Joint Ventures, Partnerships, Strategic Alliances, and Licensing

Learning Objectives Primary learning objective: To provide students with a knowledge of how to plan, structure, and manage business alliances. Secondary learning objectives: To provide students with knowledge of How business alliances represent alternative business implementation strategies to M&As; Motivations for business alliances; Factors critical to the success of business alliances; Alternative legal forms of business alliances Key business alliance deal structuring issues and challenges; and Financial performance of business alliances

Business Alliances as Alternatives to M&As Business alliances are vehicles for implementing business strategies Business alliances may be informal agreements or highly complex legal structures. Typically short term Alternative forms of business alliances (including legal and informal relationships) Joint ventures – “The Big Dig” in Boston. Strategic alliances Equity partnerships Licensing Franchising Network alliances

Motivations for Forming Alliances Risk sharing Sharing proprietary knowledge (e.g., TiVo, Sematech, and Wintel) Management skills and resources (e.g., Dow Chemical/Cordis) See web for examples in Pharma, specifically Novartis. Gaining access to new markets Using another firm’s distribution channels (e.g., Redhook & Bud) Globalization Gaining access to foreign markets where laws prohibit 100% foreign ownership or where cultural differences are substantial (e.g., China) Cost reduction Purchaser/supplier relationships (e.g., GM/Delphi, Ford, and Daimler Chrysler online purchasing consortium) Joint Manufacturing (e.g., major city newspapers) Prelude to acquisition or exit (e.g., TRW/Redi, Bridgestone/Firestone) Favorable regulatory treatment (e.g., collaborative research)

Business Alliance Critical Success Factors Clarity of purpose, roles, and responsibilities Synergy (e.g., economies of scale/scope; access to new products, distribution channels, and proprietary know-how) Risk reduction (e.g., Verizon and Vodafone share network costs to form Verizon Wireless) Cooperation (e.g, MCIWorldcom and Telefonica de Espana) Greatest when partners share similar cultures Win-win situation (e.g., TRW REDI, Merck and J&J) Compatible time frames for partners Support from the top Similar financial expectations

Chinese (International)JV To Be Successful: Clear Objectives Play to Each Other's Strengths Head off Culture Clash Language Common Causes of JV Failure Research indicates that 50 to 70% fail. Not many CEOs of joint ventures view their venture as "very successful". The most common causes of failure cited by CEOs are: • Cultural differences (49% • Poor or unclear leadership (49%) • Poor integration process (46%)

Chinese (International)JV The most common causes of failure cited by CEOs are: Cultural differences (49%) • Poor or unclear leadership (49%) • Poor integration process (46%)

Examples Starbucks Barnes & Noble – 1993 Pepsico United Airlines Kraft NAACP Apple –Clearwell , Sony, Motorola, Philips A&&T Disney – HP and McDonalds TiVo – Amazon Ford – Sirius Health Care – Lahey Clinic and Winchester Hospital

Legal Form Follows Business Strategy Business strategy provides direction If management determines a business alliance is best way to implement strategy, an appropriate legal form must be selected. Legal form affects: taxes, limitations on liability, control, duration, ease of transferring ownership, and ease of raising capital

Alternative Legal Forms of Business Alliances: Corporate Structures Generalized C Corporation Advantages: Continuity of ownership, limited liability, provides operational autonomy, facilitates funding; facilitates tax-free merger Disadvantages: Subject to double-taxation, inability to allocate losses to shareholders; relatively high setup costs Sub-Chapter S Corporation Advantages: Avoids double taxation; limited liability Disadvantages: Maximum of 100 shareholders, excludes corporate shareholders, must distribute 100% of earnings; can issue only one class of stock, lacks continuity; difficult to raise large sums of money

Alternative Legal Forms of Business Alliances: Partnerships General Partnerships: Advantages: Profits/losses and responsibilities allocated to partners; avoids double taxation Disadvantages: Partners have unlimited liability, partners jointly/severally liable, each partner has authority to bind partnership to contracts, lacks continuity; partnership interests illiquid Limited partnerships: Advantages: Profits/losses allocated to partners, liability limited if one partner has unlimited liability; avoids double taxation Disadvantages: Lacks continuity, interests illiquid; lacks financing flexibility as limited to 35 partners

Alternative Legal Forms of Business Alliances: Limited Liability Companies Advantages: Offers limited liability, owners can be managers without losing limited liability protection, avoids double taxation, allows unlimited number of members (owners), allows corporate shareholders, can own more the 80% of another firm; and offers flexibility in allocating investment, profits, losses Disadvantages: Structure lacks continuity, ownership shares illiquid as transfer subject to approval of all members; members must be active participants in the firm

Alternative Legal Forms of Business Alliances: Other Franchise alliances: Advantages: Allows repeated application of a successful business model, minimizes start-up expenses; facilitates communication of common brand and marketing strategy. Disadvantages: Royalty payments (3-7% of revenue) Equity partnerships: Advantages: Facilitates close working relationship; limits financial risk, potential prelude to merger; may not require financial statement consolidation Disadvantages: Limited tactical and strategic control Written contracts: Advantages: Less complex; no separate legal entity established; potential prelude to merger Disadvantages: Limited control, may lack close coordination; potential for limited commitment

Alliance Deal Structuring Issues Defining scope (included/excluded products and duration) Determining control and management (how are decisions made?:steering or joint management committee, majority/minority, equal division of power, or majority rules framework. How are resources to be contributed (form and value) and how is ownership determined? Tangible contributions (cash or cash commitments and assets required by the business) Intangible contributions (services, patents, brand names, and technology)

Alliance Deal Structuring Issues Continued Governance (protecting stakeholder interests)--board or partnership committee Profit/loss and tax benefits allocation and dividend determination Dispute resolution and termination (Who owns assets following dissolution?) Financing ongoing capital requirements (What happens if additional capital is needed?; Can the alliance borrow? Target debt/equity ratio?) Performance criteria (How is performance to plan measured and monitored?)

Empirical Studies of Business Alliances Abnormal returns to business alliance partners average about 2% during the 60 days preceding the alliance’s announcement. Partner share prices often increase prior to announcement for alliances involving firms within the same industry as well as in different industries However, the increase is greatest for firms to the same industry involving technical knowledge transfer. Alliances often account for 6-15% of the market value of large firms. While the number of alliances is growing rapidly, about two-thirds fail to meet participant expectations. Financial returns on investment tend to be higher for those firms with significant experience in forming alliances.

Things to Remember… Alliances often represent attractive alternatives to M&As. Motivations for forming alliances include risk sharing, gaining access to new markets, accelerating new product introduction, technology sharing, cost reduction, globalization, a desire to acquire or exit a business, or their perceived acceptability to regulators. Alliances may assume a variety of different structures from highly formal to highly informal, handshake agreements. As is true for M&As, a business plan should always precede concerns about how the transaction should be structured. Business alliance deal structuring focuses on the fair allocation of risks, rewards, resource requirements, and responsibilities of participants. While business alliances are expected to remain highly popular, their success rate in terms of meeting participants’ expectations is about the same as M&As.