What is a joint venture, and why use one?

It is often the case that two or more separate businesses will have expertise and resources that, when combined, can be utilised to pursue a set of commercial objectives. This is the underlying principle behind a joint venture (“JV”).

The motivations to create a JV are numerous. A business may seek a JV partner to expand into new territories. Indeed, it is widely accepted that JVs are the only means for accessing certain markets, particularly in developing economies where local knowledge of the commercial environment is essential. Take CR Snow, SAB-Miller’s JV with China Resources Beer, which enabled the London based brewer to grow in China, making Snow Lager the world’s biggest selling beer (follow link for reference).

In other cases, JVs are used as a platform for product development. CyMotive Technologies is a company owned between Volkswagen and three leading Israeli specialists in cyber innovation. CyMotive was incorporated to develop advanced cyber security solutions for next generation connected cars and mobile services (follow link for reference). Consider the benefits of the arrangement for the JV parties in a world where the automotive industry is becoming increasingly integrated with the internet. For Volkswagen, it recognises that “car hacking” is a potential risk for customers of its connected cars. Thus in teaming up with experts in cyber security it is able to gain vital knowhow in order to advance its core product, making it safer and more reliable to use. For the team of cyber security specialists, the JV with Volkswagen enables them to place their knowhow into a new market place.

Are JVs right for EIS companies?

EIS companies are likely to be presented with the sorts of opportunities described above. It is an attractive prospect, as a successful JV can create significant traction for an early stage business. Whilst the EIS rules allow for the use of JVs, the legislation contains complexities in this area that make it important for EIS companies to understand what the implications are before embarking on such an arrangement.
There are a number of possible structures for a JV in the UK. This article covers two forms commonly used – special purpose vehicle JVs (“JV company”) and contractual JVs – and considers how these are affected by the EIS rules.

JV company

The EIS rules do not expressly prohibit an EIS company from holding shares in a JV company. However, those EIS rules governing the relationship between an EIS company and its subsidiaries, or companies in which it holds a minority share, will have an impact on how the JV company is structured and funded. JVs constructed as 50:50 loan structures are likely to be easier to implement than JVs structured on the basis that the JV partners will hold equity holder’s participation rights.

JV company that is a 90% qualifying subsidiary of the EIS company

The reason is that an EIS company may only employ EIS money towards a company where it is a 90% qualifying subsidiary of the EIS company. A subsidiary is a qualifying 90% subsidiary of the EIS company if the following conditions are met:

(a) the EIS company possesses at least 90% of the issued share capital of, and at least 90% of the voting power in, the subsidiary,

(b) the EIS company would –
a. in the event of a winding up of the subsidiary, or
b. any other circumstances

be beneficially entitled to receive at least 90% of the assets [net of liabilities] of the subsidiary which would then be available for distribution to equity holders [see definition below] of the subsidiary.
[which, pursuant to section 166(2)(b) Corporation Tax Act 2010 (“CTA”), are always assumed to be at least £100].

(c) the EIS company is beneficially entitled to receive at least 90% of any profits of the subsidiary which are available for distribution to equity holders of the subsidiary.

[which, pursuant to section 165(2)(b) CTA are always assumed to be at least £100].

(d) no person other than the EIS company has control [see definition below] of the subsidiary, and

(e) no arrangements are in existence by virtue of which any of the conditions in paragraphs
(a) to (d) would cease to be met.

Section 158 (1) CTA defines the meaning of “equity holder” of a company as being any person who:

(a) holds ordinary shares in the company (see section 160 CTA), or

(b) is a loan creditor of the company in relation to a loan other than a normal commercial loan (see section 162 CTA).

It would be possible for an EIS company and a third party to each make fixed interest loans to a 90% qualifying subsidiary of the EIS company, so that the subsidiary can afford to finance its JV activities, with the loan terms being regulated under an intercreditor agreement containing financial and other covenants, but this may be complex and might well hinder negotiations with third parties generally.

If the JV were to proceed on the basis that the EIS company would use non EIS money to fund its share, then the EIS company, as an EIS company, can be a party to a 50:50 JV company, provided (i) the EIS company doesn’t control the company at shareholder level; and (ii) no other person controls the 50:50 JV company at shareholder level or at board level. For these purposes control includes other persons with whom one is connected and a shareholders’ agreement containing a deadlock resolution clause constitutes a connection.

There are other EIS considerations which need to be observed, but if EIS funding is required to fund the EIS company’s participation in the JV company and, as this could only generally be provided through a 50:50 loan structure not a 50:50 share capital structure, I will not mention these in this article. It isn’t possible for third parties to be equity holders with more than 10%.

Contractual JVs – commercial sales contract

Therefore, contractual JVs are often a simpler construct within the context of the EIS rules because the lack of a separate legal entity means that the issues surrounding subsidiaries and/or minority shareholdings in non-group companies are taken out of the equation. Subject to the other EIS rules that apply, the JV parties are largely free to structure the split of economic proceeds as they wish. There are other benefits of using this structure, namely that the JV parties retain ownership of their assets and will be taxed directly on its share of the profits and losses of the JV. It is also mechanically simpler to dismantle a contractual JV versus a JV company, as the contract can simply be terminated.

For example, it is possible to structure arrangements through a commercial sales contract where, say, the EIS company sells an asset to its JV third party partner for (i) cash equal to 50% of the sales value of the asset; plus (ii) a 50% profit share of the income and capital profits derived from its use and ownership by the third party, perhaps on the basis that the EIS company would also provide on-going maintenance services. It would be prudent from a tax perspective for title in the asset to pass to the third party on payment of the 50% cash element of the price, and the EIS company would need to negotiate restrictions which protect the EIS company’s JV profit share entitlement.

A contractual JV does have limitations. The lack of a separate legal entity may mean the JV parties encounter difficulties when contracting with third parties. There is also a risk that, if not drafted correctly, the contract creates a legal partnership, resulting in joint and several liability for the JV parties.

Conclusion

There is no distinct legal form for JVs under UK law, allowing parties to structure their JV in a way that is best suited to the circumstances and most likely to achieve the relevant commercial objectives. Notwithstanding this apparent flexibility, the restrictions imposed by the requirements under the EIS rules pertaining to qualifying subsidiaries, use of EIS monies, and control, mean that EIS companies must take particular care in considering whether to use a JV company. In most cases, a contractual JV will be the most workable structure under the EIS rules due to the lack of a separate entity.