What is a joint venture?
In a joint venture (JV), two or more parties agree to do business together and use their resources jointly to achieve a specific goal. In other words, a subsidiary is founded by two independent companies. The duration of the project, or even the size of the parties, is not decisive. Joint ventures can therefore differ in a number of criteria, such as the number of parties, the area of cooperation (the project could, for example, only relate to one business unit), the equity participation (not all parties have to be equally involved), the duration of the joint venture and the location. The parties share the profits, but also the possible losses, risks and costs of the project. The management is also assumed by all parties involved.
Reasons for forming a joint venture
There are basically four reasons why companies set up a joint venture.
- Leverage of resources: A joint venture has the opportunity to utilize the resources of all parties. This means that the strengths of all parties can be utilized.
- Cost savings: Economies of scale ensure that costs can be saved. Economies of scale arise, for example, when a large quantity of products is produced. This can be achieved by pooling resources. The costs always consist of a proportion of fixed costs that cannot be reduced (e.g. rent). As long as production takes place within capacity, the fixed costs do not change. By using the combined resources, the maximum can be utilized.
- Combined expertise: By working with different parties, combined expertise can also be utilized.
- Entry into foreign markets: Another advantage can be access to foreign markets.
Advantages and disadvantages of a joint venture
One advantage of the joint venture is access to resources without having to invest a lot of new capital. As mentioned above, there is leverage of resources, cost savings can be made, expertise is combined and it allows some companies access to foreign markets. Each company can return to normal business operations after the joint venture and does not lose its identity. In addition, the risk is shared by all parties.
The disadvantages of joint ventures are that some contracts can, for example, restrict other external activities while the joint project is running. The contracts can damage existing relationships with suppliers or other business partners. Another disadvantage is the coordination effort and the possible outflow of expertise.
Types of joint venture
There are different types of joint venture. When we talk about a joint venture, we often mean an equity joint venture. Another option for carrying out a joint business activity is the contractual joint venture.
Equity joint venture
In an equity joint venture, a new independent company is legally established. One advantage can be that the company can finance itself externally and may have access to the capital market if the company is founded in the form of a stock corporation. Each company can be involved in the equity joint venture in different ways. A lower equity stake usually also leads to a reduction in decision-making powers. Profits and losses are shared between the parties.
Contractual joint venture
In a contractual joint venture, no new company is founded. The joint venture is therefore based on contracts that have been negotiated and concluded between the companies. In general, the contracts can be structured more freely. For example, the parties can decide for themselves how profits and losses are to be shared between the parties. Voting rights can also be freely distributed. The formation of a contractual joint venture is generally more favorable. While the liability of an equity joint venture is limited to the equity capital (legal form of a corporation), this is not the case with a contractual joint venture.