If you’re like most business leaders, your first reaction to the topic of a 50/50 joint venture (JV) or partnership is simple: Run Away!
It’s no wonder that’s your reaction. If you take a quick look in the press, you’ll find dozens of articles describing why 50/50 partnerships are less than desirable. Here are three such articles and the common theme between them is that 50/50 partnerships are not a good idea as no one has decision-making control.
It is confounding, then, to see statistics that show 68% of all JV’s in the US are in fact 50/50. How can they be so reviled and yet so common? Surely, 50/50 partnerships and JV’s must be a great idea if so many businesses and leaders are forming them? The answer to that question is an academic topic regarding the trade-off between control-related inefficiencies and investment incentives. You can find in-depth research on the topic in articles such as the one below.
But I’m not interested in academic discussions here. What I would like to share is my own personal experience when presented with a 50/50 partnership investment opportunity a few months ago.
My first reaction, like yours, was that the deal couldn’t work as a 50/50 and at a minimum would need to be 51/49 in my favor. But the owner couldn’t imagine a situation where he wasn’t on “equal footing” regarding the equity ownership of the business he built. So I was forced to ask myself, “Why am I so averse to a 50/50 partnership?”
After reflecting upon the various experiences that I’ve had as a board member on 50/50, 80/20, 70/30, and 49/51 JV’s, I had to admit that all of the JV’s had complications in some way or another but the 50/50 JV’s were really no more or less complicated than the others. These JV’s simply had the potential issue of a stalemate between the owners. Aside from this, how well each JV worked was mainly defined by how well the JV/partnership agreement was set up originally.
Then it hit me! I didn’t like 50/50 JV’s because each of them that I’ve been party to had been set up long before I was involved and I was forced to live with an inadequate or poorly defined operating agreement. I suspect this is why most of us have such a negative first reaction to 50/50 business ventures.
Armed with this realization, I decided to try to make the 50/50 partnership option a success. This wasn’t an easy process as it involves learning a lot more about the legal aspects of a partnership operating agreement than most of us business leaders would care to know and engaging in extended partner negotiations regarding “far-off” topics. But after all of this, we were successful in putting in place the following four key elements for the partnership operating agreement:
- Clearly defined tiebreaker process: There are many ways to accomplish this but we chose to appoint a qualified, independent third-party as the designated arbiter. In this case, as I was the party bringing capital into the business, I selected the arbiter (who, by the way, tried to convince me that a 50/50 deal was a bad idea!). Other comparable methods could include appointing a third board member or arranging a 49/49/2 equity split with a third party. All achieve the same thing but I thought simply having an independent, designated arbiter was the simplest method and just as effective.
- Mutual buy-out/shoot-out agreement: This part of the partnership agreement allows either partner to make an offer at fair value (for which we defined a process and method as well) to buy out the other partner. If a partner refuses to be bought out, then they MUST buy out the offering partner at the same fair value. Some arrangement like this is an essential part of any JV or partnership agreement in my view. I’ve been party to JV’s with no practical or easily implemented exit process and it is painful.
- First right of refusal: Each partner has the first right to buy or refuse to buy the shares of the other partner in case that partner decides to sell, dies, files bankruptcy, etc. This is important so that the person you’re partnering with can’t change without your agreement.
- Clearly defined roles & authority: Depending on the roles of each partner, this is the most relevant point for how the business operates day-to-day. In my case, I took a role as an investor/owner and board member. So it was critical for me to clearly define the business decisions that require board approval. If both parties are operating partners, then you must define the leadership roles in the company (e.g., CEO, COO, CFO), their levels of authority, and how they are appointed. You can’t have both partners acting as the CEO if you want to have a properly functioning business.
With these four key elements of the operating agreement defined, a 50/50 JV or partnership is no more difficult to manage than any other equity split. Some might argue that a 51% equity share or more is better as it allows for a clear decision maker. But how effective will the business be if the minority partner always feels that he is vetoed and his viewpoints dismissed? So regardless of the equity split, you need to have all of the elements above in place so that partner disagreements can be settled in a defined, structured manner acceptable to both parties.
As any good deal experienced attorney could tell you, there are many other elements to a good JV or partnership operating agreement that are important to define. But the above four key elements are the ones that for me, as a business leader/owner, allow a 50/50 partnership to function just as smoothly as any other. But, if you can’t put them in place, by all means…..Run!