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Court Your Equal: Selecting a Partner for an International Joint Venture The first phase of an international strategy for small and medium size businesses often consists of setting up sales agents and distributors or arranging licensing agreements. These strategies are good for testing the waters and augmenting revenue, but many firms eventually conclude that to make their international efforts worthwhile, a more serious commitment is required. This commitment can take many forms, from franchising to acquiring a company to making a greenfield investment. One alternative that generally falls midway between agency and greenfield is the joint venture. More than just a strategic alliance, the joint venture alternative can significantly increase revenue and market share while spreading costs and sharing risks. The search for a joint venture partner should begin by courting firms that bring not only equal value to the table but equal fundamentals to the relationship. Let's begin with equal capital contributions. All businesses need capital in order to conduct operations. (For purposes of this article, a joint venture is considered to be a separate legal entity; that is, a company, partnership, or one of the various legal entities that limit liability. Joint ventures can be purely contractual, but these are often formed for one-off or short-term transactions and can be considered a strategic alliance.) Without making too much of an issue of relative currency fluctuations, cold hard cash, by definition, is easy to value. Both parties (or all parties if there is more than one joint venture partner) should contribute nearly equivalent amounts of cash even if ownership of the new entity is not split 50/50. Cash contributions are significantly more valuable than the “stated value” of in-kind contributions. Not only is the cash liquid, but it also represents the ability of that firm to sell products or services in their market place. Partners that have earned their cash will feel its loss more acutely than a sweat equity contribution. A cash contribution further assures that all parties work hard not to lose their money, oftentimes a more powerful incentive than working to assure the success of the project. Next, in-kind contributions come in many forms ranging from market knowledge and relationships to allocation of employee time to intellectual property. Just by having a company on your list of potential suitors means you value their in-kind contribution to the relationship. The issue then is not what they bring to the table but how that contribution is valued, a vague and fluid proposition that is likely to vary in different countries and even within different markets of the same country. For example, the value of a firm’s proven competence to market consumer products through a distribution channel. This contribution is more valuable in China than in England due to the size and growth of the market, barriers to distribution in lesser developed economies, potential product margins, and lack of competitive alternatives. The converse is true if you intend to sell luxury products where brand recognition is meaningful. The English partner’s in-kind contribution of luxury product distribution is likely to be more valuable in the upper scale European market. The best way to reasonably value your prospective partner’s in-kind contribution is to do your homework. First, determine the value of the contribution as it relates to your firm by running a spreadsheet analysis on market share, margins, investment horizon, and other critical variables. There is no substitute for crunching the numbers. Next, determine the value of the in-kind contribution within that specific market place. There may be more than one potential partner that can bring the key competency to the relationship at similar prices. There is no substitute for due diligence. You should court various partners to determine value in the marketplace the same way you would seek comparable values if you were buying a house. Not surprisingly though, equal contributions are not the same as an equal partnership. It may be prestigious to collaborate with a multi-national, publicly recognized market leader but it may not be the best partner for your international venture. The multi-national’s heft and authority cuts both ways. A one million dollar investment will not carry the same weight and commitment with a large company as the same investment with a small or medium size company. A significantly more dominant company can walk away from the venture if it doesn't meet expectations. It also will be easier to force the smaller firm out and not share profits if the venture goes better than expected. Conversely, there are concerns if you are the large company in the relationship. What if the venture requires more resources than initially planned? Can the small company scale or manage rapid growth in a foreign market? What happens if the small firm begins to experience a downturn in its domestic revenue? When you are evaluating suitors for an international joint venture, take into consideration the size of the company, its market share, its willingness to commit comparable intrinsic value, reputation, etc. Even if you already have an established relationship with your prospective partner, considering other partners is still a valuable exercise. Finding just one feasible alternative may improve your negotiating position. Does all this mean that you should not endeavor into foreign markets unless you have an equal partner? Of course not. There may be different structures that are more appropriate for unequally paired companies. The point is that you should not seek to massage an unequal relationship into an “equalizing” or “neutralizing” deal structure. Instead, your deal structure and contracts should tighten an already equal relationship. Choosing the right partner is the best protection for your investment and ultimately determines the success or failure of your international endeavor. More information on this topic and a variety of other investment banking topics can be found at www.FocusEnterprises.com. Brad Fleisher Lawyer & Principal Focus Enterprises, Inc. Brad.Fleisher@FocusEnterprises.com