Wednesday, April 8, 2020

Joint ventures as way to assist SMEs in becoming globally competitive

This article is intended to help anyone who is an entrepreneur and wants to expand their business in a joint venture (JV) to understand and cope with some of its advantages and disadvantages. The backdrop is a workshop held on 7 June by the Exporters Association of Botswana (EAOB) in collaboration with the Southern African Global Competitiveness Hub (Botswana Trade Policy and Programme) and the Ministry of Trade and Industry. The workshop’s main objective was to assist small and medium enterprises (SMEs) in becoming globally competitive, profitable and sustainable by entering into JVs with outsider participants. I was asked to facilitate the workshop and, together with others, to address reasons for forming JVs, their types, structure, benefits, failures, and successes. The article has largely grown out of the workshop’s ideas and exchanges and therefore owes a lot to all those who spoke from the podium and the many others who made their invaluable interventions from the floor.

JVs are among the earliest commercial vehicles found in Botswana, and precede independence in 1966. One prime example is the agreement negotiated in 1959 with RST, the outcome of which was the formation of BCL, a minerals company prospecting in the then Ngwato Tribal Reserve. A more recent example is course Debswana, a long-standing partnership between the Government and De Beers. JVs owe their origin in this country to factor endowment. Mineral exploration and development require unusually vast amounts of capital, know-how and technology that for many years could only be acquired through collaboration between the Government and foreign mining companies.

Historically, JVs have been the primary arrangement by which foreign mining companies were able to assume a presence in the national economy. Understandably, collaboration in the resource sector mainly occurs at the governmental level because legislation vests nearly all mineral rights in the state. In general, JVs have struggled for popularity in the private sector. In stark contrast, these arrangements have been fairly common for a long time in the more diversified economies of other developing countries. Although the developing countries experienced a decline in their share of world trade until the mid-1990s, there now seems to be a turnaround in developing country trade due mainly to the increased price of raw materials and commodities. None the less, in the garment and clothing sector some of the Least Developed Countries such as Lesotho have dramatically improved their trade performance over the last decade, thanks largely to AGOA. Regrettably, our own export companies have not taken full advantage of the preferential treatment available under AGOA. Speaking at the EAOB workshop, Ambassador Katherine Canavan observed that while the programme had 6500 eligible line items, Botswana’s exports to the US were mostly apparels, and challenged the participants to widen the range of exports under AGOA. The point I wish to make is that JVs represent a way of enabling SMEs to play a more effective role in export-oriented economic diversification.

To better understand a JV structure the focus must be on describing its main features rather than defining the concept. The main features are: (i) the association of two or more participants who can be individuals, a group of individuals, private companies or public companies; (ii) the participants must carry out a commercial project together for mutual profit; and (iii) the participants must set up “a special-purpose legal vehicle” to undertake the common enterprise.
Parties to a joint venture have to decide whether a contractual structure is a suitable form of conducting business or whether the business would be better performed by a separate legal entity. In practice, there are a wide range of approaches to collaborative working including the joint bid, partnership, corporate form, company merger or acquisition, etc. In the joint bid participants bring their experience and interests to the bid (with the lead organisation putting the bid together) and they revert to their previous work usually where the bid is unsuccessful.

If the JV is a partnership, typically, the partnership agreement deals with ownership of business assets, joint control of the business, joint liability, cost and profit sharing, etc.

If it is not, a participant cannot bind other participants by his or her act (unless authorised to do so by agreement), or incur obligations that others have incurred separately to third parties. We can sense that the exact difference between a JV and a partnership is sometimes one that is difficult to explain. In one sense, the JV is a legal partnership; in another sense, it is not a partnership. A JV can take on a corporate form and in some instances two or more companies merge. A company merger takes place for many reasons including rationalisation and economies of scale and size or service synergies. In contrast, a take-over is used to solve the problems of a company experiencing financial trauma or that is ailing.

The above cases illustrate the different degrees of collaboration. Which of the different approaches is preferable to participants is usually dependent on such factors as domestic economic policy, tax, organisational purpose, or whether funding is tied to collaborative efforts. The participants can agree between themselves to undertake their business on a short or long term basis.

If the purpose is short-lived it might not make good business sense to incur time and expense setting up a corporate JV vehicle. One instance is where a given country’s economic policy requires at least one participant to be a citizen to qualify for a public tender or where a joint bid is specifically required. The participants may do this by means of entering into a number of contracts between them which are (progressively) designed to regulate various aspects of this undertaking. If the bid is unsuccessful, it means that the substratum of the JV collapses. On the other hand, it is poor advice to set up a transitory structure if the objective is a permanent pooling of skills and resources so as to undertake business over an extended period of time.

From the point of view of efficient tax planning (whether the JV is a transient or permanent transaction), some questions on the tax consequences of the JV arise: whether the participants will benefit from losses and expenses previously incurred separately when the JV was being negotiated or structured; whether these losses and expenses will be locked into the new legal vehicle; whether the JV will benefit from the higher tax rates for partnerships or the lower tax rates for companies; whether dividends distributed to shareholders will be subject to further taxation; whether the JV company should be listed on the Stock Exchange so that dividends are exempt from tax; whether a share employee scheme would impact on tax liability; and so on and so forth.

In a special-purpose vehicle each person or company contributes assets and shares risks, profits and decision-making. In fact, joint ventures are attractive because they enable participants to share both risks and costs. It is this element of risk and cost sharing that mainly distinguishes joint ventures from shams disguised as legitimate collaboration such as “fronting” by citizens for payment of consideration in one form or another. Participants do not always have to contribute money as part of their commitments, and by agreement some may contribute intellectual capital (e.g., an accountant) or even “sweat capital” (e.g., a wheeler dealer). Such service to the common enterprise may be valued and paid for by allotment of shares.

What then, are the benefits of JVs? What attracts the foreign participant to the joint venture is that the citizen, presumably, has already established the relationship and requisite governmental documentation such as licences within the home country. What attracts the citizen (risk reduction through capital and resource sharing aside), is that the foreign company brings new technologies and business practices into the JV, the opportunity to increase sales, gain access to wider markets, the capacity to manufacture and market new products, and the longer-term prospect of the JV being used to gain entrance into foreign economies.

There is also the international aspect.

Where a JV is entered into by two or more participants of different countries, the process of establishing the JV tends to be more laborious, time consuming and legally complicated than would otherwise have been the case had one been dealing with the process of creating a joint venture between two or more participants from the same country.

Travel and communication become a factor due to the need for at least one to familiarise oneself with the practices of the foreign environment with which to deal, e.g., due diligence and the import of technological know-how. Additionally, it is obvious in a JV between two citizens which legal system it is whose rules apply. But not so regarding a JV involving a foreign based person or company. This gets even more complicated if the participant is based, say, in the United States because of the federated system which has produced federal and state law. This consideration leads to the question of a legal environment.

An American judge has said that the growth and expansion in world trade has at the same time resulted in increasing use of international arbitration as a dispute settlement mechanism in that trade. Aarbitration is used increasingly to resolve international commercial disputes because there is no realistic alternative. The export trade presupposes the conclusion of international sales contracts, and thus the problem of different national origins arises. When JV participants are of different national origins, it is important to choose a neutral law that has no link with any them. The choice of the seat of future contractual disputes must be convenient for them taking into account access, language, available legal services and production of evidence. Therefore, the parties’ choice of the proper law of the sales contract is critical because this proper law is the law that governs their contractual rights and obligations.

The UN Convention on Contracts for the International Sale of Goods of 1980 (CISG) is intended to assist parties in resolving their commercial disputes. However, the number of acceptance of the CISG by African countries has been disappointing. In Southern Africa, only Zambia and Lesotho have acceded. Second, a Model Law on International Commercial Arbitration was prepared by the UN Commission on International Trade Law in 1985. The Model Law has been a major impetus behind the increasing usage of arbitration internationally, but, with the notable exception of Zimbabwe, few countries in Southern Africa have signed, despite that all pre-1985 English based model arbitration statutes (e.g., our Arbitration legislation dates back to 1959) are unsuitable for international arbitration.

The main conclusion is that the workshop represented early steps in a long march. Clearly, the task of establishing JVs can be challenging to participants and their professional advisors alike. The reason for this is that joint venturing is an area characterized by the interplay of commercial, financial, technical and legal factors that can sometimes be difficult to separate. This broad range of issues needs to be researched when collaboration is proposed. In other words, participants must have the benefit of multi-disciplinary advice, a tall order for most legal practitioners. In addition, even as JVs are being embraced, albeit begrudgingly, the lack of an enabling environment hampers the global competitiveness, profitability and sustainability of SMEs.

RELATED STORIES