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MACR/U1 Topic 6 Tax motives Financial Evaluation, Joint Venture and Strategic Alliance

A company with a large taxable income will look at merging with a company with large carry forwards tax losses. By doing so, the acquiring company can lower the tax liability. A merger purely for reducing tax liabilities will not be approved by regulators, however, companies can hide this reason under other strong motivations to merge.

UNLOCKING HIDDEN VALUE

A struggling company may be bought by an acquirer to unlock its hidden value. The acquiring company may believe that by making some improvements in management and organizational structure and adding more resources, it can make the company perform better. Of course, the acquirer will pay a lower price than the market price.

JOINT VENTURE

In any case, the parties in the JV share in the management, profits, and losses, according to a joint venture agreement (contract).

Joint ventures are often entered into for a single purpose – a production or research activity. But they may also be formed for a continuing purpose.

Examples of Joint Ventures

Joint ventures can combine large and small companies on big and little projects. Here are some examples: 

MillerCoors is a joint venture between SABMiller and Molson Coors Brewing Company to see all their beer brands in the U.S. and Puerto Rico.

In 2011, Ford and Toyota agreed to work together to develop hybrid trucks. 

Mining and drilling are expensive propositions, and often two companies in these industries will combine as a joint venture to mine or drill in a particular area.

Forming a Joint Venture

All that’s needed to form a joint venture is a written agreement between the parties.

The agreement should spell out the details of the purpose, how the two (or more) parties share in profits and losses, and how the parties share in making decisions about the joint venture. A joint venture, even if it’s between two small businesses, should have at minimum this sort of written agreement

What a Joint Venture is NOT

A joint venture may have some similarity to a partnership, but it’s not. A partnership is a single business entity formed by two or more people. A joint venture joins several different business entities (each of which may be any type of legal entity) into a new entity, which may or may not be a partnership. Partnership income taxes are paid by the owners individually.

Don’t confuse a JV with a ‘qualified joint venture,’ – a specific taxation form for husbands and wives in partnerships.

You may have heard the term “consortium” used to explain a joint venture.

A consortium is a looser arrangement between several different and distinct business entities. A consortium doesn’t create a new entity. In the travel industry, for example, a consortium of travel agencies allow memberships with benefits. The consortium negotiates on behalf of its members for special rates from hotels, resorts, and cruise lines.

What Are the Risks Involved?

Because strategic alliances are built on trust and convergent goals, one of the main risks you can face may occur if the partners are from different cultures. They may not trust operating a certain “way” or have divergent goals. Even with similar strategic goals, two partners who lack trust in each other may lack the willingness to reciprocate. When joint venturing, be prepared to give and take.

This sharing principle should govern the entire process. Many potential joint ventures, including large-scale projects, have died before the ink on the contract was dry, because of divergent goals and self-serving attitudes, which are not in sync with the essence of the joint venture. One example of this was the British Aerospace/Taiwan Aerospace alliance. After tough negotiations, the two parties signed an agreement during a celebrated ceremony in Taiwan. Soon after, Taiwan announced its wish to pull out of the deal. Why? Because their goals were divergent. Taiwan wanted to acquire new technology, which the British refused to give away, and the British wanted to capture new markets in Asia, which Taiwan refused to grant.

A joint venture concept is only effective when there is a true willingness to move forward together. Not even signed contracts have value if mutual trust and acceptance of the terms are not present. It is actually better not to consider a joint venture project if motives from either side are questioned by the other side. A graceful exit before any legal obligation takes effect will most likely prevent an inevitable failure. The risks involved are therefore simple to evaluate. You can:

  • Waste your time
  • Lose money
  • Let go of important technology
  • Gain nothing of significance in return
  • Squander your credibility

Even though these and other risks in joint ventures are present, the rewards can far outweigh pitfalls. It is important to completely evaluate your risks, and do your homework before and during the process.

Strategic Alliance

Strategic alliances are agreements between two or more independent companies to cooperate in the manufacturing, development, or sale of products and services or other business objectives.

For example, in a strategic alliance, Company A and Company B combine their respective resources, capabilities, and core competencies to generate mutual interests in designing, manufacturing, or distributing of goods or services.

Types of Strategic Alliances

There are three types of strategic alliances: Joint Venture, Equity Strategic Alliance, and Non-equity Strategic Alliance.

#1 Joint Venture

A joint venture is established when the parent companies establish a new child company. For example, Company A and Company B (parent companies) can form a joint venture by creating Company C (child company).

In addition, if Company A and Company B each own 50% of the child company, it is defined as a 50-50 Joint Venture. If Company A owns 70% and Company B owns 30%, the joint venture is classified as a Majority-owned Venture.

#2 Equity Strategic Alliance

An equity strategic alliance is created when one company purchases a certain equity percentage of the other company. If Company A purchases 40% of the equity in Company B, an equity strategic alliance would be formed.

#3 Non-equity Strategic Alliance

A non-equity strategic alliance is created when two or more companies sign a contractual relationship to pool their resources and capabilities together.

Reasons for Strategic Alliances

To understand the reasoning for strategic alliances, let us consider three different product life cycles: Slow cycle, Standard cycle, and Fast cycle. The product life cycle is determined by the need to innovate and continually create new products in an industry. For example, the pharmaceutical industry operates a slow product lifecycle, while the software industry operates in a fast product lifecycle. For companies whose product falls in a different product lifecycle, the reasoning for strategic alliances are different:

#1 Slow Cycle

In a slow cycle, the company’s competitive advantages are shielded for relatively long periods of time. The pharmaceutical industry operates in a slow product life cycle as the products are not developed yearly and patents last a long time.

Strategic alliances are formed to gain access to a restricted market, maintain market stability (setting product standards), and establishing a franchise in a new market.

#2 Standard Cycle

In a standard cycle, the company launches a new product every few years and may or may not be able to maintain their leading position in an industry.

Strategic alliances are formed to gain market share, try to push out other companies, pool resources for large capital projects, establish economies of scale, and gain access to complementary resources.

#3 Fast Cycle

In a fast cycle, the company’s competitive advantages are not protected and companies operating in a fast product lifecycle need to constantly develop new products/services to survive.

Strategic alliances are formed to speed up the development of new goods or services, share R&D expenses, streamline market penetration, and overcome uncertainty.

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