Editor’s note: This is the third article of a four-part series on finance business partnering in joint ventures. Read the first two articles on setting up a JV and shutting down an unprofitable JV. Next week, the final article in this series will be a case study on a successful turnaround of a loss-making JV. To receive updates, sign up for the CGMA Advantage newsletter.
A few things come to mind when I reflect on the successful joint venture negotiations I’ve been involved in as a finance business partner. In this third article in the four-part series on JVs, I share practical pointers to set you up during negotiations.
Before negotiation: Know your potential JV partner and know thyself
Even before negotiations begin, it is important to know your potential JV partner and the expectations of both companies in the venture. This also means evaluating how the “pie” could be expanded if the parties decide to form a JV. Some key factors to evaluate include:
Customer network. For one party, the JV may be a way to expand its customer network beyond the home market. For the other party, it could be to move into a higher-margin market segment with relatively lower sales volume instead of an existing market segment with lower margins and a high sales volume. For both parties, there can be a synergy if operations were combined, as opposed to each of them investing a lot of resources to produce similar results. From my experience, the expansion of customer networks via strategic alliance could help increase product or service offerings, create a better business model, and create more value for customers.
For example, assume a taxi company is the dominant player on its home turf. If a successful JV is formed with a taxi company in another country, the same product or service could be expanded. The taxi company could lease vehicles to drivers beyond its home country.
Financial support. When I was evaluating many potential deals, I noted that some potential JV partners had high levels of debt and needed deleveraging.
Companies knew that rapid expansion to gain a substantial market share could help build an economy of scale and a barrier to entry. Incumbents’ strong positions would make it very difficult for competitors or new players to enter the same market. As such, many incumbents took credit from banks to finance expansion. When banks could no longer lend based on these companies’ financial position, companies sought an initial public offering (IPO), a capital injection from minority shareholders, or JV partners by selling their assets mostly at a premium.
The financial condition of a company is important to find out even before negotiations begin. Knowing a potential JV partner is experiencing tight liquidity is useful information during negotiations.
Potential operational synergy. It is important to evaluate whether there will be any operational synergy during a joint operation. The team should consist of key management from both sides, while reliance on the local partner for knowledge of local regulations, local practices, and labour rules would be expected.
For example, local partners often know where to procure raw materials and assets at a price with the best value and where to recruit a regional labour force at competitive wages. Before negotiations begin, it’s important to find out the potential JV partner’s capabilities both in their home market and their potentials in other markets. In other words, what would the future look like with this JV partner?
I recommend obtaining such information from other market players, suppliers, and sometimes from customers, prior to negotiations. In the process of JV negotiations, it’s important to constantly see the possible synergistic effect with the potential JV partner. This ensures alignment in both parties and reduces the need to negotiate on these points when the JV is formed.
Throughout the entire JV negotiation and formation process, I suggest finance business partners continue asking, “What would the future look like with this JV partner?” This will entice both parties to work towards a common goal that will eventually lead to a successful JV negotiation.
Position against competitors. Identifying a unique value proposition for one’s goods and services is a long-term competitive advantage for many businesses. A large market share, a wide customer network, and a strong financial position are generally the main factors that build strong barriers to entry.
A JV alliance that holds potential for a stronger position in terms of market share and financial position against other competitors makes sense for both parties. The key question is whether the JV partners can create more value and achieve higher profits for their shareholders by operating together as opposed to operating separately.
Technology deployment. Technology transfer between JV partners is common and should also be considered during negotiations, especially if your company has the better technology. Consider, for example, a company from a developed country exploring a JV in an emerging market. The company from the developed country would most likely be deploying more advanced technologies in a less technologically advanced market. The possibility of boosting technological capabilities could be one reason a local company seeks a foreign partner.
In another case, I noted that a JV partner was using mostly manual business processes to fulfil its back-office operations. The company had no experience or resources to automate back-office operations to increase operational efficiency. Understanding this, I used the possibility of more efficient processes as a selling point to negotiate the JV.
During negotiations: Understand and test bottom lines
After both sides understand the capabilities each party could bring to the table, negotiations can move to the initial offer. In my experience, it doesn’t matter which party makes the first offer because most JV negotiations are back-and-forth exchanges of offers and counteroffers.
There may be exceptions to the ebb and flow of the lengthy process. In a case where a potential partner is under a liquidity crunch, a request for the negotiation process to be sped up to safeguard their financial viability while getting the best value out of a negotiation may occur.
During negotiations, it is very important to focus on the following:
Win-win value propositions. It is very important to treat potential JV partners as mid- to long-term strategic partners. If negotiations include offers for financial support and technology deployment at a certain entry price, it must be a win-win value proposition. JV partners’ constraints must be considered from their point of view to make it easier for them to “bite” the offer and come to a mutual agreement.
However, if negotiations are based on one party extracting a lot more value at the expense of the other, the negotiations are less likely to succeed. So how do you know whether an offer extracts considerable value at the expense of the other? A simple test is to look at the other company’s bottom line.
Let’s again use the example of a taxi company. Assume I offered to value taxi licences at the prevailing market price and provide financial support and technology deployment to a potential JV partner. After much deliberation, the target company countered that the taxi licences could be either:
- Valued at the market price if I cross-guarantee their related companies so that they could continue obtaining bank loans; or
- Valued at 40% above the market price.
At this point, it’s important to step back and ask, “What do I know about the potential JV partner before and throughout the entire negotiation process?”
In my case, I realised I did not have sufficient information to decide on option 1 or 2. So, I decided to ask the potential JV partner the reason behind its counteroffers. It became clear that most of these taxi licences were mortgaged to banks and clean titles had to be obtained before assets could be injected into the JV.
After understanding the potential JV partner’s bottom line, I discussed and debated extensively with the management team. Eventually, we countered with an offer to pay for the taxi licences at 35% above the market value. This would enable the company to inject these taxi licences as clean titles into the JV. It resulted in a win-win for both.
Leaving the door open even if talks fail. Many deals fall through because both parties fail to agree on a mutually beneficial entry price. But that doesn’t mean it’s the end of the negotiations.
For instance, in a past negotiation I was involved in, a potential JV partner wanted certain assets to be valued at 50% to 60% above market value. In terms of return on investment and payback period, the deal did not make sense unless there were strategic nonfinancial reasons. To continue the negotiations, a counteroffer was made, but the other party decided not to continue with JV negotiations.
Instead of rejecting the potential partner, I realised it’s important to leave the door open, and communicated that the valuation can always be revisited later. This leaves the door open for both parties to reach out again in the case of future changes to the factors negotiated.
— C.F. Wong, ACMA, CGMA, is a member of the Association North Asia regional advisory board and head of finance for a company with manufacturing and sales operations in China. He has more than 20 years of experience in finance, including finance business partnering, operational improvement, mergers and acquisitions, and strategic planning and execution. To comment on this article or to suggest an idea for another article, contact Alexis See Tho, an FM magazine associate editor, at Alexis.SeeTho@aicpa-cima.com.