In the dynamic landscape of business partnerships and collaborations, joint ventures are a powerful catalyst for innovation, synergistic growth and business success. Joint ventures involve companies pooling resources and expertise to pursue common goals, fostering synergies that lead to mutually beneficial outcomes. The notable advantages of joint ventures range widely from enhanced innovation, market expansion, to cost-sharing and risk mitigation.
This article explores the different use-cases of a joint venture, the common types of joint venture, and the key considerations for parties to consider and negotiate before undertaking a joint venture in Malaysia.
A. What is a joint venture (“JV”)?
A joint venture is a collaborative alliance of two or more parties or businesses, pooling together their resources including capital, skills, technology, intellectual property creation, market presence, competitive advantages, and other assets, to achieve a common synergistic objective.
Is a joint venture the same as a merger?
While both JVs and mergers involve the concept of ‘two become one’, there is a fundamental difference between a JV and a merger. A joint venture typically involves a collaboration between independent entities for a specific purpose which involves a new jointly owned entity as the vehicle for collaboration. On the other hand, a merger involves the integration of two or more companies into a single new entity, via an acquisition or absorption of one company by another.
Both joint ventures and mergers are strategic business arrangements aimed at achieving specific objectives, but they differ in the level of integration and autonomy retained by the participating entities.
When are JVs used?
- Market Entry and Expansion: Companies often form joint ventures to enter foreign markets where they may lack local knowledge, contacts, distribution channels or regulatory understanding. Local partners in the joint venture can provide insights, established distribution networks, and cultural understanding, facilitating a smoother entry by the foreign partner into the market.
- Technology Development and Innovation: Joint ventures are commonly utilized to combine technological capabilities, pool resources such as capital and expertise to further develop such innovations, especially in research and development projects which result in the creation of proprietary intellectual property.
- Risk & Resource Sharing: High-risk or complex projects, such as large infrastructure developments or exploration ventures, may involve joint ventures (also known as “consortiums” where multiple parties are involved) to distribute the manpower, financial, legal and operational risks among participating parties. These joint ventures can be designed to exist only for a finite duration, and be dissolved upon the completion of a specific project.
- Compliance with Local Regulations: Some countries, including Malaysia, may have regulations that restrict foreign ownership or prescribe a minimum local equity ownership in certain protected industries. Forming joint ventures with local partners can help foreign companies comply with such regulations or obtain the necessary licenses, gaining direct access to these regulated markets.
- Brand and Marketing Collaborations: Companies may form joint ventures to co-brand products or engage in joint marketing efforts to leverage each other’s brand recognition and customer base.
B. Common types of JVs in Malaysia
There are generally 2 different types of joint ventures, the ‘incorporated JV’ and the ‘unincorporated JV’.
(i) Incorporated JV
- Legal Entity: An incorporated JV involves the creation of a new legal entity, often referred to as a “special purpose vehicle”, which becomes a distinct entity from the joint venture parties. In Malaysia, the private limited company (Sdn Bhd) and the limited liability partnership (LLP) are the two most common vehicles used in incorporated JVs.
- Liability: Under the separate legal entity doctrine, the legal liability of each joint venture party is limited to the amount of unpaid capital committed in the JV. The incorporated JV entity, being regarded as a separate legal entity, assumes its own legal responsibilities and obligations arising from the business. This essentially means that the joint venture parties are ring-fenced against the legal and financial risks of the JV entity, unless contractually agreed otherwise.
- Ownership & Control: Participants in an incorporated JV typically hold shares in the newly formed entity, and the ownership structure is defined by the distribution of these shares. On the other hand, control over the incorporated JV will normally be dictated via the board’s composition and reserved matters in the joint venture agreement, just as how a company would typically be controlled.
- Separation of Assets & Profits: Assets and liabilities of the JV are distinct from those of the JV parties. The incorporated JV has its own set of assets usually contributed by the JV parties upon incorporation, which may include intellectual property, equipment, and capital, and may generate profits of its own. To reduce the likelihood of disputes, the JV parties should address the distribution of profits and the rights of ownership over assets developed by the JV, both during the partnership and in the event of termination of the JV. The tax on any profit arising from an incorporated JV will typically be confined to and borne by the JV entity itself.
(ii) Unincorporated JV
- Legal Status: Unlike an incorporated JV, an unincorporated JV is not a separate legal entity on its own. Instead, the participating JV parties maintain their independent legal identities and the unincorporate JV operates merely as a creation of contractual agreement. However, as an unincorporated JV is not a separate legal entity, it may face challenges and delays in obtaining specific licenses or approvals from regulatory authorities, opening of bank accounts, and entering into contracts with third parties.
- Liability: By default, the JV parties share joint and several liability in respect of the third-party contracts entered into by the unincorporated JV. Each party is directly responsible for the actions and obligations of the joint venture, unless specifically allocated to one party in the joint venture agreement. The careful allocation of risks and liability between the joint venture parties in the joint venture agreement is critical.
- Ownership & Control: The ownership structure is more flexible and is defined by the terms of the JV agreement. Participants may share ownership in the venture in proportions that suit the collaboration. However, ensuring a clear separation of ownership of contributed assets can become quite complicated and may involve tedious discussions from the start. Control and decision making is also commonly addressed at length in an unincorporated JV through a management committees empowered to make decisions, as there is no default governance structure prescribed by the company laws to fall back on.
- Asset Integration & Use: Assets and liabilities are typically not separated from those of the JV parties. The unincorporated JV may utilize the existing assets of the parties for the collaborative effort, and the joint venture agreement typically define limitations, conditions or restriction on the use of specific assets. The tax consequences on any profit arising from an unincorporated JV should also be considered carefully, which presents more complexity compared to an incorporated JV especially if the JV parties are non-tax residents of Malaysia.
C. Key considerations when entering into a JV
The following, which are by no means exhaustive, are some key factors that parties should consider before entering into a JV.
| No. | Considerations | Rationale |
|
(i) |
Strategic Objectives | The purpose, goals and objectives of the joint venture should be clearly defined and aligned with the strategic interests of the parties. Addressing this in the definitive joint venture agreement, even if only in the recitals, provides a helpful context for the terms to follow. |
| (ii) | Regulatory and Licensing Requirements | Parties should consider whether any foreign equity restrictions and licensing requirements apply to the JV at the outset. This is to ensure compliance with local regulations and to assess any restrictions on foreign entities, whether directly or indirectly, participating in the JV, some of which still apply to selected industries and projects in Malaysia.
Example: In the Oil & Gas industry, foreign companies must obtain a license from Petroliam Nasional Berhad (i.e. PETRONAS), which requires, amongst others, foreign companies to either appoint a Malaysian company to act as its agent, form a Malaysian joint-venture with a Malaysian entity, or open a local branch of the company in Malaysia. The formation of a JV which impacts market share and significantly reduces competition can potentially trigger competition law or merger control regulations. At the time of writing, the Malaysia Competition Commission (MyCC) has contemplated amendments to the Competition Act 2010 to introduce a new hybrid merger control regime. |
| (iii) | Type of Entity and Class of Shares | The choice of the type of legal entity to use as the JV vehicle may give rise to different legal, compliance, risk, operational and tax implications.
If a private company limited by shares (a “Sdn Bhd”) is used, ordinary shares are typically issued by the incorporated joint venture entity to the parties. The voting rights, distribution of dividends and return of capital will follow the proportion of ordinary shares held by each party. However, preference shares also can be used to enable the redemption of contributed funds, or to secure a preferred distribution of profits, dividends or capital back to the holder of the preference shares. |
| (iv) | Roles and Contributions | There should be a clear delineation of each party’s roles, responsibilities, initial and ongoing contributions in the JV to avoid ambiguity.
What resources (financial, intellectual property, technology, etc.) will each party contribute to the joint venture, and by when must these contributions be completed? Who will bear the incidental costs and risks of transfer, which may arise from the transfer of assets such as equipment, land, intellectual property and even employees? |
| (v) | Decision-Making & Governance | How the JV is managed, the voting, decision making and general governance structure is a fundamental component of any joint venture. How conflicts or deadlocks will be escalated and resolved are equally important.
Such provisions will need to be carefully crafted in a manner that is practical and legally enforceable under the company laws and the constitution of the incorporated JV. |
| (vi) | Financial Arrangements and Profit Sharing | The financial commitments, initial and ongoing capital contributions, repayment of loans and profit-sharing mechanisms, should also be clearly defined.
This aspect is particularly important where there is a disproportionate financial contribution by one party, while the other party contributes know-how, expertise or effort in lieu of financial contribution. Are parties expected to contribute subsequent working capital proportionate to their equity holdings? If financial support by way of a loan is provided by a joint venture partner, what are the terms of repayment and costs of borrowing that the JV company will be bound by? |
| (vii) | Data and Intellectual Property Ownership | In situations where the JV uses intellectual property (which often include data & confidential information) contributed by a party, or develops its own unique intellectual property in the course of the collaboration, navigating the eventual ownership and exploitation of such intellectual property is often neglected or glossed over during the negotiation stage.
How will intellectual property and technology be shared or licensed among the joint venture partners during or after the JV ceases? Are there restrictions or conditions related to the use of such proprietary information or technology? Will one party have a first right to purchase and own the intellectual property of the JV? |
| (viii) | Confidentiality & Non-Compete | As a joint venture is a collaboration that requires a pooling and sharing of resources between parties, the sharing of sensitive information and trade secrets from the parties to the JV and vice versa, is often inevitable. Concerns about how such information is exploited during or after the joint venture are normal.
What confidentiality agreements are in place to protect sensitive information shared within the joint venture? Can this information be retained by the joint venture or the parties once disclosed? Are there restrictions imposed on the participating parties not to compete in specific business endeavours, or not to poach talent from each party, during and after the joint venture? |
| (ix) | Termination Risks and Exit Strategies | Lack of a clear exit mechanism between the parties from the joint venture vehicle may result in deadlock situations, financial losses suffered by the JV, and even challenges in winding up the JV.
Robust “deadlock” and “termination” clauses clearly specifying triggering events, reasonable procedures, buy-out valuation, call or put options, and detailing the parties’ obligations upon termination, is necessary to protect and preserve the interests of both parties as well as the JV vehicle. |
| (x) | Dispute Resolution Mechanisms | Without established dispute resolution mechanisms, conflicts may escalate, leading to prolonged legal battles, damage to relationships, reputational damage, and operational disruptions for both parties as well as the JV entity.
Dispute resolution mechanisms that involve qualified third parties to facilitate the process include mediation, arbitration, and/or court proceedings, and parties should opt for a mechanism that is most appropriate to preserve any intended business relations in a JV arrangement. |
D. What is the typical process to form a JV?
In a typical incorporated JV situation, the following steps are usually undertaken:
| No. | Steps | Explanatory Notes |
| (i) | Execution of a Term Sheet / Memorandum of Understanding | Once the JV parties have agreed on the feasibility, commercial synergies and strategic objectives of a joint venture, a term sheet will often be the first preliminary document determining the legal structure and outlining the key terms of the proposed JV.
By executing the term sheet, even if non-legally binding, both parties signal their intent and commitment to moving forward with the collaboration. |
| (ii) | Due Diligence Process | Occasionally, limited due diligence may be necessary for parties to better understand and verify the key assets or resources that would be transferred as contributions to the JV. Not doing so could be putting the cart before the horse. |
| (iii) | Negotiations | Based on the due diligence findings, parties identify and prioritize key issues that require attention and resolution. This could include addressing any uncovered risks, clarifying operational processes, or refining financial arrangements.
Legal and financial advisors play a crucial role in this negotiation and planning stage. Their expertise is sought to navigate complex legal and financial considerations, ensuring that the negotiated terms align with both parties’ strategic objectives and legal requirements. |
| (iv) | Legal Documentation | This phase includes the drafting and execution of legal documents, primarily the joint venture agreement, and ensures that the terms and conditions of the JV are clearly articulated in a formal legally-binding agreement.
The joint venture agreement typically addresses the ownership structure, decision-making processes, profit-sharing mechanisms, termination, dispute resolution, and exit strategies. |
| (v) | Implementation of the JV | Following the signing of the joint venture agreement, the next crucial step is the implementation of the JV which may include the following:
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In a business collaboration taking the form of a joint venture, a meticulously crafted business plan, joint venture agreement and execution plan are critical foundations to the success of the joint venture.
The investment of time by parties into the careful negotiation and drafting of the joint venture agreement at the outset, ultimately, provides clarity and safeguards the interests of both joint venture parties.
Seeking advice from legal, financial, tax and industry experts early can help ensure that the joint venture is well-planned, legally compliant, and aligned with the strategic goals of all participating parties.
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This article was written by Shawn Ho (Partner) & George Teng (Associate) from the corporate practice group of Donovan & Ho. Shawn leads the corporate practice group of Donovan & Ho, and has been recognised as a Notable Practitioner, whilst the firm has been recognised as a Notable Firm for Corporate and M&A by Asialaw Profiles 2020 and 2021. We are also ranked as a Recommended Firm by IFLR1000 2020 and 2021.
Our corporate practice group advises on corporate acquisitions, restructuring exercises, joint venture arrangements, shareholder agreements, employee share options and franchise businesses, Malaysia start-up founders and can assist with venture capital funds in Seed, Series A & B funding rounds. Feel free to contact us if you have any queries.
