A joint venture is when multiple business entities start a new business together as a cooperative arrangement. When creating a joint venture, each of the involved entities agrees to what assets they will contribute, how they are going to distribute income and share expenses, and how the new entity will move forward.
Owners need to carefully assess how to proceed before deciding to get involved in this type of business enterprise. It is essential that every detail of the new organization’s operations is addressed ahead of time. This includes from a management and tax liabilities perspective, down to how profits and losses will be distributed.
Forming a Joint Venture
Even though a joint venture represents a cooperative between business entities, each entity retains its original legal status. This includes whether they are companies, corporations or individuals. Not all joint ventures involve the actual formation of a new business entity. However, if a new entity is created – it will need to pay its own taxes. In this case, tax liability is based on the form of business entity adopted. If unincorporated – the tax on profits will belong to the entities who originally joined the agreement. As a corporation, a venture will have its own tax responsibility.
A joint venture can exist solely as an agreement between the original cooperating entities. Whatever form this collaboration takes, it is best to formalize it with a detailed contract. This type of contract should specify certain baselines including:
- what assets each of the participating entities will contribute,
- how the new entity will be managed,
- who will be in control of important decisions, and
- how the distribution of profits and losses will be accomplished.
Why Form a Joint Venture?
There are numerous advantages to forming a joint venture. The most common include combining distinct talent and background from two separate entities to create a novel product or service. Or taking advantage of one entity’s strength in marketing with another’s innovation. A successful example of this business arrangement is the BMW Brilliance Automotive, Ltd. BMW Group and Brilliance China Automotive Holdings formed this venture. The two created a new entity to sell BMW vehicles in China, leveraging Brilliance China’s geographic presence to sell BMW’s products.
Among the reasons to consider this type of arrangement include:
- Leveraging the combined resources of multiple entities in order to strengthen the organization’s strength and viability.
- Leveraging the expertise of one or more of the original entities in order to create a better product. Or improve the product’s delivery or marketing.
- To achieve economies of scale.
How Does It Work?
A joint venture can take the shape of any type of business entity, including a partnership or corporation. However, whatever type of entity the founding entities land upon, decisions need to be made. Specifically these include:
- division of stock (if a corporation),
- who will be on the board of directors,
- how much responsibility for the new entity’s management each original entity will carry.
In some cases, a joint venture is established under a unique federal income tax arrangement. They call this a qualified joint venture. Under these circumstances, this type of tax arrangement allows a married couple greater simplicity in filing their joint return than they would find if a business they operate together were to be established as a partnership.
Though similar, a consortium is not the same as a joint venture. Different from a joint venture, a consortium is a more casual business arrangement that does not involve the creation of a new entity. Rather, in a consortium, distinct entities remain separate but make the decision to cooperate.
Crafting a Business Agreement
While that multiple entities could enter a joint venture on a casual basis, or even consider this collaborative effort via an oral agreement, there is usually some legal contract. (There is no requirement that a joint venture register with either a state or federal government). It is important to realize it is undeniably better to involve an attorney who can craft a document that all parties agree with. A well-formulated agreement may include:
- The names of all entities involved in the agreement
- Type of management structure that will be adopted
- The ownership percentage of each of the named members
- If a percentage of profit/loss allocated to each named member (also known as their distributive share)
- The name of the bank through which the business will manage its funds
- The identities of all contractors and employees who will manage the day-to-day operations
- The resources available for the organization
- How financial statements and records will be created, dispersed, documented and archived
- Under what state’s laws the joint venture will operate
If you have any questions about joint ventures or business entities, please contact our office.
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