Corporate Finance

Venturing Out

When partnerships sink, companies with solid exit strategies can avoid major grief.
Roy HarrisSeptember 1, 1999

US Airways was shocked in 1996 when British Airways–its partner in a critical transatlantic joint-service arrangement– created a second major alliance with US Airways rival American Airlines. Having given up its own U.K. routes when it signed on with British Airways three years earlier, Arlington, Virginia-based US Airways had to patch together an alternative strategy after breaking off the partnership. It quickly began seeking permission to serve London again on its own.

A similar jolt hit Murray Hill, New Jersey­ based Lucent Technologies Inc. last year, when a promising venture with Dutch giant Philips Electronics NV failed to take the U.S. digital mobile-phone market by storm, as the partners had expected it would. Pulling the plug on the 18-month-old pact left Lucent with large write- offs, bad PR from the finger-pointing that had gone on between the companies, and a hasty decision to abandon the domestic digital-phone business altogether.

Call it the Titanic syndrome. Optimistic executives launch a joint venture and view their carefully crafted enterprise as unsinkable, then give little thought to such uncomfortable details as how many lifeboats to take along, or what course to set if they survive an iceberg hit. What’s needed is a formal exit strategy, envisioning various possibilities for a rational, perhaps even profitable, divorce. Companies with experience in planning for a joint venture’s end recommend careful analysis of alternative valuation scenarios, lots of contingency planning–and making the finance chief master of the cold, hard realities.

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“Business leaders sometimes fall victim to the enthusiasm of euphoria,” says Robert Agate, the recently retired CFO of Colgate-Palmolive Co., who arranged numerous global alliances during his 35-year tenure (9 as CFO) at the New York­based consumer-products concern. Part of the problem, he suggests, is that joint ventures are so often portrayed as routine. “It’s such a common topic, with people always saying that there have to be more and more of them. But in reality, they are very difficult to pull off successfully,” Agate says.

“Prudence, and the history of joint ventures dissolving, dictate that you’ve got to spend a lot of time thinking about how this thing could end,” adds Case Corp. CFO Ted French, who describes ventures as “love fests by their very nature.” Much of the problem, he says, arises when operations executives are charged with planning the terms, without any critical oversight. “Operating people have a very hard time with the divorce issue. It takes somebody to step back and have perspective,” according to French.

A Question of Value

“It really is a CFO issue,” says David Ernst, a Washington, D.C.-based partner at consulting firm McKinsey & Co. “The CEO and line managers who craft a joint venture may not be the best people to negotiate exit arrangements, because they are working to build trust and an effective joint management team. The CFO and general counsel often take a lead role in negotiating exit arrangements and other zero- sum issues.

“The average life span of a joint venture is seven years,” Ernst notes, “and there is often a huge swing in value that will be reflected in the exit price.” Occasionally, an initial public offering or open-market bidding marks the end of a venture, making valuation simple. But when the partners themselves are responsible for valuation, they often don’t consider in advance whether to use a multiple of earnings, book value, cash flow, or other means, or to arrange for independent appraisals.

Indeed, “few companies spend time thinking about any exit provisions at all, because it’s uncomfortable to do that,” Ernst says. Instead, many rely on boilerplate exit clauses, with their general counsel’s blessing. Standard caveats allow a breakup over the change of ownership of a partner, replacement of key managers, or transfer- pricing disagreements, for example; a standard exit clause may contain a basic outline for one partner or another to sell its share or buy out the other’s stake under these circumstances. But this approach “doesn’t go nearly far enough toward understanding the acceptable range of exit outcomes.”

Among the other significant developments that could trigger a breakup, Ernst lists changes in the marketplace or in the regulatory environment. That’s why he often suggests that clients prepare contingency business strategies for the end of a venture, or seek alternate access to components that might now come from a venture, for example. And such visions of an unpredictable world require a good blend of precision and flexibility in the language used to set out terms for an arrangement’s conclusion.

“Things change. And you can’t possibly think of everything when you start a joint venture,” says Mickey Foret, CFO of Minneapolis-based Northwest Airlines, which recently restructured its own long-term partnership with KLM Royal Dutch Airline.

Hold that Trademark

Agate, the retired Colgate-Palmolive CFO, says Colgate has traditionally made sure its joint- venture contracts specify that intellectual- property rights will be properly returned to their corporate owners if a joint venture ends.

“A venture is fine if it goes till the end of time,” he says. “But if you have to break it off, you don’t want a third party using Colgate trademarks, for example.” So provisions are written into new ventures allowing for the return of certain rights–and also allowing the company contributing the trademark to take it back during the venture, for a price.

It works both ways in Colgate ventures. Often, a foreign company wants Colgate to contribute its marketing skills to build up a regional product name. In one case, because of the way the exit terms were written, Colgate “ended up with a lump sum because the other side wanted to extricate itself from the venture,” says Agate. “If you are a company like Colgate, and you’re in a country where there is a good trademark and good market share, and the country wants your global support, you have to have some formulas whereby either party can negotiate its way out if circumstances change.”

At Racine, Wisconsin-based Case, a farm- equipment operator now negotiating a $4.3 billion merger with New Holland NV, CFO French has given a lot of attention to valuing its ventures under different scenarios. “Sometimes, our exit terms involve the exercise of call options, based on multiples of earnings,” he says. But other times, the venture’s earnings “aren’t reflective of ultimate value,” and other valuation devices are employed.

Throughout the process of documenting the venture terms, Case takes an adversarial approach, assigning a team of executives essentially to shoot holes in the proposed language–as a way of strengthening the exit provisions. “Both our legal guys and our corporate development people do exactly that as part of the exercise,” French says. “The best advice I can give is to think wildly about all the possible scenarios, no matter how far-fetched. If you do, then you’ve got language that works for anything that could possibly happen.”

He adds, with a laugh: “In some cases, we may fail to think about something–like merging with New Holland.”

A Nice Bounce for Ball

Thinking creatively can even help position a company for future success after a venture’s breakup. Take the case of Broomfield, Colorado- based Ball Corp., perhaps best known for its glass home-canning jars, which in 1994 decided to create a joint venture with Paris, France- based Compagnie de Saint-Gobain. The partners acquired Foster-Forbes from Pechiney SA of France and renamed it Ball-Foster. Ball took a 41 percent interest in the venture, under terms that would allow it to sell out to its partner in seven years. The idea, says Ball CFO R. David Hoover, was to fulfill a long- term plan to get out of lower-margin glass containers and focus on higher-margin businesses, such as aluminum-can making.

“Taking less than 50 percent was the watershed event for us,” he says. And since the company was already contemplating an exit from the venture, it was careful to negotiate provisions to protect its minority interest. One such provision gave Ball the right to veto future acquisitions, or alternatively, the right to sell its interest to partner Saint- Gobain immediately if Saint-Gobain made a move that might negatively affect Ball’s investment. Thus, when Saint-Gobain did propose an acquisition just one year into the venture, Ball prepared to invoke the clause.

“After a couple of angry conversations,” Hoover says, Saint-Gobain “came back and offered to buy us out.” Ball was happy with the $200 million price, which was 18 times the company’s pre­joint venture EBIT. And Ball suddenly, and happily, was out of glassmaking, far short of its seven-year plan, with cash to help it build itself into the nation’s largest aluminum-can maker. It later bought the can operations of Reynolds Metals Co.

“Candidly, it’s better to be lucky than good,” says Hoover. But he concedes that there may have been a bit more than luck in his exit planning. “In the glass industry, you could have predicted further consolidation”–and the likelihood that Saint-Gobain shortly would want to make an acquisition over which Ball would have veto power. “If we had not negotiated this veto right,” he notes, “we could have been stuck” for seven years.

“Doing Unnatural Things”

Few companies want to discuss a venture- related problem in detail–unless, of course, it’s a competitor’s problem. While Northwest Airlines’s Mickey Foret says all his company’s ventures have gone smoothly, and have exit clauses tailored to potential problems, he readily points to the acrimonious US Airways­ British Airways breakup as proof that care must be taken in writing the terms of ventures. “Our relationship with KLM requires us not to compete, and if we were to sign an agreement with British Airways, we would be in violation,” he says.

“In the airline business, alliances come in all shapes and sizes,” Foret notes. And for Northwest, they run from mere frequent-flier partnership programs to a KLM tie that is “a complete joint venturing on all of our flying across the Atlantic.” His guiding principle in relationships: Know thy partner–to get insight into your own company’s vulnerability in a joint venture. Awareness of that vulnerability, he says, helps you draw up more- intelligent exit terms.

In the early stages of the Northwest-KLM relationship, Northwest protected itself by keeping things fluid and informal, and not risking too much of its own operations on potential failures at its venture partner. Exit provisions weren’t needed. “Over time, though, our confidence grew, and we were sure enough to take some pretty long steps,” recalls Foret. Northwest turned the joint- pricing function over to a KLM team in Amsterdam, leaving Northwest to handle the Dutch airline’s reservations and ground- handling systems in the United States, for example. Northwest thus became more dependent– and vulnerable, requiring the protection of a more-formal 13-year pact.

“A venture that is so extensive drives your accounting systems to do unnatural things– capturing information from both partners and applying it in different ways,” says Foret. “It can take years to accommodate your accounting to the procedures.” And future moves could make the arrangements even more complex, not only tying together more information systems, but also adding those of additional partner airlines like Continental and Alitalia.

In writing terms to reflect potential exit scenarios, “the scope of the venture needs to be considered–revenue base and revenue splits, as well as production contribution to the venture, and what the parties are going to be compensated,” says Foret. “There are a million things you probably don’t consider at first when you think about how costs are split” in a venture. But airline ventures get complicated when they involve taking passengers “from Des Moines to Amsterdam to Dubai.”

So any exit terms must recognize that complexity. “In unwinding a joint venture like ours,” he adds, “we would have to think about who the product assets and resources belong to, and how we could recover them.” Also to be considered: “Who the old software belongs to, [and] old contracts with customers, say, General Motors, if we provide [corporate] flying to them.”

Would Northwest CEO John Dasburgh, a former executive vice president for finance and administration at Northwest, get involved with much of this? Hardly, says Foret. “The CEO takes the bows” for the venture. “The CFO and others, including the head of marketing, are left to make it work.”

———————————————– ——————————— Breaking Up is Hard to Do

Especially when your venture fits a profile with these elements.

  1. The venture requires ongoing use of resources or brands from the parent companies after the relationship with the parents ends.
  2. The parents continue to depend on a remaining venture company — for product, components, or service–after the venture partnership ends.
  3. One company is reasonably likely to be the seller of the venture company, and the partner will be in a position of advantage over other potential buyers.
  4. A venture is “asymmetrical,” with partners contributing resources unevenly, or drawing disproportionate benefits from it.
  5. Considerable intellectual property is involved in a venture.

Source: David Ernst, McKinsey & Co.

———————————————– ——————————— The Good-Bye Game

Exit provisions for joint ventures should be clarified in advance.

Triggers for Evolution/Termination

  • Option of either partner
  • Nonperformance by partners
  • Failure of venture to meet performance targets
  • Pre-specific time
  • Inability to agree on key issues
  • Change of ownership of either parent


  • Agreed before deal signed
  • Negotiated “in the heat of the moment”

Structural Options

  • Put/call options held by one or both partners
  • Both partners share costs of separating their interests
  • Right of first refusal
  • “Shotgun auction” or buy-sell offer
  • Penalty to partner that triggers dissolution

Valuation of Termination

  • Negotiation, based on offers by one or both partners
  • Formula, based on predetermined method and/or multiples
  • Arbitration, based on independent assessment by third party

Alternatives for Disposition

  • Acquisition of one partner’s interest by other partner
  • Spin-off
  • Renegotiation, when JV is restructured/broadened
  • Separation of interests (rare)
  • Sales to third party

Source: McKinsey & Co.

———————————————– ——————————— A Chinese Revolution

For years, the Sino-American joint venture was considered about the only practical way for a U.S. company to operate in the world’s most populous country. Certainly, going it alone was rarely advised. But lately, China’s liberalized view toward foreign business activity has changed everything–and helped bail some U.S. and European concerns out of problem ventures.

Some companies now are setting up their own “wholly foreign-owned enterprises”– Woofies, for short, reflecting the WFOE acronym–to replace their old Chinese joint ventures. And they are often finding the experience more satisfying than operating under the constraints of the old partnerships. Among recent Woofie devotees: Dow Chemical Co. and General Motors Corp.’s Delphi Automotive System. Dow now runs a petrochemical plant near Shanghai on its own, while Delphi has taken over a Beijing fuel-pump factory that it formerly owned with a Chinese company.

“The conventional wisdom was always that you couldn’t enter China without a partner,” says CFO Ted French, CFO of Case Corp., which recently closed a three-year-old venture producing loader-backhoes, and opened its own Woofie unit in Shanghai. “For a lot of reasons, the venture just didn’t work out.” Case’s managers, he says, “wish they’d known about the Woofie alternative up front.”

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