Alliances and Joint Ventures:Structures and Legal Issues

Craig McCrohonPartnerHolland & Knight, LLCJanuary 12, 2006craig.mccrohon@hklaw.com

Alliances and Joint Ventures:Structures and Legal Issues

Craig McCrohonPartnerHolland & Knight, LLCJanuary 12, 2006craig.mccrohon@hklaw.com

2

Craig McCrohon practices in the areas of corporate and securities, including technology and financial services. He advises companies and boards of directors regarding corporate transactions, director and officer liability, corporate finance, intellectual property and regulatory matters. His work has included organizing bank holding companies, negotiating venture capital investments, assisting with initial public offerings, providing general counsel to technology companies, and negotiating joint ventures in Europe, China and Hong Kong

He is a graduate of Harvard University and received his joint law degree from the University of Pennsylvania and M.B.A. from the Wharton School of Business. He also was a graduate student in law and economics at the London School of Economics. Prior to entering private practice in Chicago he worked with the legal staff of the United States Senate Committee on Banking, Housing and Urban Affairs. He is listed in Who's Who in American Law, and served as President of the Board of Directors of the Technology Executives Roundtable of the Evanston/Northwestern University Research Park, and was named by the Chicago Lawyer as one of the 40 Under 40 Outstanding Illinois Attorneys.

3

What is a JV?What is a JV?

4

JVs Like Pornography: You’ll Know it When you See ItJVs Like Pornography: You’ll Know it When you See It

• JV/Alliance Elements:– Long-term commitments– Bet the company deals– Gatekeeper power– Multi-departmental– Zero-sum element

5

The JV/Alliance Family TreeThe JV/Alliance Family TreeJoint

Venture

Equity

Partnerships/LLCs/Corps.

Corp. VC Distribution

Contractual

LicensesDevelopment/

Research

6

The Strategic Alliance ContinuumThe Strategic Alliance Continuum

One-shot customer/research agmt.

Bulk sale

Bulk Purchase

Distribution – non-exclusive

Distribution - exclusive

Joint Development

Technology/Process Licensing

Jointly-owned new entity

7

Blurred Boundaries: JVs Versus Other DealsBlurred Boundaries: JVs Versus Other DealsAcquisitio

n

JV Investme

nt

Bulk Sales

Actual Alliance

ContractDevelopmen

t

JointDevelopmen

t

Outsourcing

Joint Resources

8

JVs and Alliances as the Mother of All Consulting ProjectsJVs and Alliances as the Mother of All Consulting Projects

9

Psychology of the JVPsychology of the JV

10

The Problem: Company Yearns for Joint Ventures, but Isn’t Sure What They AreThe Problem: Company Yearns for Joint Ventures, but Isn’t Sure What They Are

• Keeping up with the Jones: – If my competitor announced a “joint venture” or “strategic alliance”, then I

should have one too– Supplier, customer proposes an “alliance”, but does not specify what this is– Reporting to senior management that more than a simple contract has been

executed

• Asking for the “preprinted strategic alliance form”

11

The Why of the JVThe Why of the JV

• Get money from someone else• Get technology• Access to markets:

– Regulatory hurdles– Foreign barriers to entry– Cultural barriers to entry

• Share risks– Iridium

• Share costs– Auto joint ventures

• Eliminate competition• Develop industry standards

(computers, auto makers)

12

JV Justification: More than Just LoveJV Justification: More than Just Love

Market Focused Technology Focused

Defensive Blocking;

Protecting existing customers;

Success=status quo

Acquire proprietary formulas, designs

Offensive Expand to new markets Acquire understanding of unwritten process

13

JV Justification: More than Just LoveJV Justification: More than Just Love

Market Focused Technology Focused

Defensive BlockingProtecting existing customersSuccess=status quo

Acquire proprietary formulas, designs

Offensive Expand to new markets Acquire understanding of unwritten process

14

JV Justification: More than Just LoveJV Justification: More than Just Love

Market Focused Technology Focused

Defensive BlockingProtecting existing customersSuccess=status quo

Acquire proprietary formulas, designs

Offensive Expand to new markets

Acquire understanding of unwritten process

15

JV Justification: More than Just LoveJV Justification: More than Just Love

Market Focused Technology Focused

Defensive BlockingProtecting existing customersSuccess=status quo

Acquire proprietary formulas, designs

Offensive Expand to new markets Acquire understanding of unwritten process

16

Sociology of the JVSociology of the JV

17

Concentrated Industries and Joint VenturesConcentrated Industries and Joint Ventures

• Like Europe on the eve of WWI: a few powers, unstable alliances• Automotive JVs:

– Rover Group/Honda (1980)– GM and Toyota Motor Corporation (1983) agree to form a joint venture, New

United Motor Manufacturing, Inc. (NUMMI), to produce a small Chevrolet automobile in the Fremont, Calif., assembly plant previously operated by GM

– GM/Volvo (1986) (U.S. production)– GM/Toyota (1987) (Australia production)– Ford/Nissan (1992)

• PC Hardware and Software JVs:– IBM/Microsoft 1988 (OS/2)– IBM/Apple: 1991 Kaleida; Taligent (in 1994, adds HP)– Apple/IBM: 1997– Microsoft/IBM: 2001 (Amicore)

18

Industry Defines the Agreement, Like Sports Defines the AthleteIndustry Defines the Agreement, Like Sports Defines the Athlete

• R&D joint ventures– Pharmaceuticals– Biotechnology

• Distribution alliances– Software– Manufacturing– Services

• Manufacturing joint ventures– Automotive– Consumer/business durables (copy machines, refrigerators)

• Strategic marriages– Cross-border JV’s– Real estate joint ventures

19

Strategy of the StrategyStrategy of the Strategy

20

Strategic Alliances as a Chess GameStrategic Alliances as a Chess Game

Success determined by more than simply ROI

• If we don’t do the deal with them, will my competitor?• Locking up the best JV partners• Locking up markets• Locking up suppliers, distributors, governments• Hurting the competition, and little else

– Life as a zero sum game

21

Game Theory and AlliancesGame Theory and Alliances

• The everybody wins, many fish in the sea NON-game• Hold up game• Prisoners Dilemma – multi-period game• The zero-sum game• Signaling• Short versus long-term exploitation

22

OxymoronsOxymorons

• Jumbo Shrimp• Middle East peace

Alliance Portfolio

23

JV SpecimensJV Specimens

24

The Brief Sad Life of Iridium: 1990 - 2000The Brief Sad Life of Iridium: 1990 - 2000

• Among the partners: Lockheed, Raytheon, Sprint• Global satellite network• $5 billion satellite network; only 10,000 customers• Bad first call: VP Al Gore• One of the largest bankruptcies in history at the time• Was it a failure?

25

Fisher Body/General MotorsFisher Body/General Motors

• Fisher Body supplier to GM• 1919 GM acquires 40% - 60% of Fisher Body• 10-year supply contract• Fisher Body threatens to locate plants far from GM

assemblies• 1926: GM acquires Fisher Body

26

International ExamplesInternational Examples

• Italian submarines and Chinese jungle power plants– The hold up problem

• European market research– The prisoners dilemma– Long-term became short-term game

27

The How-To Manual: Getting StartedThe How-To Manual: Getting Started

28

Cutting Through the FogCutting Through the Fog

• What does the company actually want:– Identifying the transaction components, legal categories– Joint venture entity– License– Distribution Agreement

• Greatest need for integrating the business with the legal decisions

29

The Complexity of the Joint VentureThe Complexity of the Joint Venture

• Not the straightforward two-party transaction• Multiple parties

– Competing interests, timetables, resources, cultures

• Multiple venues– regulated versus unregulated; domestic versus foreign; for-profit versus association

• Multiple transactions– Licenses, partnerships, distributorships, leases

• The Multiplying Matrix– Not: 3 + 3, but 3 x 3

• Balancing extreme pessimism of the law, extreme optimism of the manager

30

Legal PracticalitiesLegal Practicalities

• Simplify transaction– Fees can be enormous

• Target streamlined:– Management– Dispute resolution– Accounting– Structure– Unwind provisions

31

JV – Basic StructuresJV – Basic Structures

32

Master Joint Venture AgreementMaster Joint Venture Agreement

Master JV Agreement

Entity Agreement

License Agreements

Financing Agreements

33

JV Structure: Bypassing the Long-Form JV AgreementJV Structure: Bypassing the Long-Form JV Agreement

Contrib.Agreement

Distribution

Leases

OperatingAgreement

Trademark License

Licenses

JV Entity/LLC/LP Agrmt

LOI?Distinct Entity, Distinct

Transactions

34

The Contractual Alliance: Single DealThe Contractual Alliance: Single Deal

Licensor/Manufacturer

Licensee/Contractor/Researcher

35

Contractual Joint Ventures:No Master Agreement ShellContractual Joint Ventures:No Master Agreement Shell

• Licenses• Distribution agreements• OEM arrangements• Supply agreements• Development agreements

36

Pre-nuptial Agreements or Purchase Orders?Pre-nuptial Agreements or Purchase Orders?

• Contractual alliances must be:– Long-term– Exclusive– Significant– Jointly governed

• Industry/product specific terms– Delineate territory– Specify standards

• Invading their personal space:– When the legal agreement includes business details

37

Joint Ventures – the AgreementsJoint Ventures – the Agreements

38

Summary Checklist:Master Joint Venture Agreement – The Town PlanSummary Checklist:Master Joint Venture Agreement – The Town Plan

OverviewOutline of new entityOutline of non-competition obligations

Products and services deliveredTerritory of operation

Outline of future entity agreementsPercentage ownershipListing by country/industry

Capital contributionsConditions to closingAppointment of initial directorsContributions to be madeThe “no joint venture” joint venture disclaimers

39

One Little Definition – Huge ImpactOne Little Definition – Huge Impact

• The product• Uses• Geographic market• Milestones• Time period

40

Joint Venture Entity: Organizational Documents – The House DesignJoint Venture Entity: Organizational Documents – The House Design• Limited Partnership Agreement, Operating Agreement

– Twin of the master joint venture agreement; often used as the form for the master joint venture agreement– Parallel structure:

• Purpose• Capital contributions• Management• Dissolution• Transfer restrictions• Dispute resolution

• The corporate packet– Articles of incorporation– Bylaws– Shareholders Agreement

41

Summary Checklist:Ancillary Equity Joint Venture Agreements – Interior DecoratingSummary Checklist:Ancillary Equity Joint Venture Agreements – Interior Decorating

• Financing agreements– Secured/unsecured– Covenants/defaults

• Other licenses and distribution agreements:

42

Joint Venture Entity:Contribution AgreementJoint Venture Entity:Contribution Agreement

• Specify assets• Representations and warranties• Closing conditions

43

Contribution Agreement TrapsContribution Agreement Traps

• Insider transactions• Inflated asset values/questionable accounts

– receivable

• Litigation• Title to intellectual property• Employment agreements/change of control• High risk/high cost employees

– Beware foreign laws regarding accepting employees who are VERY expensive to terminate

• Concealing true reason for alliance interest: Desperate for someone with cash

44

Joint Venture Entity:Operating AgreementJoint Venture Entity:Operating Agreement

• Rent– Beware assignment of the worst space: outskirts of Frankfort

• Salaries• Allocation of overhead• Transfer pricing

– Beware of inflated prices, especially at a distance• Schedules identifying assets contributed, services to be

provided– Which machines– The backdoor termination: shifting workers to shift termination costs

45

Control: Equity Joint VenturesControl: Equity Joint Ventures

JV or Operating Agreement• Executive hires• Significant spending• Financial reporting• Approval of business plan• Significant corporate transactions• Borrowing, sales of equity• Disposal of assets• Non-competition/non-solicitation

46

Termination TriggersTermination Triggers

• Bankruptcy• Failure to fund/contribute• Failure to achieve milestones• Anti-trust judgments• Change of control• Breach of confidentiality/non-competition

47

Lessons from the Life Sciences JVLessons from the Life Sciences JV

48

Ostex/Metrika: Ostex Direct ContributionsOstex/Metrika: Ostex Direct Contributions

Non-exclusive License technology to selected reagents for measuring bone collagen metabolites

Fund clinical trials and regulatory applications Purchase of Metrika stock Marketing expenses Royalties to Metrika for sales

49

Ostex/Metrika: Ostex ContributionsOstex/Metrika: Ostex Contributions

Assist with regulatory approval of Metrika measurement deviceTechnical assistance regarding assay technology to development

measuring deviceTraining of Metrika’s employees in the critical reagentsSell the measurement devices

50

Ostex/Metrika: Risk ShiftingOstex/Metrika: Risk Shifting

For first 90 days, either party may terminate if appears that the other cannot meet its obligations

Initial term of at least one year; automatic one year renewal termsTermination after six months notice if development schedules

unsatisfied by a partySix months notice if commerciality determined not commercially

viable30 days notice if parties cannot agree

on allocation of cost overrunsTerminates upon expiration of

applicable patents, bankruptcy ofa party

51

Ostex/Metrika: Documentation and ManagementOstex/Metrika: Documentation and Management

Product Management committeeBoth parties report quarterly regarding marketing activities and

orders madeRolling forecasts by Metrika for quantities of critical reagents

from OstexGeneral business plan for the venture

52

Ostex/Metrika: Ownership of New InventionsOstex/Metrika: Ownership of New Inventions

If relating to the Ostex technology exclusively, then with Ostex

If relating to the Metrika technology exclusively, then to Metrika

In all other cases, with the party for whom the inventor works

53

Ostex/Metrika: Metrika ContributionsOstex/Metrika: Metrika Contributions

Manufacturing facility

Royalty payment to Ostex for use of Critical ReagentsFund clinical trials and regulatory applications for measuring

deviceCommitment to pay a percentage of gross sales for marketing the

measurement devices for the first yearPayment of customs duties and taxes on the reagents and

measurement devices Invent a measurement device Regulatory approval for the device

54

Ostex/Metrika: Dispute ResolutionOstex/Metrika: Dispute Resolution

Escrow account; prevailing party gets the funds plus 10%15 – 60 day cure periods for breachesArbitration, after third party mediation

55

Common JV Problems

Common JV Problems

56

The Alliance Life SpansThe Alliance Life Spans

0

5

10

15

20

25

1 2 3 4 5 6 >6

Years Until Termination

Built-in Obsolesence

% Terminated: AutoJVs

57

Matching CulturesMatching Cultures

• Profit/for profit• Institutional/entrepreneurial• Capitalist/communist• Eastern/western• Publicly held/closely held• Different levels within the organizations• Differing significance to the partners

58

Balancing RisksBalancing Risks

Similar Business

New Business

Non-Competit

or

DirectCompetit

or

JVExperienc

e

New to JVs

Equal Leverage/Importanc

e

Unequal Leverage/Importanc

e

CultureSimilar

CultureDissimilar

59

Conflicts of InterestConflicts of Interest

• Using money for intended purpose• Shifting funds to projects of more interest to only one party• Doing nothing • Allocating inventive responsibility when scientist working on

joint development and proprietary development simultaneously

60

JVs Like Hollywood Couples: The Inevitable Break-upJVs Like Hollywood Couples: The Inevitable Break-up

• Changing market• Learning technology• Learning markets, making friends• Spoiled by success• Changing fortunes of the partners

61

Crime and PunishmentCrime and Punishment

Techniques for Punishing Non-Performing Partners* dilution of interests (failure to make capital call)* loss of director, officer role* reversion of IP rights to the other party* increase product costs to a partner* release one party from exclusivity obligations

62

Calling it QuitsCalling it Quits

63

When the Honeymoon Is OverWhen the Honeymoon Is Over

• Abusive insider transactions:– Excessive rent/transfer pricing

• Poor financial records• Fraternizing with the enemy: doing deals in violation of non-

competition covenants• Asleep at the wheel: ignoring obligations• The Common Theme: Siphoning money, signaling interest in

terminating the arrangement• Solutions: solve the problem; turn out the lights• Lawyer as letter writer: need to continually document actions

64

Termination RemediesTermination Remedies

• Sale of interest to partner– Punitive valuation

• Valuation formula, premium applied

• Purchase of interests from partner– Punitive valuation

• Valuation formula, discount applied• Book value

• Sale of the entire JV• Liquidation of the JV• Do nothing/stay married

65

Ostrex: After the Divorce: Dividing the AssetsOstrex: After the Divorce: Dividing the Assets

• Product of the joint venture– Each party non-exclusively– One party, pursuant to a license– Each party, according to field of use or territory

• Variations if agreement terminated through the fault of one of the parties

• If developed solely by a party, then to that party• If shares of a joint venture entity, then valuation and

purchase by a party; otherwise liquidation and cross licensing

Alliances and Joint Ventures:Structures and Legal Issues

Craig McCrohonPartnercraig.mccrohon@hklaw.com

*Holland & Knight LLP is a limited liability partnership registered under Florida law. In Illinois, Holland & Knight LLP is a limited liability partnership registered under Florida law. In Illinois, attorneys practice as Holland & Knight LLC, an Illinois limited liability companyattorneys practice as Holland & Knight LLC, an Illinois limited liability company

Alliances and Joint Ventures:Structures and Legal Issues

Craig McCrohonPartnercraig.mccrohon@hklaw.com

*Holland & Knight LLP is a limited liability partnership registered under Florida law. In Illinois, Holland & Knight LLP is a limited liability partnership registered under Florida law. In Illinois, attorneys practice as Holland & Knight LLC, an Illinois limited liability companyattorneys practice as Holland & Knight LLC, an Illinois limited liability company