Risk Management And Joint Ventures

Joint ventures provide brilliant opportunities for entry into untapped markets and/or the development of new products. But like all great romances, be they personal or business, there is potential for things to go sour. In worst case scenarios, they can cause catastrophic damage to the environment, communities, and human health. Therefore, no matter how exciting things are at the outset, you must understand how risk management applies to joint ventures. This involves undertaking a comprehensive risk assessment before drafting or signing a joint venture agreement.

What is risk management?

Risk management is the orderly process of identifying, assessing, and mitigating threats or uncertainties affecting a joint venture or any other type of business transaction or initiative. It involves analysing the likelihood of a risk occurring and its subsequent impact, developing strategies to minimise harm, and monitoring the effectiveness of measures put in place to mitigate identified risks.

What are the main types of risks related to joint ventures?

Bringing together two or more businesses to launch a new venture is fraught with risks, including:

• Undefined mission and scope.
• Disputes developing over the operation of the joint venture, profit sharing etc.
• Incorporating the joint venture into the wrong structure for maximum tax planning.
• Management and staff personality clashes.
• Miscalculations regarding capital and resources required by each party to the venture.
• Flaws in the Joint Venture Agreement.

The above is far from an exhaustive list. Much of the risk management process around a joint venture agreement will relate to the industry and territory in which the venture occurs. This is why it is crucial to understand how to manage joint venture risks.

What are the risks associated with tax when setting up a joint venture?

Joint ventures are typically structured as either:

• Companies
• Partnerships
• Contractual arrangements.

Understanding the tax implications when choosing a joint venture structure is critical to its success. Tax will be an issue upon establishing a joint venture, throughout its operation, and at termination. For example, in the case of a company joint venture, stamp duty charges may apply if shares or marketable securities are transferred. And at the end of the joint venture, transferring assets back to the founding parties will attract tax, especially if the assets have gained in value. However, tax reliefs are available, and part of the risk management exercise should involve identifying these reliefs and structuring the venture to ensure they can be accessed.

Cross-border joint ventures that bring together parties from different backgrounds and span the legal and fiscal regimes of more than one jurisdiction require even more diligent risk management concerning tax. Take, for example, the tax laws of many jurisdictions that seek to penalise cross-border interest payments to affiliates. In Germany, interest paid by a partnership to its partners can be treated as an allocation of profit and be non-deductible. In France, interest payments by French entities will generally qualify for deduction. Still, restrictions may apply if those payments are set at a non-commercial rate or, in some cases, on payments to equity holders in the joint venture. 

How do I undertake a joint venture risk management assessment?

Most organisations require external advice when undertaking a joint venture risk management exercise. For SMEs lacking the legal, operational, and financial knowledge and experience needed to analyse and plan for risk thoroughly, outsourcing the risk management process will ensure the venture gets off to the best possible start. The risk manager’s role is to analyse the commercial, operational, accounting, regulatory, legal, and tax aspects of the proposed venture, identify the risks, and decide how those risks should be dealt with. The most common way to deal with risks is to allocate them to one of the four T’s:

• Transfer – passing the risk onto a third party, most commonly an insurer.
• Tolerate – no action is taken to mitigate or remove the risk, perhaps because the likelihood of the event is so low the venture can accept it. Another reason to choose toleration is that the capital required to mitigate the risk is not cost-effective.
• Treat – putting in place contingency measures, training and awareness campaigns, and diversifying resources to mitigate an identified risk’s impact.
• Termination – discontinuation of the process or undertaking linked with the risk. This is used when the venture considers the identified risk intolerable or, should it eventuate, its negative impact far outweighs any potential positive outcomes.

The team or person in charge of the risk management process should create a risk register accessible to relevant stakeholders. A comprehensive risk register provides a systematic strategy for tracking and monitoring risks, ensuring that they are regularly analysed and managed before and during the lifespan of the joint venture and throughout the termination process.

Concluding comments

Conducting a thorough risk management analysis before launching a joint venture and creating a centralised risk register demonstrates to investors, shareholders, and other stakeholders that the joint venture is well-run, with proper risk management in place to protect their interests.

At 43Legal, we have the knowledge and resources to undertake a comprehensive risk management process for your joint venture. We can also advise and represent you if a joint venture dispute develops. We will resolve the dispute as quickly and cost-effectively as possible while protecting your best interests.

To learn more about any matters discussed in this article, please email us at [email protected] or phone 0121 249 2400.

The content of this article is for general information only.  It is not, and should not be taken as, legal advice.  If you require any further information in relation to this article, please contact 43Legal.