Joint Ventures
Joint Ventures
A joint venture is an association of two or more individuals or business entities.
The parties combine and pool their respective:
Expertise, financial resources, skills.
Experience, and knowledge.
The purpose of such pooling is to further a particular project or undertaking.
A joint venture may take various forms depending on the nature of the arrangement.
It may involve:
The running of a business on a long-term basis.
The execution or realisation of a specific project.
The venture may be:
An entirely new undertaking.
An existing venture into which a new partner is introduced.
In the case of an existing venture, the parties believe that the introduction of a new partner will be beneficial.
A joint venture is a highly flexible concept.
The nature and structure of any particular joint venture depend largely on:
The specific facts of the case.
The resources involved.
The requirements of the joint venture partners.
There may be several reasons for establishing a joint venture.
One reason is that joint venture partners may use co-operation to:
limit the capital investment required for a business or project, and
reduce exposure to risks.
This is particularly relevant in joint ventures that:
involve heavy expenditure on research and development, or
are established to carry out large-scale construction projects.
Co-operation may also help in reducing:
manufacturing costs, or
other overheads,
by achieving economies of scale.
Joint venture partners may possess complementary:
skills, or
resources,
which they contribute to the joint venture.
The partners may also have experience in different industries.
Such complementary skills and diverse industry experience are expected to produce synergistic benefits for the joint venture.
Joint Venture Options
While setting up a joint venture, compliance with relevant legal provisions must be ensured.
These include compliance with:
company law,
partnership law,
contract law, and
exchange control regulations.
Depending on the nature of the transaction, other areas of law may also become applicable.
In particular, these may include laws relating to:
taxation,
competition,
intellectual property, and
environment.
Joint Venture Companies
A corporate vehicle is very commonly used to set up a joint venture intended to continue for a long or indefinite period.
The use of a corporate vehicle offers the advantage of limited liability.
Such a structure is supported by company law.
Company law is highly adaptable and allows flexibility in structuring the joint venture.
A foreign entity intending to establish a joint venture in India may do so in either of the following ways:
(a). Incorporating a Separate Joint Venture Company
The parties to the joint venture may jointly incorporate a company under the Companies Act, 1956.
Each party subscribes to the shares of the company in an agreed proportion.
The incorporation documents of the joint venture company include:
the Memorandum of Association, and
the Articles of Association.
These documents are suitably drafted to reflect the:
rights, and
obligations
of the joint venture partners.
This route is preferred as it provides structural flexibility.
It allows the creation of an entity that is tailor-made to suit the specific requirements and specifications of both parties.
(b). Investing in the Share Capital of an Exisiting Company
In this scenario, the new joint venture partner acquires shares of an existing company.
The existing company may be:
a subsidiary of the local joint venture partner, or
the joint venture entity itself.
To ensure that the intentions of the parties are properly captured, their:
rights, and
obligations
must be clearly reflected.
For this purpose, the Memorandum of Association and Articles of Association of the existing company must be amended.
Such amendments must be:
in accordance with the joint venture agreement, and
carried out in the manner specified under the Companies Act.
Partnerships
A partnership is, in many respects, simpler and less public than a company.
It may be regarded as lying between:
a corporate joint venture, and
a purely contractual arrangement.
This position is reflected in the tax regime, under which:
profits are computed as if the partnership were a separate entity, but
partners are assessed separately for tax purposes.
There are practical difficulties in running a substantial business through a partnership.
One such difficulty is the absence of a corporate vehicle to hold:
assets, and
liabilities.
A major disincentive to using a partnership is the unlimited liability of partners.
Consequently, partnerships are not normally used for major businesses.
Exceptions exist where partnerships are used:
by professionals such as solicitors and accountants, or
where specific tax advantages are available.
Unincorporated Organisations (Contractual Agreements)
Under this type of arrangement, there is no formal legal structure or separate legal vehicle.
The venture between the parties is based purely on a contractual arrangement.
Such arrangements may take the form of:
consortium agreements, or
collaboration agreements.
These contractual arrangements are typically used where the parties intend to establish the venture:
for a limited period, or
for a limited purpose.
An example of such a limited-purpose venture is:
submitting a joint bid for a construction contract.
Foreign Direct Investment & Regulatory & Sectoral Policy
Under the existing Foreign Direct Investment (FDI) policy, FDI is freely permitted in all sectors, including the service sector.
This is subject to the condition that:
FDI is not allowed beyond the prescribed ceiling in sectors where the existing and notified sectoral policy imposes such limits.
Foreign Direct Investment may be brought into India in the following ways:
Automatic route
In sectors where Foreign Direct Investment (FDI) is permitted under the automatic route, prior approval is not required.
Specifically, the foreign investor need not obtain prior approval from:
the Government of India, or
the Reserve Bank of India (RBI).
Foreign Direct Investment (FDI) up to 100 per cent is permitted under the automatic route in all activities and sectors, except those that require prior approval of the Government of India (GOI).
The FDI policy is reviewed on an ongoing basis.
Measures for further liberalisation of the FDI policy are introduced from time to time.
Changes in sectoral policy or sectoral equity caps are notified through press notes issued by the Secretariat for Industrial Assistance (SIA) under the Department of Industrial Policy and Promotion.
The policy announcements issued by SIA are subsequently notified by the Reserve Bank of India (RBI) under the Foreign Exchange Management Act, 1999 (FEMA).
FDI up to 100 per cent is allowed under the automatic route from foreign and Non-Resident Indian (NRI) investors in most sectors, including the services sector.
Investments made under the automatic route do not require prior approval from either:
the Government of India, or
the Reserve Bank of India (RBI).
However, investors are required to comply with post-investment reporting requirements.
Specifically, investors must:
notify the concerned regional office of the RBI within 30 days of receipt of inward remittances, and
file the prescribed documents with the RBI within 30 days of issuance of shares to foreign investors.
Non-Automatic Route
Where Foreign Direct Investment (FDI) is not permitted under the automatic route, it may be undertaken with prior approval.
Such approval is granted by the Foreign Investment Promotion Board (FIPB) under the applicable government approval route.
This category includes:
certain restricted sectors, and
cases where the foreign investor has, or had, a previous joint venture, technology transfer, or trademark agreement in the same or an allied field in India.
The Reserve Bank of India (RBI) has granted general permission under the Foreign Exchange Management Act (FEMA) for proposals approved by the Government.
Indian companies receiving foreign investment approval through the non-automatic route do not require any further clearance from the RBI for:
receipt of inward remittances, or
issuance of shares to foreign investors.
However, such companies are required to comply with post-receipt reporting obligations.
Specifically, they must:
notify the concerned regional office of the RBI of the receipt of inward remittances within 30 days of such receipt, and
file the prescribed documents with the concerned regional office of the RBI within 30 days of issuing shares to foreign investors or Non-Resident Indians (NRIs).
Inbound & Outbound Investment
Inbound and outbound investments are governed by:
the Foreign Direct Investment (FDI) Policy, which provides the broad policy framework, and
the Foreign Exchange Management Act, 1999 (FEMA), which lays down the detailed rules for foreign exchange transactions.
Inbound Investments
All inbound Foreign Direct Investment (FDI) into India must comply with:
the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000,
now updated and notified as the 2020 Regulations, commonly referred to as FEM (TISPROI).
Outbound Investments
Outbound investments from India are regulated under:
the Foreign Exchange Management (Overseas Investment) Rules, 2022.
The earlier Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2000 have been repealed and replaced by the 2022 framework.
Permitted Investments
Indian parties are permitted to invest directly:
in joint ventures (JVs), or
in wholly owned subsidiaries (WOSs)
outside India under the automatic route.
Investments in Pakistan remain prohibited.
Financial Commitment Limit
The total financial commitment of an Indian party in overseas JVs or WOSs is capped at:
400% of the net worth of the Indian party.
This represents an increase from the earlier limit of 100% of net worth, pursuant to the 2022 overseas investment reforms.
Due-Diligence & Compliance Issues
Broken down into structured points:
Due diligence is a form of research carried out by investors or prospective joint venture partners.
The purpose of due diligence is to ensure that the parties are acquiring exactly what they have agreed to acquire.
As a matter of good business practice, due diligence involves verification of facts with third parties.
Due diligence focuses on:
understanding, and
quantifying
the risks of the proposed transaction, rather than merely identifying its advantages.
Due diligence is particularly important in:
joint ventures, and
mergers and acquisitions.
In the context of a joint venture, where an equity interest in an existing company is proposed to be acquired and converted into a joint venture company, the acquiring joint venture partner may wish to conduct a thorough due diligence exercise.
Prior to acquiring an equity stake, the prospective joint venture partner may carry out due diligence to:
assess the state of affairs of the company, and
identify contingent liabilities or exposures faced by the company.
Such due diligence enables the prospective joint venture partner to:
undertake an informed risk analysis, and
obtain appropriate representations and indemnities from the joint venture partner in respect of acts done prior to the investment.
In cases where an overseas party proposes to purchase the stake of an overseas joint venture partner in an Indian joint venture company, a comprehensive due diligence must be undertaken.
In such cases, the due diligence would also include:
a review of the existing joint venture agreement.
Due diligence is a detailed investigation of the affairs of a business.
The primary aim of due diligence is to identify problems within the business.
Particular emphasis is placed on identifying issues that may give rise to:
unexpected liabilities in the future.
Due diligence involves investigation across multiple areas.
All forms of due diligence—whether:
legal,
financial, or
commercial—
are aimed at finding and analysing relevant information.
A proper understanding of a target company requires a combination of:
financial due diligence,
legal due diligence, and
commercial due diligence.
Depending on the industry involved, due diligence may also include:
environmental due diligence, and
other specialised forms of due diligence.
The objectives of conducting comprehensive due diligence include the following:
(i) To provide a key input for valuation by forecasting:
potential growth,
key success factors, and
methods to increase profit margins.
(ii) To secure the best possible negotiating position for the buyer by:
strengthening the buyer’s negotiating power.
(iii) To facilitate post-deal integration by:
identifying stewardship and other operational issues in advance, and
enabling efficient integration planning.
(iv) To minimise risk by:
ensuring a thorough understanding of the company and its markets.
(v) To identify potential deal-breakers at an early stage so as to:
avoid unnecessary investment of time, cost, and resources.
Commercial due diligence is typically undertaken in situations involving a change in the shareholding of a business.
Such situations include:
acquisitions,
joint ventures, and
managed or leveraged buy-outs.
Commercial due diligence may also be conducted even where there is no change in ownership.
This occurs particularly in cases where a company’s business success depends on another party.
Examples of such situations include:
evaluating potential distributors, or
assessing suppliers.
Commercial due diligence differs from legal and financial due diligence.
Unlike legal and financial due diligence, commercial due diligence focuses more on:
the future performance of the target company.
The objective of commercial due diligence is to develop a clear understanding of the target company as:
a competitor within specific markets.
In addition to understanding the internal operations of the target company, buyers must also obtain clarity on:
the industry in which the target operates, and
the specific market segments in which it competes.
As a result, commercial due diligence relies more heavily on:
external and outside sources of information,
compared to other forms of due diligence.
While information provided by the target company is relevant, information from secondary sources is of primary importance.
Commercial due diligence relies significantly on:
primary research, such as interviews with existing customers, competitors, and other industry participants.
Since commercial due diligence is more dependent on external sources, it involves:
greater complexity in data collection, and
more extensive analysis.
Legal Due-Diligence
Legal due diligence is performed by lawyers.
It is often perceived as serving an almost exclusively legal purpose, namely:
assisting in the drafting of legal documents which the business community hopes will never need to be relied upon.
Whether the legal due diligence process actually informs the business decisions involved in a transaction is sometimes debated.
However, in international transactions, legal due diligence plays a clearly significant role.
In such transactions, legal due diligence assists business persons who are unfamiliar with the local jurisdiction by:
extracting factual information, and
helping them assess the viability of their commercial objectives.
Although the due diligence process can be:
arduous, and
time-consuming,
its ultimate objective is to conclude a mutually beneficial transaction.
Legal due diligence also seeks to ensure that:
no unforeseen issues arise after the transaction has been completed.
