What Is a Joint Venture and How Does It Work?
A joint venture is an agreement by two or more people or companies to accomplish a specific business goal together.
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Updated · 10 min read
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Managing Editor As a small-business owner, you need a collaborative mindset to succeed. You need to develop solutions with employees, business partner and investors on a regular basis. Sometimes, you might have a great business idea that requires expertise or resources from another individual or company. In this case, you might consider entering into a joint venture with that individual or company.
What is a joint venture?
A joint venture is an agreement by two or more people or companies to accomplish a specific business goal together. A joint venture can be structured as a separate business entity or simply grow out of a contract between the parties. Unlike a partnership, a joint venture is typically temporary, dissolving after the task is complete.
How does a joint venture work?
In a joint venture, two or more people or companies come together for a specific purpose. The parties don’t have any legal responsibilities to each other beyond the scope of the joint venture.
Business owners enter into joint ventures to access new markets, tap into complementary skill sets or combine resources. Joint ventures are particularly common in the real estate, media and technology sectors.
Characteristics of a joint venture
Generally, a joint venture consists of each of the following characteristics:
- The parties undertaking the joint venture are legally independent, with the exception of the work they do together during this collaboration.
- The parties set out to accomplish a specific, mutually beneficial goal.
- Both parties contribute resources, share ownership of the joint venture’s assets and liabilities, and share in the implementation of the project.
- The joint venture is temporary (but can be short or longer-term), dissolving once the goal is reached.
Overall, the key to this arrangement is that both parties contribute to it and share in the opportunities and risks.
However, the contributions don’t need to be equal. For instance, one party might manufacture the product, and the other party might offer a distribution channel. One party might offer 70% of the money, while the other might bring just 30%.
No matter how you split contributions and profits though, each party is fully liable for anything that might go wrong with the joint venture.
As an example, let’s say two real estate developers launch a joint venture to build an apartment building. A bystander gets injured by construction debris that one of the developers leaves behind. Under the law of every state, both developers will share fully in the liability if the bystander sues, even though only one was responsible for the accident.
The only way to eliminate this shared liability is to form a legally separate entity for the joint venture (which we'll explain below). Although a joint venture doesn't require that you form a separate entity, many businesses choose to take this route.
Joint venture agreement
The terms of a joint venture should be documented in a written joint venture agreement. Although a written contract isn’t legally required to establish a joint venture, it's the best way to ensure that each party is committed to the shared effort and knows what is expected of them.
The contract should specify what each party will contribute to the joint venture, each party’s rights and duties and how much each party will profit from the venture, similar to a partnership agreement.
Just like any type of business collaboration, without a written agreement, joint ventures can fall apart due to disagreement between the parties. It's worth taking the time to draft and agree upon a contract from the beginning.
Joint ventures can be useful in any situation where distinct companies have complementary resources and a shared goal. The examples of joint ventures you’ve read about might have been two mega corporations coming together, but small-business owners can benefit from this type of arrangement, as well.
Joint venture examples
Here are some joint venture examples:
- Two mobile phone companies agree to share their network.
- A transportation provider and network provider join forces to provide Wi-Fi on the transportation platform.
- Multiple real estate developers work together to build a shopping complex.
- A restaurant teams up with a big distributor to get their products into supermarkets nationwide.
- Two car companies pair up to conduct research about fuel efficiency.
Benefits and risks of a joint venture
There are pros and cons to consider before agreeing to a joint venture with another business or individual.
Pros
Your business can gain access to markets, resources, people, capital, technology, etc. that you wouldn't have otherwise.
You can reduce competition — especially if you're working with a direct competitor.
By working with another individual or business, you can more easily accomplish a goal or objective that would have been difficult on your own — which hopefully leads to an increase in profits.
You may be able to bypass time-consuming business license or regulatory requirements by working with a company that has already met those requirements.
You can designate a specific part of your business to work on a joint venture project with another business, without having to completely combine your organizations.
Cons
You may find it difficult to work with the other business and have to sort through disputes.
The joint venture could end badly and result in wasted time, effort, money and resources.
The project or goal you've taken on through the joint venture could end up failing.
You can open yourself up to additional liability and other legal risks by working with another business (especially if you don't create a separate entity for the joint venture).
How to form a joint venture in 5 steps
If you think this type of arrangement may be a worthwhile opportunity for your business, here are the steps you'll need to take to form one:
1. Find a partner
Finding a joint venture partner (or more than one partner for larger joint ventures) starts with clearly defining your objective. For instance, perhaps you’ve developed a new product but lack wide distribution channels to get it into stores. You can ask fellow business owners what distributors they use and do some independent market research. Then, reach out to different distributors to gauge their interest in a joint venture.
You should evaluate the people who you'll be working with both in terms of their skills or knowledge and their cultural fit. Obviously, they must be able to prove the reach of their distribution channels.
You should also assess how committed they are to the final goal. Can you trust the people in charge? What’s the financial condition of the company and what are their financial expectations from the joint venture? Does the firm have any other commitments or conflicts of interest that would hurt this arrangement?
When trying to find a partner, you should be prepared for a lot of negotiation and back and forth in the process of forming your arrangement. You might need to exchange production schedules, customer lists and other proprietary details with your would-be partner, and they’ll need to share their own information.
To protect the confidential information of everyone involved, it’s a good idea to prepare and sign a mutual nondisclosure agreement.
2. Choose a type of joint venture
After you've found a partner, your next step will be to structure your joint venture.
As we've discussed, there are two ways to do this:
- Form a separate legal entity for the joint venture, such as a corporation or limited liability company, with each party having an ownership stake in the new entity.
- Operate under a joint venture agreement without creating a separate legal entity. This is called an unincorporated joint venture.
Just as is the case with forming a joint venture itself, there are both advantages and disadvantages to the two structure options.
Forming a separate legal entity for your joint venture is the more expensive and complex option. If you form a corporate joint venture, for example, the joint venture will be responsible for filing and paying its own business taxes. However, having a separate legal entity also provides more legal protection if something goes wrong.
The faster, less expensive option is to get started with a simple contractual arrangement. In this case, the joint venture doesn’t report any profits of its own and doesn’t pay taxes on its own. The profits flow through to the respective parties’ tax returns.
If you’re exploring a joint venture for a narrowly defined purpose where liability isn’t much of a concern, it might be fine to get started this way. For a more complicated joint venture, on the other hand, it’s safest to establish a separate legal entity.
3. Draft a joint venture agreement
No matter what type of joint venture you create, you should draft a joint venture agreement that contains the details of how it will be run. You can start with a joint venture agreement template to create your own agreement for your specific arrangement. Depending on the business you're working with and the risks associated with the joint venture, however, you might also decide to consult a business attorney for assistance.
This being said, at a minimum, your joint venture agreement should contain the following information:
- The purpose of the joint venture.
- Formation process (i.e. if the arrangement will be a separate entity or established by contract).
- How the parties will allocate profits and losses, which need not be equal (though an outside claimant is free to sue either or all parties).
- Each party’s contributions, which need not be equal.
- What duties each party is responsible for to ensure the joint venture’s success.
- Meeting schedule to decide on important matters.
- Voting rights of each party.
- When the joint venture will end.
Overall, when you're drafting and signing the joint venture agreement, it’s a good idea for both parties to have legal representation as part of the process.
4. Pay taxes
As with any profit-seeking enterprise, you must pay taxes when you’re part of a joint venture. As we mentioned above, the taxation of your joint venture depends on how the arrangement is structured.
If you form a separate legal entity, any profits of the joint venture will be taxed based on the entity type. For example, C corporations pay a 21% flat income tax rate on business profits, and shareholders pay taxes again on dividends. LLCs, on the other hand, are taxed as pass-through entities, which means the business income and losses are reflected on each owner’s tax return.
Unincorporated joint ventures are similar to LLCs in terms of tax treatment. The profits of the joint venture flow through to the parties to report on their individual tax returns, in line with their respective share of the profits as outlined in the joint venture agreement.
If the parties to the joint venture are corporations, then each corporation reports the joint venture income on their corporate tax return. An unincorporated joint venture doesn’t itself complete a business tax return.
5. Follow other applicable regulations
Finally, you'll want to make sure you follow any other regulations that might apply to your joint venture at the local, state, or federal level.
For instance, if you’re “borrowing” employees from either company that is a party to the arrangement, you’ll need an employer identification number and to follow other labor laws. Depending on which industry your joint venture belongs to, you might need a business license to operate.
And if you’re considering a cross-border joint venture, a host of international regulations come into play that might limit your ability to operate in other countries.
Joint venture alternatives
Although joint ventures may seem similar to other types of business arrangements — and sometimes the term "joint venture" is used interchangeably with terms like "partnership" — joint ventures are unique.
Here's how joint ventures differ from other common business arrangements:
Joint ventures vs. partnerships
A general partnership is a specific type of business structure where two or more people govern a company together. The partners share in the profits and losses of the business.
Unlike a joint venture, a partnership is typically designed to last indefinitely. Joint ventures are usually temporary and initiated for a specific project, though they have more permanence than a simple licensing or distribution agreement, particularly when larger companies are involved.
Joint ventures vs. franchises
In a franchise, the parent company grants a license to run a business using the parent company’s name, brand and operating methods. Think McDonald’s, Subway or UPS.
Usually, a franchise is a long-term arrangement, and the franchisee pays an initial fee to the franchisor for the right to operate the business. Additionally, the franchisor exerts a certain degree of control over the franchisee’s business decisions. In a joint venture, neither party is in “control,” and both contribute toward a shared goal.
Joint ventures vs. licensing
Licensing is similar to franchising because the licensor permits the licensee to use the company’s name and logo. The licensee manufactures products and pays a royalty fee to the licensor for the rights to use the brand.
With joint ventures, on the other hand, both parties work together to reach a common goal and assume equal liability should something go wrong with the project.
Joint ventures vs. mergers or acquisitions
In a merger, two companies combine to become a single business entity. Sometimes, two companies of similar size come together, like Exxon-Mobil.
Alternatively, a large company could acquire the assets of a smaller company. The purpose of a merger is usually to capture new market share, and an acquisition is often used to buy out a smaller competitor.
In contrast, the purpose of a joint venture is to achieve a common goal, and each party maintains its independence.
Joint ventures vs. qualified joint ventures
A qualified joint venture is a partnership that’s run by spouses, each of whom participates in managing the business.
For tax purposes, the IRS allows each spouse to file a Schedule C for their portion of the business income and losses, in the same way that sole proprietors do.
A version of this article originally appeared on JustBusiness, a subsidiary of NerdWallet.
