wishes to liquidate its ownership position. A corporate legal structure may be warranted if the JV's goals are long term and the parties choose to contribute cash directly to the JV. In return for the cash contribution, the JV partners receive stock in the new company. If the initial strategic reasons for the JV change and the JV no longer benefits one of the partners, the stock in the JV can be sold. Alternatively, the partner–shareholder can withdraw from active participation in the JV corporation but remain a passive shareholder in anticipation of potential future appreciation of the stock. In addition, the corporate structure facilitates a tax-free merger, in which the stock of the acquiring firm can be exchanged for the stock or assets of another firm. In practice, the transferability of ownership interests is strictly limited by the stipulations of a shareholder agreement created when the corporation is formed.
Under a corporate structure ownership can be easily transferred, which facilitates raising money. A corporate structure also may be justified if the JV is expected to have substantial future financing requirements. A corporate structure provides a broader array of financing options than other legal forms, including the ability to sell shares and the issuance of corporate debentures and mortgage bonds. The ability to sell new shares enables the corporation to raise funds to expand while still retaining control if less than 50.1% of the corporation's shares are sold.
Under the corporate structure, the parent's liability is limited to the extent of its investment in the corporation. Consequently, an individual stockholder cannot be held responsible for the debts of the corporation or of other shareholders. However, a corporation's owner can be held personally liable if he or she directly injures someone or personally guarantees a bank loan or a business debt on which the corporation defaults. Other exceptions to personal liability include the failure to deposit taxes withheld from employees' wages or the commission of intentional fraud that causes harm to the corporation or to someone else. Finally, an owner may be liable if he or she treats the corporation as an extension of his or her personal affairs by failing to adequately capitalize the corporation, hold regular directors and shareholders meetings, or keeps business records and transactions separate from the other owners.
Subchapter S Corporations
Effective December 31, 2004, a firm having 100 or fewer shareholders may qualify as an S-type corporation and elect to be taxed as if it were a partnership and thus avoid double taxation. The maximum number of shareholders was increased from 76 to 100 under the 2004 American Jobs Creation Act. This act allows the members of a single family to be considered as a single shareholder. For example, a husband and wife (and their estates) would be treated as a single shareholder. Members of a family are individuals with a common ancestor, lineal descendants of the common ancestor, and the spouses of such lineal descendants or common ancestor. Moreover, an ESOP maintained by an S corporation is not in violation of the maximum number of shareholders' requirement because the S corporation contributes stock to the ESOP.
The major disadvantages to an S-type corporation are the exclusion of any corporate shareholders, the requirement to issue only one class of stock, the necessity of distributing all earnings to the shareholders each year, and that no more than 25% of the corporation's gross income may be derived from passive income. To be treated as an S-type corporation, all shareholders must simply sign and file IRS Form 2553.
C corporations may convert to Subchapter S corporations to eliminate double taxation on dividends. Asset sales within ten years of the conversion from a C to an S corporation are subject to taxes on capital gains at the prevailing corporate income tax rate. However, after ten years, such gains are tax-free to the S corporation but are taxable when distributed to shareholders at their personal tax rates. In 2007, turnaround specialist Sam Zell, after taking the Tribune Corporation private, converted the firm to an S corporation to take advantage of the favorable tax treatment (see Case Study 13.2). Sales of assets acquired by an S corporation, or after a ten-year period following conversion from one form of legal entity to an S corporation, are taxed at the capital gains tax rate, which is generally more favorable than the corporate income tax rate. The ten-year “built-in-gains” period is designed by the IRS to discourage C corporations from converting to Subchapter S corporations to take advantage of the more favorable capital gains tax rates on gains realized by selling corporate assets. Gains on the sale of assets by C corporations are taxed at the prevailing corporate tax rate rather than a more favorable capital gains tax rate.
As discussed next, the limited liability company offers its owners the significant advantage of greater flexibility in allocating profits and losses and is not subject to the many restrictions of the S corporation. Consequently, the overall popularity of the S corporation has declined.
Limited Liability Company
Like a corporation, the LLC limits the liability of its owners (called members) to the extent of their investment. Like a limited partnership, the LLC passes through all of the profits and losses of the entity to its owners without itself being taxed. To obtain this favorable tax status, the IRS generally requires that the LLC adopt an organization agreement that eliminates the characteristics of a C corporation: management autonomy, continuity of ownership or life, and free transferability of shares. Management autonomy is limited by expressly placing decisions about major issues pertaining to the management of the LLC (e.g., mergers or asset sales) in the hands of all its members. LLC organization agreements require that they be dissolved in case of the death, retirement, or resignation of any member, thereby eliminating continuity of ownership or life. Free transferability is limited by making a transfer of ownership subject to the approval of all members.
Unlike S-type corporations, LLCs can own more than 80% of another corporation and have an unlimited number of members. Also, corporations as well as non-U.S. residents can own LLC shares. Equity capital is obtained through offerings to owners or members. Capital is sometimes referred to as interests rather than shares, since the latter denotes something that may be freely traded. The LLC can sell shares or interests to members without completing the costly and time-consuming process of registering them with SEC, which is required for corporations that sell their securities to the public. However, LLC shares are not traded on public exchanges. This arrangement works well for corporate JVs or projects developed through a subsidiary or affiliate. The parent corporation can separate a JV's risk from its other businesses while getting favorable tax treatment and greater flexibility in the allocation of revenues and losses among owners. Finally, LLCs can incorporate before an initial public offering tax-free. This is necessary because they must register such issues with the SEC. The life of the LLC is determined by the owners and is generally set for a fixed number of years in contrast to the typical unlimited life for a corporation.
The LLC's management structure may be determined in whatever manner the members desire. Members may manage the LLC directly or provide for the election of a manager, officer, or board to conduct the LLC's activities. Members hold final authority in the LLC, having the right to approve extraordinary actions such as mergers or asset sales.
The LLC's drawbacks are evident if one owner decides to leave. All other owners must formally agree to continue the firm. Also, all the LLC's owners must take active roles in managing the firm. LLC interests are often illiquid, since transfer of ownership is subject to the approval of other members. LLCs must be set for a limited time, typically 30 years. Each state has different laws about LLC formation and governance, so an LLC that does business in several states might not meet the requirements in every state. LLCs are formed when two or more “persons” (i.e., individuals, LLPs, corporations, etc.) agree to file articles of organization with the secretary of state's office. The most common types of firms to form LLCs are family-owned businesses, professional services firms such as lawyers, and companies with foreign investors.
Partnership Structures
Frequently used as an alternative to a corporation, partnership structures include general partnerships and limited partnerships. While the owners of a partnership are not legally required to have a partnership agreement, it usually makes sense to have one. The partnership agreement spells out how business decisions are to be made and how profits and losses will be shared.
General Partnerships
Under the general partnership legal structure, investment, profits, losses, and operational responsibilities are allocated to the partners. The arrangement has no effect on the autonomy of the partners. Because profits and losses are allocated to the partners, the partnership is not subject to tax. The partnership structure also offers substantial flexibility in how the profits and losses are allocated to the partners. Typically, a corporate partner forms a special-purpose subsidiary to hold its interest. This not only limits liability but also may facilitate disposition of the JV interest in the future. The partnership structure is preferable to the other options when the business alliance is expected to have a short (three to five years) duration and if high levels of commitment and management interaction are necessary for short time periods.
The primary disadvantage of the general partnership is that all the partners have unlimited liability and may have to cover the debts of less financially sound partners. Each partner is said to be jointly and severally liable for the partnership's debts. For example, if one of the partners negotiates a contract resulting in a substantial loss, each partner must pay for a portion of the loss, based on a previously determined agreement on the distribution of profits and losses. Because each partner has unlimited liability for all the debts of the firm, creditors of the partnership may claim assets from one or more of the partners if the remaining partners are unable to cover their share of the loss. Another disadvantage includes the ability of any partner to bind the entire business to a contract or other business deal. Consequently, if one partner purchases inventory at a price that the partnership cannot afford, the partnership is still obligated to pay.
Partnerships also lack continuity in that they must be dissolved if a partner dies or withdraws, unless a new partnership agreement can be drafted. To avoid this possibility, a partnership agreement should include a buy–sell condition or right of first refusal allowing the partners to buy out a departing partner's interest so the business can continue. Finally, partnership interests may also be difficult to sell because of the lack of a public market, thus making it difficult to liquidate the partnership or to transfer partnership interests.
Forming a partnership generally requires applying for a local business license or tax registration certificate. If the business name does not contain all of the partners' last names, the partnership must register a fictitious or assumed business name in the county in which it is established. The body of law governing partnerships is the Uniform Partnership Act (UPA).
Limited Partnerships
A limited liability partnership is one in which one or more of the partners can be designated as having limited liability as long as at least one partner has unlimited liability. Those who are responsible for the day-to-day operations of the partnership's activities, whose individual acts are binding on the other partners, and who are personally liable for the partnership's total liabilities are called general partners. Those who contribute only money and are not involved in management decisions are called limited partners. Usually limited partners receive income, capital gains, and tax benefits, whereas the general partner collects fees and a percentage of the capital gain and income.
Typical limited partnerships are in real estate, oil and gas, and equipment leasing, but they also are used to finance movies, R&D, and other projects. Public limited partnerships are sold through brokerage firms, financial planners, and other registered securities representatives. Public partnerships may have an unlimited number of investors, and their partnership plans must be filed with the SEC. Private limited partnerships are constructed with fewer than 35 limited partners, who each invest more than $20,000. Their plans do not have to be filed with the SEC.
The sources of equity capital for limited partnerships are the funds supplied by the general and limited partners. The total amount of equity funds needed by the limited partnerships is typically committed when the partnership is formed. Therefore, ventures that are expected to grow are not usually set up as limited partnerships. LLPs are very popular for accountants, physicians, attorneys, and consultants. With the exception of Louisiana, every state has adopted either the Uniform Limited Partnership Act or the Revised Uniform Limited Partnership Act.
Franchise Alliance
Franchises typically involve a franchisee making an initial investment to purchase a license, plus additional capital investment for real estate, machinery, and working capital. For this initial investment, the franchisor provides training, site-selection assistance, and discounts resulting from bulk purchasing. Royalty payments for the license typically run 3% to 7% of annual franchisee revenue. Franchise success rates exceed 80% over a five-year period as compared with some types of start-ups, which have success rates of less than 10% after five years.7 The franchise alliance is preferred when a given business format can be replicated many times. Moreover, franchise alliances are also appropriate when there needs to be a common, recognizable identity presented to customers of each of the alliance partners and close operational coordination is required. In addition, a franchise alliance may be desirable when a common marketing program needs to be coordinated and implemented by a single partner.8
The franchisor and franchisee operate as separate entities, usually as corporations or LLCs. The four basic types of franchises are distributor (auto dealerships), processing (bottling plants), chain (restaurants), and area franchises (a geographic region is licensed to a new franchisee to subfranchise to others). Franchisors are required to comply with the Federal Trade Commission's Franchise Rule, which requires franchisors to make presale disclosures nationwide to prospective franchisees. Registration of franchises falls under state law modeled on the Uniform Franchise Offering Circular, which requires franchisors to make specific presale disclosures to prospective franchisees, including their financial statements for the preceding three years, as well as the terms and conditions of the franchise agreement, territory restrictions, and the like.
Equity Partnership
An equity partnership involves a company's purchase of stock (resulting in a less than controlling interest) in another company or a two-way exchange of stock by the two companies. It often is referred to as a partnership because of the equity ownership exchanged. Equity partnerships commonly are used in purchaser–supplier relationships, technology development, marketing alliances, and in situations in which a larger firm makes an investment in a smaller firm to ensure its continued financial viability. In exchange for an equity investment, a firm normally receives a seat on the board of directors and possibly an option to buy a controlling interest in the company. The equity partnership may be preferred when there is a need to have a long-term or close strategic relationship, to preempt a competitor from making an alliance or acquisition, or as a prelude to an acquisition or merger.
In early 2011, British Petroleum and Russian oil and gas exploration and development giant Rosneft exchanged shares prior to forming a JV to develop oil and gas properties in the Arctic Sea. The purpose of the share exchange may have been to ensure that both parties would remain motivated to work together, since a successful JV may significantly increase the market value of both firms. As noted in Case Study 14.3, the viability of this JV may be in jeopardy unless pending lawsuits are resolved.
Written Contract
The written contract is the simplest form of legal structure. This form is used most often with strategic alliances because it maintains an “arms-length” or independent relationship between the parties to the contract. The contract normally stipulates such things as how the revenue is divided, the responsibilities of each party, the duration of the alliance, and confidentiality requirements. No separate business entity is established for legal or tax purposes. The written contract most often is used when the business alliance is expected to last less than three years, frequent close coordination is not required, capital investments are made independently by each party to the agreement, and the parties have had little previous contact.
Strategic and operational plans
Planning should precede deal-structuring activities. Before any deal-structuring issues are addressed, the prospective parties must agree on the basic strategic direction and purpose of the alliance as defined in the alliance's strategic plan, as well as the financial and nonfinancial goals established in the operation's plan.
The strategic plan identifies the primary purpose or mission of the business alliance; communicates specific quantifiable targets, such as financial returns or market share and milestones; and analyzes the business alliance's strengths and weaknesses, and opportunities and threats relative to the competition. The purpose of a business alliance could take various forms, as diverse as R&D, cross-selling the partners' products, or jointly developing an oil field. The roles and responsibilities of each partner in conducting the day-to-day operations of the business alliance are stipulated in an operations plan. Teams representing all parties to the alliance should be involved from the outset of the discussions in developing both a strategic and an operations plan for the venture. The operations plan (i.e., annual budget) should reflect the specific needs of the proposed business alliance. The operations plan should be written by those responsible for implementing the plan. The operations plan is typically a one-year plan that outlines for managers what is to be accomplished, when it is to be accomplished, and what resources are required.
Resolving business alliance deal-structuring issues
The purpose of deal structuring in a business alliance is to allocate risks, rewards, resource requirements, and responsibilities fairly among participants. Table 14.3 summarizes the key issues and related questions that need to be addressed as part of the business alliance deal-structuring process. This section discusses how these issues most often are resolved.9
Table 14.3. Business Alliance Deal-Structuring Issues
| Issue | Key Questions |
| Scope | Which products are included and which are excluded? Who receives rights to distribute, manufacture, acquire, or license technology or purchase future products or technology? |
| Duration | How long is the alliance expected to exist? |
| Legal Form | What is the appropriate legal structure—stand-alone entity or contractual? |
| Governance | How are the interests of the parent firms to be protected? Who is responsible for specific accomplishments? |
| Control | How are strategic decisions to be addressed? How are day-to-day operational decisions to be handled? |
| Resource Contributions and Ownership Determination | Who contributes what and in what form? Cash? Assets? Guarantees/loans? Technology including patents, trademarks, copyrights, and proprietary knowledge? How are contributions to be valued? How is ownership determined? |
| Financing Ongoing Capital Requirements | What happens if additional cash is needed? |
| Distribution | How are profits and losses allocated? How are dividends determined? |
| Performance Criteria | How is performance to the plan measured and monitored? |
| Dispute Resolution | How are disagreements resolved? |
| Revision | How will the agreement be modified? |
| Termination | What are the guidelines for termination? Who owns the assets on termination? What are the rights of the parties to continue the alliance activities after termination? |
| Transfer of Interests | How are ownership interests to be transferred? What are the restrictions on the transfer of interests? How will new alliance participants be handled? Will there be rights of first refusal, drag-along, tag-along, or put provisions? |
| Tax | Who receives tax benefits? |
| Management/Organization | How is the alliance to be managed? |
| Confidential Information | How is confidential information handled? How are employees and customers of the parent firms protected? |
| Regulatory Restrictions and Notifications | Which licenses are required? Which regulations need to be satisfied? Which agencies need to be notified? |
Scope
A basic question in setting up a business alliance involves which products specifically are included and excluded from the business alliance. This question deals with defining the scope of the business alliance. Scope outlines how broadly the alliance will be applied in pursuing its purpose. For example, an alliance whose purpose is to commercialize products developed by the partners could be broadly or narrowly defined in specifying what products or services are to be offered, to whom, in what geographic areas, and for what time period. Failure to define scope adequately can lead to situations in which the alliance may be competing with the products or services offered by the parent firms. With respect to both current and future products, the alliance agreement should identify who receives the rights to market or distribute products, manufacture products, acquire or license technology, or purchase products from the venture.
In certain types of alliances, intellectual property may play a very important role. It is common for a share in the intangible benefits of the alliance, such as rights to new developments of intellectual property, to be more important to an alliance participant than its share of the alliance's profits. What started out as a symbiotic marketing relationship between two pharmaceutical powerhouses, Johnson & Johnson and Amgen, deteriorated into a highly contentious feud. The failure to properly define which parties would have the right to sell certain drugs for certain applications and future drugs that may have been developed as a result of the alliance laid the groundwork for a lengthy legal battle between these two corporations.
Duration
The participants need to agree on how long the business alliance is to remain in force. Participant expectations must be compatible. The expected longevity of the alliance is also an important determinant in the choice of a legal form. For example, the corporate structure more readily provides for a continuous life than a partnership structure because of its greater ease of transferring ownership interests. There is conflicting evidence on how long most business alliances actually last.10 The critical point is that most business alliances have a finite life, corresponding to the time required to achieve their original strategic objectives.
Legal Form
Businesses that are growth oriented or intend to eventually go public through an IPO generally become a C corporation due to its financing flexibility, unlimited life, continuity of ownership, and ability to combine on a tax-free basis with other firms. With certain exceptions concerning frequency, firms may convert from one legal structure to a C corporation before going public. The nature of the business greatly influences the legal form that is chosen (Table 14.4).
Table 14.4. Key Factors Affecting Choice of Legal Entity
| Determining Factors: Businesses with | Should Select |
| High liability risks | C corporation, LLP, or LLC |
| Large capital/financing requirements | C corporation |
| Desire continuity of existence | C corporation |
| Desire for managerial autonomy | C corporation |
| Desire for growth through M&A | C corporation |
| Owners who are also active participants | LLC |
| Foreign corporate investors | LLC |
| Desire to allocate investments, profits, losses, and operating responsibilities among owners | LLC and LLP |
| High pretax profits | LLC and LLP |
| Project focus/expected limited existence | LLP |
| Owners who want to remain inactive | LLP and C corporation |
| Large marketing expenses | Franchise |
| Strategies that are easily replicated | Franchise |
| Close coordination among participants not required | Written “arms-length” agreement |
| Low risk/low capital requirements | Sole proprietorship or partnership |
Governance
In the context of a business alliance, governance may be defined broadly as an oversight function providing for efficient, informed communication between two or more parent companies. The primary responsibilities of this oversight function are to protect the interests of the corporate parents, approve changes to strategy and annual operating plans, allocate resources needed to make the alliance succeed, and arbitrate conflicts among lower levels of management. Historically, governance of business alliances has followed either a quasi-corporate or quasi-project approach. For example, the oil industry traditionally has managed alliances by establishing a board of directors to provide oversight of managers and protect the interests of nonoperating owners.
In contrast, in the pharmaceutical and the automotive industries, where nonequity alliances are common, firms treat governance the same as project management by creating a steering committee that allows all participants to comment on issues confronting the alliance. For highly complex alliances, governance may have to be implemented through multiple boards of directors, steering committees, operating committees, alliance managers, and project committees.
Resource Contributions and Ownership Determination
As part of the negotiation process, the participants must agree on a fair value for all tangible and intangible assets contributed to the business alliance. The valuation of partner contributions is important in that it often provides the basis for determining ownership shares in the business alliance. The shares of the corporation or the interests in the partnership are distributed among the owners in accordance with the value contributed by each participant. The partner with the largest risk, the largest contributor of cash, or the person who contributes critical tangible or intangible assets generally is given the greatest equity share in a JV.
It is relatively easy to value tangible or “hard” contributions such as cash, promissory cash commitments, contingent commitments, stock of existing corporations, and assets and liabilities associated with an ongoing business in terms of actual dollars or their present values. A party that contributes “hard” assets, such as a production facility, may want the contribution valued in terms of the value of increased production rather than its replacement cost or lease value. The contribution of a fully operational, modern facility to a venture interested in being first to market with a particular product may provide far greater value than if the venture attempted to build a new facility because of the delay inherent in making the facility fully operational.
In contrast, intangible or “soft” or “in-kind” contributions such as skills, knowledge, services, patents, licenses, brand names, and technology are often much more difficult to value. Partners providing such services may be compensated by having the business alliance pay a market-based royalty or fee for such services. If the royalties or fees paid by the alliance are below standard market prices for comparable services, the difference between the market price and what the alliance actually is paying may become taxable income to the alliance.
Alternatively, contributors of intellectual property may be compensated by receiving rights to future patents or technologies developed by the alliance. Participants in the business alliance that contribute brand identities, which facilitate the alliance's entry into a particular market, may require assurances that they can purchase a certain amount of the product or service, at a guaranteed price, for a specific time period. See Case Study 14.1 for an illustration of how the distribution of ownership between General Electric and Vivendi Universal Entertainment may have been determined in the formation of NBC Universal.
Case Study 14.1
Determining Ownership Distribution in a Joint Venture
In 2003, Vivendi Universal Entertainment contributed film and television assets valued at $14 billion to create NBC Universal, a joint venture with TV network NBC, which was wholly owned by General Electric at that time. NBC Universal was valued at $42 billion at closing. NBC Universal's EBITDA was estimated to be $3 billion, of which GE contributed two-thirds and VUE accounted for the remaining one-third. EBITDA multiples for recent transactions involving TV media firms averaged 14 times EBITDA at that time. GE provided VUE an option to buy $4 billion in GE stock, assumed $1.6 billion in VUE debt, and paid the remainder of the $14 billion purchase price in the form of NBC Universal stock. At closing, VUE converted the option to buy GE stock into $4 billion in cash. GE owned 80% of NBC Universal and VUE owned 20%. How might this ownership distribution have been determined?
Solution
Step 1: Estimate the total value of the joint venture.
Step 2: Estimate the value of assets contributed by each partner.
Reflecting the relative contribution of each partner to EBITDA (
from GE; 
from VUE), GE's contributed assets were valued at $28 billion (i.e., of $42 billion) and VUE's at $14 billion (i.e., of $42 billion).
Financing Ongoing Capital Requirements
The business alliance may finance future capital requirements that cannot be financed out of operating cash flow by calling on the participants to make a capital contribution, issuing additional equity or partnership interests, or borrowing. Cingular's 2004 purchase of AT&T Wireless in an all-cash offer totaling $41 billion (the largest all-cash purchase on record) resulted in SBC and Bell Atlantic (co-owners of the Cingular JV) contributing 60% and 40% of the purchase price, respectively, to the joint venture to fund the acquisition. Their percentage equity contributions reflected their ownership shares of the joint venture.
If it is decided that the alliance should be able to borrow, the participants must agree on an appropriate financial structure for the enterprise. Financial structure refers to the amount of equity that will be contributed to the business alliance and how much debt it will carry. Alliances established through a written contract obviate the need for such a financing decision because each party to the contract finances its own financial commitments to the alliance. Because of their more predictable cash flows, project-based JVs, particularly those that create a separate corporation, sometimes sell equity directly to the public or though a private placement.
Owner or Partner Financing
The equity owners or partners may agree to make contributions of capital in addition to their initial investments in the enterprise. The contributions usually are made in direct proportion to their equity or partnership interests. If one party chooses not to make a capital contribution, the ownership interests of all the parties are adjusted to reflect the changes in their cumulative capital contributions. This adjustment results in an increase in the ownership interests of those making the contribution and a reduction in the interests of those not making contributions.
Equity and Debt Financing
JVs formed as a corporation may issue different classes of either common or preferred stock. JVs established as partnerships raise capital through the issuance of limited partnership units to investors, with the sponsoring firms becoming general partners. An LLC structure may be necessary when one of the owners is a foreign investor. When a larger company aligns with a smaller company, it may make a small equity investment in the smaller firm to ensure it remains solvent or to benefit from potential equity appreciation. Such investments often include an option to purchase the remainder of the shares, or at least a controlling interest, at a predetermined price if the smaller firm or the JV satisfies certain financial targets. Non-project-related alliances or alliances without financial track records often find it very difficult to borrow. Banks and insurance companies generally require loan guarantees from the participating owners. Such guarantees give lenders recourse to the participating owners in the event the alliance fails to repay its debt.
Control
Control is distinguishable from ownership by the use of agreements among investors or voting rights or by issuing different classes of shares. The most successful JVs are those in which one party is responsible for most routine management decisions, with the other parties participating in decision making only when the issue is fundamental to the business alliance. The business alliance agreement must define what issues are to be considered fundamental to the alliance and address how they are to be resolved, either by majority votes or by veto rights given to one or more of the parties. The owner who is responsible for the results of the alliance will want operational control. Operational control should be placed with the owner best able to manage the JV.
The owner who has the largest equity share but not operational control is likely to insist on being involved in the operation of the business alliance by having a seat on the board of directors or steering committee. The owner also may insist on having veto rights over such issues as changes in the alliance's purpose and scope, overall strategy, capital expenditures over a certain amount of money, key management promotions, salary increases applying to the general employee population, the amount and timing of dividend payments, buyout conditions, and acquisitions or divestitures.
Distribution Issues
Distribution issues relate to dividend policies and how profits and losses are allocated among the owners. The dividend policy determines the cash return each partner should receive. How the cash flows of the venture will be divided generally depends on the initial equity contribution of each partner, ongoing equity contributions, and noncash contributions in the form of technical and managerial resources. Allocation of profits and losses normally follows directly from the allocation of shares or partnership interests. When the profits flow from intellectual property rights contributed by one of the parties, royalties may be used to compensate the party contributing the property rights. When profits are attributable to distribution or marketing efforts of a partner, fees and commission can be used to compensate the partners. Similarly, rental payments can be used to allocate profits attributable to specific equipment or facilities contributed by a partner.
Performance Criteria
The lack of adequate performance measurement criteria can result in significant disputes among the partners and eventually contribute to the termination of the venture. Performance criteria should be both measurable and simple enough to be understood and used by the partners and managers at all levels and spelled out clearly in the business alliance agreement. Nonfinancial performance measures should be linked to financial return drivers. For example, factors such as market share, consistent product quality, and customer service may be critical to success in the marketplace. In licensing arrangements, the licensor should require that the licensee provide a forecast of unit sales and the value contributed by the license in such sales to provide a basis for auditing the licensee royalty payments. The balanced scorecard technique may be applied to measuring alliance performance by having the partners agree on a small number (i.e., five to ten) of relevant indicators. The indicators should include financial and nonfinancial, short- and long-term, and internal and customer-focused measures.11
Dispute Resolution
How disputes are resolved is affected by the choice of law provision, the definition of what constitutes an impasse, and the arbitration clause provided in the alliance agreement. The choice of law provision in the agreement indicates which state's or country's laws have jurisdiction in settling disputes. This provision should be drafted with an understanding of the likely outcome of litigation in any of the participants' home countries or states and the attitude of these countries' or states' courts in enforcing choice of law provisions in the JV agreements.12 The deadlock or impasse clause defines what events trigger dispute-resolution procedures. Care should be taken not to define the events triggering dispute-resolution procedures so narrowly that minor disagreements are subject to the dispute mechanism. Finally, an arbitration clause addresses major disagreements by defining the type of dispute subject to arbitration and how the arbitrator will be selected.
Revision
Changing circumstances and partner objectives may prompt a need to revise the objectives of the business alliance. If one of the parties to the agreement wishes to withdraw, the participants should have agreed in advance how the withdrawing party's ownership interest would be divided among the remaining parties. Moreover, a product or technology may be developed that was not foreseen when the alliance first was conceived. The alliance agreement should indicate that the rights to manufacture and distribute the product or technology might be purchased by a specific alliance participant. If agreement cannot be reached on revising the original agreement, it may be necessary to terminate the enterprise.
Termination
A business alliance may be terminated as a result of the completion of a project, successful operations resulting in merger of the partners, diverging strategic objectives of the partners, and failure of the alliance to achieve stated objectives. Termination provisions in the alliance agreement should include buyout clauses enabling one party to purchase another's ownership interests, prices of the buyout, and how assets and liabilities are to be divided if the venture fails or the partners elect to dissolve the operation. In some instances, a JV may convert to a simple licensing arrangement. Consequently, the partner may disengage from the JV without losing all benefits by purchasing rights to the product or technology.
Transfer of Interests
JV and alliance agreements often limit how and to whom parties to the agreements can transfer their interests. This is justified by noting that each party entered the agreement with the understanding of who its partners would be. In agreements that permit transfers under certain conditions, the partners or the JV itself may have right of first refusal (i.e., the party wishing to leave the JV first must offer its interests to other participants in the JV). Parties to the agreement may have the right to “put” or sell their interests to the venture, and the venture may have a call option or right to purchase such interests. There also may be tag-along and drag-along provisions, which have the effect of a third-party purchaser acquiring not only the interest of the JV party whose interest it seeks to acquire but also the interests of other parties as well. A drag-along provision requires a party not otherwise interested in selling its ownership interest to the third party to do so. A tag-along provision gives a party to the alliance, who was not originally targeted by the third party, the option to join the targeted party in conveying its interest to the third party.
Buyout clauses in alliances that give one party an option to sell its share of the partnership to the other at a fixed price can backfire. Examples abound. AOL Time Warner had to pay a German media firm $6.75 billion for its half of AOL Europe, four times its estimated value at the time. The best alliance agreements avoid clauses such as fixed or minimum buyout prices, short payment periods, and strict payment options, such as cash only, to avoid giving substantial leverage to one party over the other. In early 2005, General Motors and Fiat agreed to dissolve their five-year partnership after GM agreed to pay Fiat $2 billion in cash to avoid having to exercise a put option to buy the financially weak Fiat Auto.
Taxes
As is true for a merger, the primary tax concerns of the JV partners are to avoid the recognition of taxable gains on the formation of the venture and minimize taxes on the distribution of its earnings. In addition to the double taxation of dividends discussed earlier, the corporate structure may have other adverse tax consequences. If the partner owns less than 80% of the alliance, its share of the alliance's results cannot be included in its consolidated income tax return. This has two effects. First, when earnings are distributed, they are subject to an intercorporate dividend tax, which can be 7% if the partner's ownership interest in the venture is 20% or more. Second, losses of the business alliance cannot be used to offset other income earned by the participant. For tax purposes, the preferred alternative to a corporate legal structure is to use a pass-through legal structure, such as a limited liability company or partnership.
A partnership can be structured in such a way that some partners receive a larger share of the profits, whereas others receive a larger share of the losses. This flexibility in tax planning is an important factor stimulating the use of partnerships and LLCs. These entities can allocate to each JV partner a portion of a particular class of revenue, income, gain, loss, or expense.13
Services provided to the JV, such as accounting, auditing, legal, human resource, and treasury services, are not viewed by the IRS as being “at risk” if the JV fails. The JV should pay prevailing market fees for such services. Services provided to the JV in return for equity may be seen as taxable to the JV by the IRS if such services are not truly “at risk.”
Management and Organizational Issues
Before a business alliance agreement is signed, the partners must decide what type of organizational structure provides the most effective management and leadership.
Steering or Joint Management Committee
Control of business alliances most often is accomplished through a steering committee. The steering committee is the ultimate authority for ensuring that the venture stays focused on the strategic objectives agreed to by the partners. To maintain good communication, coordination, and teamwork, the committee should meet at least monthly. The committee should provide operations managers with sufficient autonomy so they can take responsibility for their actions and be rewarded for their initiative.
Methods of Dividing Ownership and Control
A common method of control is the majority–minority framework, which relies on identifying a clearly dominant partner, usually the one having at least a 50.1% ownership stake. In this scenario, the equity, control, and distribution of rewards reflect the majority–minority relationship. This type of structure promotes the ability to make rapid corrections, defines who is in charge, and is most appropriate for high-risk ventures, where quick decisions often are required. The major disadvantage of this approach is that the minority partner may feel powerless and become passive or alienated.
Another method of control is the equal division of power framework, which usually means that equity is split equally. This assumes that the initial contribution, distribution, decision making, and control are split equally. This approach helps keep the partners actively engaged in the management of the venture. It is best suited for partners sharing a strong common vision for the venture and possessing similar corporate cultures. However, the approach can lead to deadlocks and the eventual dissolution of the alliance.
Under the majority rules framework, the equity distribution may involve three partners. Two of the partners have large equal shares, whereas the third partner may have less than 10%. The minority partner is used to break deadlocks. This approach enables the primary partners to remain engaged in the enterprise without stalemating the decision-making process.
In the multiple party framework, no partner has control; instead, control resides with the management of the venture. Consequently, decision making can be nimble and made by those who best understand the issues. This framework is well suited for international ventures, where a country's laws may prohibit a foreign firm from having a controlling interest in a domestic firm. In this instance, it is commonplace for a domestic company to own the majority of the equity but for the operational control of the venture to reside with the foreign partner. In addition to a proportional split of the dividends paid, the foreign company may receive additional payments in the form of management fees and bonuses.14
Regulatory Restrictions and Notifications
From an antitrust perspective, the Department of Justice historically looked on business alliances far more favorably than mergers or acquisitions. Nonetheless, JVs may be subject to Hart-Scott-Rodino filing requirements because the parties to the JV are viewed as acquirers and the JV itself is viewed as a target. For JVs between competitors to be acceptable to regulators, competitors should be able to do something together that they could not do alone. In general, competitors can be relatively confident that a partnership will be acceptable to regulators if, in combination, they control no more than 20% of the market. Project-oriented ventures are looked at most favorably. Collaborative research is encouraged, particularly when the research is shared among all the parties to the alliance. Alliances among competitors are likely to spark a review by regulators because they have the potential to result in price fixing and dividing up the market.
Empirical findings
Reflecting their flexibility and relatively low capital requirements, business alliances are becoming increasingly popular ways to implement business strategies. Under the right conditions, alliances can generate significant abnormal financial returns.
Abnormal Returns
Empirical evidence shows that JVs and strategic alliances create value for their participants (Table 14.5). Abnormal returns average about 1.5% around the announcement date of the formation of a business alliance. Partners in horizontal JVs (i.e., those involving partners in the same industry) tend to share equally in wealth creation. However, for vertical JVs, suppliers experience a greater portion of the wealth created.15 Moreover, the increase in wealth is often much greater for horizontal alliances involving the transfer of technical knowledge than for nontechnical alliances.16 Firms with greater alliance experience enjoy a greater likelihood of success and greater wealth creation than those with little experience.17 Finally, strategic alliances most often represent the final form of cooperation between partners and do not often represent a prelude to a more formal arrangement, such as a joint venture corporation or a merger. However, investors in those firms participating in the alliance tend to react more favorably around the announcement date of the alliance if they believe the partners will eventually merge.18
Table 14.5. Abnormal Returns to Alliance Participants around Announcement Dates
| Empirical Study | Abnormal (Excess) Return |
| McConnell and Nantell (1985): 136 JVs 1972–1979 | 2.15% |
| Woolridge and Snow (1990): 767 JVs 1972–1987 | 2.45% |
| Koh and Venkatraman (1991): 239 technology firms in JVs 1972–1986 | 0.87% |
| Chan, Kensinger, Keown, and Martin (1997): 345 strategic alliances 1983–1992 | 0.64% for both horizontal and nonhorizontal alliances 3.54% for horizontal alliances involving technical knowledge transfer |
| Das, Sen, and Sengupta (1998): 119 strategic alliances 1987–1991 | 1% (for technology transfer alliances) |
| Johnson and Houston (2000): 191 JVs 1991–1995 | 1.67% |
| Kale, Dyer, and Singh (2002): 1,572 strategic alliances 1988–1997 | 1.35% (for firms with significant alliance experience); otherwise 0.18% |
Strategic alliances can have a salutary effect on the share prices of their suppliers and customers and a negative impact on the share prices of competitors. For alliances created to share technologies or develop new technical capabilities, suppliers benefit from increased sales to the alliance and customers benefit from using the enhanced technology developed by the alliance in their products. Competitors' share prices decline due to lost sales and earnings to the alliance.19
The Growing Role of Business Alliances
The average large company now has more than 30 alliances.20 Although the average number of merger transactions per year exceeds the number of new alliances, alliance formation is accelerating.21 The acceleration in alliance formation in part reflects a loosening of antitrust regulatory policies with respect to business alliances.
Despite rapid growth, studies show that most companies have yet to develop the skill to implement alliances successfully, with as many as 60% of all business alliances failing to meet expectations.22 These studies make no allowance for different levels of experience in forming and managing alliances among the firms in their samples. Cumulative experience seems to be an important factor in increasing the likelihood that an alliance will meet expectations, with reported financial returns from alliances increasing with the number of businesses alliances implemented.23
Some things to remember
Business alliances may represent attractive alternatives to M&As. The motivations for business alliances can include risk sharing, gaining access to new markets, accelerating new product introduction, technology sharing, globalization, a desire to acquire (or exit) a business, and the perception that they are often more acceptable to regulators than acquisitions or mergers. Furthermore, business alliances may assume a variety of legal structures: corporate, LLCs, partnership, franchise, equity partnership, or written contract. Key deal-structuring issues in forming alliances include the alliance's scope, duration, legal form, governance, and control mechanism. The valuation of resource contributions ultimately determines ownership interests. Alliance agreements also must be flexible enough to be revised when necessary and contain mechanisms for breaking deadlocks, transferring ownership interests, and dealing with the potential for termination.
Empirical studies suggest that alliances formed by partners in the same industry are more likely to create value than those that are not. Partners in such horizontal alliances are more likely to share equally in the benefits than parties to vertical alliances between a customer and a supplier. In such arrangements, studies suggest that suppliers tend to experience a disproportionate amount of the benefit. Finally, the greatest value creation seems to occur for horizontal alliances that result in a technology or knowledge transfer among the parties to the alliance. Nonetheless, the success rate of business alliances in terms of meeting participants' expectations does not seem to be materially different from that of M&As.
Discussion Questions
14.1 Under what circumstances does a business alliance represent an attractive alternative to a merger or acquisition?
14.2 Compare and contrast a corporate and partnership legal structure.
14.3 What are the primary motives for creating a business alliance? How do they differ from the motives for a merger or acquisition?
14.4 What factors are critical to the success of a business alliance?
14.5 Why is a handshake agreement a potentially dangerous form of business alliance? Are there any circumstances under which such an agreement may be appropriate?
14.6 What is a limited liability company? What are its advantages and disadvantages?
14.7 Why is defining the scope of a business alliance important?
14.8 Discuss ways of valuing tangible and intangible contributions to a JV.
14.9 What are the advantages and disadvantages of the various organizational structures that could be used to manage a business alliance?
14.10 What are the common reasons for the termination of a business alliance?
14.11 Google invested $1 billion for a 5% stake in Time Warner's America Online unit as part of a partnership that expands the firm's existing search engine deal to include collaboration on advertising, instant messaging, and video. Under the deal, Google would have the usual customary rights afforded a minority investor. What rights or terms do you believe Google would have negotiated in this transaction? What rights do you believe Time Warner might want?
14.12 Conoco Phillips announced the purchase of 7.6% of the stock of Lukoil (a largely government-owned Russian oil and gas company) for $2.36 billion during a government auction of Lukoil's stock. Conoco would have one seat on Lukoil's board. As a minority investor, how could Conoco protect its interests?
14.13 Johnson & Johnson sued Amgen over their 14-year alliance to sell a blood-enhancing treatment called erythropoietin. The relationship had begun in the mid-1980s with J&J helping commercialize Amgen's blood-enhancing treatment, but the partners ended up squabbling over sales rights and a spin-off drug. The companies could not agree on future products for the JV. Amgen won the right in arbitration to sell a chemically similar medicine that can be taken weekly rather than daily. Arbitrators ruled that the new formulation was different enough to fall outside the licensing pact between Amgen and J&J. What could these companies have done before forming the alliance to have mitigated the problems that arose after the alliance was formed? Why do you believe they may have avoided addressing these issues at the outset?
14.14 General Motors, the world's largest auto manufacturer, agreed to purchase 20% of Japan's Fuji Heavy Industries, Ltd., the manufacturer of Subaru vehicles, for $1.4 billion. Why do you believe that initially General Motors may have wanted to limit its investment to 20%?
14.15 Through its alliance with Best Buy, Microsoft is selling its products—including Microsoft Network (MSN) Internet access services and hand-held devices such as digital telephones, hand-held organizers, and WebTV that connect to the Web—through kiosks in Best Buy's 354 stores nationwide. In exchange, Microsoft has invested $200 million in Best Buy. What do you believe were the motivations for this strategic alliance?
Answers to these Chapter Discussion Questions are available in the Online Instructor's Manual for instructors using this book.
Chapter business cases
Case Study 14.2
Estimating the Real Cost of Comcast's Investment in NBC Universal
Following months of intense review, regulators approved the creation of a media giant consisting of Comcast Corporation and General Electric's NBC Universal on January 17, 2011. GE and Comcast had announced a deal on December 2, 2009, to form a joint venture consisting of NBCU and selected Comcast assets. The transaction is noteworthy for its potential impact on the entertainment industry, its complexity, and as an exit strategy for GE from the media and entertainment business. The transaction also illustrates the payment of a significant control premium by Comcast.
Comcast is primarily a cable company and provider of programming content, with 23.8 million cable customers, 15.7 million high-speed Internet customers, and 7.4 million voice customers. Comcast hopes to be able to diversify its holdings as it faces encroaching threats from online video and more aggressive competition from satellite and phone companies that offer subscription TV services by adding more content to its video-on-demand offerings. Furthermore, by having an interest in NBCU's digital properties such as Hulu.com, Comcast is hoping to capitalize on any shift of its cable customers to viewing their favorite TV programs online. Comcast also will have more control over the videos that users watch on the web. By having a controlling interest in NBC Universal, Comcast could offer popular films on movies-on-demand channels ahead of or on the same day as a DVD release.
Comcast's strategy is to achieve vertical integration by owning the content it distributes through its cable operations. Previous attempts to do this, such as AOL's acquisition of Time Warner in 2001, have ended in failure largely because the cultures of the two firms did not mesh. Some media companies have successfully merged—for example, Time Warner's merger with Turner Broadcasting. Having learned from AOL's headlong rush to achieve synergy, Comcast is taking an approach that will allow the NBC Universal JV to operate largely independently of the parents.
General Electric is a diversified infrastructure, finance, and media firm whose products include aircraft engines and power generation to financial services, medical imaging, and television programming. The GE decision to sell reflects the deteriorating state of the broadcast television industry and a desire to exit a business that never quite fit well with its industrial side. NBC has been moored in fourth place among the major broadcast networks, and the economics of the broadcast television industry have deteriorated in recent years amid declining overall ratings and a decline in advertising. In contrast, cable channels have continued to thrive because they rely on a steady stream of subscriber fees from cable companies such as Comcast. Moreover, while NBCU was profitable in 2009, it is expected to go into the red in the coming years. The Comcast deal helps GE to reduce its debt as it tries to shore up its big finance arm, which got hit in the 2008 financial crisis, and to focus more on its manufacturing and infrastructure operations.
The joint venture will be 51% owned by Comcast and 49% owned by GE, with Comcast managing the JV. GE will contribute to the joint venture NBCU businesses valued at $30 billion, including cable networks, movies, television programming, and theme parks.
Comcast will contribute its cable channels, ten regional sports networks, and digital media properties, such as its equity interest in Hulu.com (jointly owned by NBC, News Corporation, and Walt Disney Company), valued collectively at $7.25 billion. Comcast will also pay GE up to $6.5 billion in cash subject to a balance sheet adjustment between signing and closing. In addition, NBCU will borrow $9.1 billion from lenders and distribute the cash to GE, bringing the total cash received by GE for selling a 51% stake in NBCU to $15.6 billion. By having NBCU borrow the $9.1 billion, Comcast and GE may be able to protect themselves from NBCU's creditors if the firm eventually goes into bankruptcy because such loans are backed by NBCU's assets and cash flow.
GE will acquire Vivendi's 20% interest in NBCU for $5.8 billion. The Vivendi agreement values NBCU at $29 billion ($5.8 ÷ 0.2), reflecting a slight minority discount for the Vivendi stake. GE expects to realize $8 billion in cash from the receipt of $6.5 billion from Comcast and loan proceeds of $9.1 billion at closing after paying Vivendi for its 20% stake in NBCU, NBCU's preclosing debt, and associated transaction fees.
GE has put options allowing it to sell one-half of its interest after three and a half years and its remaining interest at the end of the seventh year following closing. The JV is obligated to buy out GE only if its debt levels do not exceed two and three-quarters times EBITDA as a result of the purchase of the GE interest and if the JV is able to maintain investment-grade credit ratings.Comcast has a call option to buy GE's interest at specific intervals at a 20% premium to the public market value of its stock
Table 14.6 shows how the two parties valued the JV. While it has been widely reported that Comcast paid $13.75 billion for a stake in NBC Universal, the real cost to Comcast was much greater. The actual price could have been almost $23 billion.
Table 14.6. NBC Universal Joint Venture Valuation and Purchase Price Determination ($ billion)
| NBC Universal Joint Venture Valuation ($ billion)a | $37.25 |
| Comcast Purchase Price for 51% of NBC Universal JV – Cash from Comcast paid to GE – Cash proceeds paid to GE from NBCU borrowingsb – Contributed assets (Comcast network) Total |
$6.50 9.10 7.25 $22.85 |
| GE Purchase Price for 49% of NBC Universal JV – Contributed assets (NBCU) – Cash from Comcast paid to GE – Cash proceeds paid to GE from NBCU borrowings Total |
$30.00 (6.50) (9.10) $14.40 |
| Implied Control/Purchase Premium Paid by Comcastc | 20.3% |
| Implied Minority/Liquidity Discount to GE's Purchase Priced | (21.1)% |
a Equals the sum of NBCU ($30 billion) plus the fair market value of contributed Comcast properties ($7.25 billion) and assumes no incremental value due to synergy.
b The $9.1 billion borrowed by NBCU will be carried on the consolidated books of Comcast, since it has the controlling interest in the joint venture. Since it reduces Comcast's borrowing capacity by that amount, it represents a portion of the purchase price. In practice, the additional $9.1 billion in debt from the JV on Comcast's consolidated balance sheet may not reduce the firm's borrowing capacity by an equivalent amount if lenders view the JV's cash-flow potential sufficient to more than offset the debt service requirements of the debt. Nonetheless, the additional debt will reduce Comcast's overall borrowing capacity. As such, some portion of the debt should be included in the purchase price Comcast paid for a 51% stake in the JV, making the actual purchase price much closer to $23 billion than the widely reported $13.75 billion.
c The control premium represents the excess of the purchase price paid over the fair market value of the net acquired assets and is calculated as follows: {[$22.85/(0.51 × $37.25)] – 1} × 100 = {[$22.85/$19.00] – 1} × 100 = 20.28%.
d The minority/liquidity discount represents the excess of the fair market value of the net acquired assets over the purchase price and is calculated as follows: {[$14.40/(0.49 × $37.25)] – 1} × 100 = (21.1)%.
As the controlling shareholder, Comcast must show the debt accumulated by the JV on its consolidated balance sheet. As such, this additional debt may have the effect of reducing Comcast's borrowing capacity dollar for dollar. Since the deal required NBCU to borrow $9.1 billion and then transfer the proceeds to GE, this debt should be included in the calculation of the purchase price paid by Comcast. Including the debt raises the purchase price to $22.85 billion. In practice, the reduction in Comcast's borrowing capacity is likely to be less because lenders will take into consideration the firm's substantial cash-generating ability.
As a result of its 51% interest, Comcast will own $19 billion in net assets of the JV (i.e., 0.51 × $37.25 billion). The excess of the $22.85 billion over the $19 billion in net assets constitutes an approximate 20% premium paid by Comcast for control and anticipated strategic and operating synergies. The premium may be excessive, since there were no other firms that expressed serious interest in buying NBC Universal.
GE's purchase price for 49% of the joint venture is $14.4 billion. This figure represents the fair market value of NBCU less the cash proceeds received from Comcast and from NBCU and includes a combined 21% minority and liquidity discount, reflecting its lack of control and inability to “cash out” of its ownership interest until the put exercise dates. Both the estimated control premium and the minority/liquidity discount are likely to be overstated because no estimate of synergy was included in the calculation of the NBCU valuation due to a lack of information.
To gain approval, the U.S. Federal Communications Commission and the Department of Justice required Comcast and NBCU to relinquish their voting rights and board representation to Hulu, although they could continue to remain part owners. Furthermore, Comcast would have to ensure what the FCC called “reasonable access” to its programming for its competitors. Comcast also may not discriminate against programming that competes with its own offerings.
Critics suggest there is little overlap between Comcast and NBCU's businesses to provide significant cost savings. Moreover, big media deals have a poor track record, as illustrated by the AOL Time Warner debacle. Comcast is placing a big bet that it will be able to successfully combine content and distribution.
Discussion Questions
1. Speculate as to why GE may have found it difficult to manage NBC Universal. Be specific.
2. In theory, GE is responsible for 49% of NBC Universal's debt because it owns 49% of the joint venture. Do you believe that Comcast should be responsible for only 51% of the debt rather than the entire $9.1 billion? Explain your answer.
3. Speculate as to the potential circumstances in which either Comcast or GE would be likely to exercise their call or put options. Which party do you believe is likely to exercise its options first and why?
4. What are the likely challenges Comcast and GE will have in integrating the various businesses that make up the joint venture? Be specific.
Answers to these case study questions are found in the Online Instructor's Manual for instructors using this book.
Case Study 14.3
British Petroleum and Russia's Rosneft Unsuccessful Attempt to Swap Shares
Extending its already close ties with Russia, British Petroleum PLC announced an agreement to exchange shares with Russia's largest oil company, OAO Rosneft, on January 14, 2011. Rosneft is 75% owned by the Russian government. BP and Rosneft also announced the formation of a JV to develop three massive offshore exploration blocks that Rosneft owns in northern Russia. The two firms said they will jointly explore three areas in the South Kara Sea in the Russian Arctic, spending between $1.4 and $2 billion on seismic tests and drilling wells in the initial exploration phase. The JV will be two-thirds owned by Rosneft, with the remainder owned by BP.
Reflecting Europe's escalating dependence on Russia for an increasing share of its energy resources, particularly for clean-burning natural gas, the agreement is backed by Britain's prime minister, David Cameron, and Russia's prime minister, Vladimir Putin. Russia holds one-fifth of the world's proven reserves of natural gas, and, by some estimates, the South Kara Sea contains some of the largest reserves of oil and gas in the world.
The deal comes in the wake of BP's sale of assets to raise funds to cover the costs of the Gulf of Mexico oil spill in mid-2010. Such costs are expected to eventually total $40 billion. Rosneft, which had announced in late 2010 that it was seeking a partner for exploiting its Arctic leases, indicated that BP's experience in dealing with such problems gives it an edge over other potential partners. Rosneft also regards BP's deep-water drilling technology and experience as cutting edge. BP's expertise received another vote of confidence when Australia granted BP licenses to initiate extensive drilling activity off its coast several days after the Rosneft announcement.
The share exchange gives Rosneft a 5% interest in British Petroleum's voting shares, making it BP's single largest shareholder. In return, BP receives a 9.5% ownership stake in Rosneft. Each stake is valued at about $7.8 billion. Both firms agreed to hold each other's equity for at least two years before selling any stock. BP's shares currently pay a dividend about twice that of Rosneft's. BP and Rosneft have stated publicly that they believe investors have significantly undervalued their firms. The Russian government has a particularly strong interest in seeing the value of its holdings appreciate, since it announced plans to privatize a number of largely state-owned enterprises, including Rosneft, in 2014 in order to raise funds.
At the time of the announcement, BP's market capitalization was about $154 billion. With almost 90% of its shares owned by the Russian government and Sherbank, Russia's biggest retail savings bank, the firm's stock trading in public markets tends to be limited and not reflective of Rosneft's true value. However, the terms of the share exchange imply a market capitalization for Rosneft of about $81 billion.
The transaction represents the first time there has been a cross-shareholding between major international oil firms and a major government-owned national oil company. Unlike more conventional oil and gas JVs, the Rosneft JV will not own the oil leases but merely the right to develop them. This structure is similar to Russian oil company Gazprom's agreement with France's Total SA and Norway's Statoil for the development of the Shtokman gas field in early 2008.
Rosneft became Russia's leading extraction and refining company after purchasing assets of the former privately owned oil giant Yukos at state-sponsored auctions, in which the global community decried what appeared to be the Russian government expropriation of the privately owned assets. In 2006, Rosneft conducted one of the largest IPOs in history by issuing nearly 15% of its shares on the Russian Trading System and the London Stock Exchange. With the shares priced at $7.55 each, the offering raised about $10.7 billion. Most of the proceeds went to the Russian government. BP began its relationship with Rosneft by buying $1 billion in shares in the firm's initial public offering, equivalent to 1.3%. Thus, the recent agreement brings BP's ownership interest in Rosneft to 10.8%.
Previous attempts to invest in Russia and to create partnerships between Russian state oil companies and Western oil firms have failed due to outright expropriation by the Russian government or heavy-handed tactics employed by certain Russian billionaires (so-called oligarchs) with close ties to the Russian government. For example, Russian officials forced Shell Oil to sell control of its Sakhalin II oil and gas development to state-owned Gazprom. BP and Gazprom signed a global joint venture in 2007 in which each was to contribute assets valued at $1.5 billion, but it was later dissolved due to disagreements between BP and large Russian investors. TNK-BP, BP's 50%-owned JV with a group of Russian billionaire business people, has also had a troubled history. The JV that contributes a quarter of BP's global production and nearly a fifth of its reserves was rocked by a shareholder dispute in 2008 that cost BP some of its control. BP chief executive Bob Dudley had served as chief executive of that JV for five years until he was expelled by BP's Russian partners during the disagreement.
On news of the agreement, BP's partners in the TNK-BP JV stated that BP had not notified them adequately and that the Rosneft deal violated their “right of first refusal” as stated in the JV agreement. The partners were successful in getting a court injunction in the United Kingdom to block the implemention of the JV in February 2011. TNK-BP at the time of this writing is considering a legal claim against BP for damages of up to $10 billion for allegedly reneging on its commitment to use TNK-BP as its main vehicle for investment in Russia. These developments raise serious questions about the longer-term viability of the BP-Rosneft JV.
Discussion Questions
1. Speculate as to the purpose of the share swap between BP and Rosneft.
2. What is the purpose of the two-year lockup period during which neither partner can sell its stock? How might the lockup period impact the value of each firm's holdings?
3. Would you expect the share exchange to be dilutive to BP shareholders in the short run? In the long run? Explain your answer.
4. Why would you expect the publicly traded Rosneft shares not to reflect the true value of the firm?
5. How would you estimate the market capitalization for Rosneft based on the terms of the share exchange? Show your work.
6. How can BP best protect its interests in the JV with Rosneft in the highly uncertain political and economic environment of Russia?
Answers to these case study questions are provided in the Online Instructor's Manual for instructors using this book.
2 Lerner, Shane, and Tsai, 2003
4 Kantor, 2002; Child and Faulkner, 1998; Lynch, 1990, 1993
5 Technically, a “handshake” agreement is also an option. However, given the inordinate risk associated with the lack of a written agreement, those seeking to create a business alliance are encouraged to avoid this type of arrangement. However, in some cultures, this type of informal agreement may be the most appropriate. Efforts to insist on a detailed written agreement or contractual relationship may be viewed as offensive.
8 Multistate franchises must be careful to be in full compliance with the franchise laws of the states in which they have franchisees.
9 For an excellent discussion of deal structuring in this context, see Ebin (1998), Freeman and Stephens (1994), and Fusaro (1995).
10 Mercer Management Consulting, in ongoing research, concludes that most JVs last only about three years (Lajoux, 1998), whereas Booz-Allen and Hamilton (1993) reported an average life span of seven years.
11 Examples of performance indicators include return on investment, operating cash flow, profit margins, asset turnover, market share, on-time delivery, and customer satisfaction survey results. Managers will ignore performance indicators if their compensation is not linked to their actual performance against these measures. The top alliance managers should be evaluated against the full list of balanced scorecard performance measures. The performance of lower-level managers should be evaluated only against those measures over which they have some degree of control.
12 In international JVs, the choice of common law or civil law countries for settling disputes can have profoundly different outcomes. Common law countries, found typically in North America and Western Europe, rely on case law (i.e., resolutions of prior disputes) for guidance in resolving current disputes. In contrast, civil law countries, located primarily in Asia, do not rely on case law but allow magistrates to apply their interpretation of existing statutes to resolve current disputes. Consequently, the outcome of certain types of disputes may be less predictable in civil rather than common law countries.
13 These special allocations can be made in the documents governing the creation of the partnership or LLC. Thus, partners or LLC members need not share the results of the venture on a pro rata basis. When one of the partners contributes technology, patent rights, or other property to the JV, the contribution may be structured so that the partner receives equity in exchange for the contribution. Otherwise, it will be viewed by the IRS as an attempt to avoid making cash contributions and treated as taxable income to the JV.
16 Chan, Kensinger, Keown, and Martin, 1997; Das, Sen, and Sengupta, 1998
17 Kale, Dyer, and Singh, 2002
18 Marciukaityte, Roskelley, and Wang, 2009
22 Kalmbach and Roussel (1999) indicate that 61% of the alliances are viewed as either disappointments or outright failures. This figure substantiates earlier findings by Robert Spekman of the Darden Graduate School of Business Administration that 60% of all ventures fail to meet expectations (Ellis, 1996). Klein (2004) reports that 55% of alliances fall apart within three years of their formation.
23 According to a Booz-Allen survey of 700 alliances (Booz-Allen and Hamilton, 1993), financial returns on investment are directly related to a company's experience in forming and managing business alliances. Companies with one or two alliances in place tended to earn a 10% average return on investment as compared with 15% for those with three to five, 17% for those with six to eight, and 20% for those with nine or more.