Companies may have to innovate their capital deployment strategies to stay ahead of the current massive market and economic disruptions. But those capabilities cannot always be scaled in-house or addressed through traditional mergers and acquisitions.
CFOs are increasingly using joint ventures to grow their businesses while sharing risk and benefiting from optionality. Companies frequently use joint ventures to limit risk exposure when they buy new assets or enter new markets. A recent EY survey of C-suite executives showed that 43% of companies are considering joint ventures as an alternative form of investment.
While companies often turn to traditional M&A to spur growth and innovation over and above organic options, M&A can be challenging in the current environment: potentially large capital outlays with a limited line-of-sight on return, inconsistent market growth assumptions, or merely a higher threshold to clear for the business case.
Companies may need to weigh the trade-offs between managing disruption and risk as they consider pursuing a joint venture or alliance, specifically, (i) how disruption will facilitate differentiated growth and (ii) the risk inherent in capital deployment when there is uncertainty in the market. The answers to these questions will help inform the path forward (shown in the following graphic).
Agree on the transaction rationale and perimeter. A lack of alignment between joint venture partners regarding strategic objectives, goals, and governance structure may impact not only deal economics but also business performance. Whether the gap is related to the definition of relative contribution calculations or each partner’s decision rights, addressing the issues early in the deal process can help achieve deal objectives.
Begin due diligence early and with urgency. Do not underestimate the time and effort required to prepare and exchange appropriate information with which your team is comfortable. Plan for due diligence, as well as potential reverse due diligence, to include not only financial and commercial components but also functional diligence aspects, such as human resources and information technology.
Define the exit strategy before exiting. While partners may exit joint ventures based on the achievement of a milestone or due to unforeseen circumstances, the ideal exit opportunity should be predetermined prior to forming the structure. Reactive disagreements, arbitration, or litigation threats over the mechanisms of JV dissolution and asset valuation can result in not only economic but unnecessary reputational loss.
Once both companies have navigated the challenges of diligence, the heavy lifting begins with standing up the entity. The CFO, critical in structuring the business’s economics, can also help ensure a successful close and realization of early-year objectives. Key areas of focus include:
Defining the path to value creation. In joint ventures, value creation can come from achieving revenue growth and reducing costs through combining capabilities. Building alignment and commitment within the organization and parent companies to realize the growth plan may be critical. Companies that fail to create value often do so because they (i) insufficiently plan, (ii) lose focus after deal close, or (iii) establish poor governance related to accountability and monitoring.
Developing the operating model. A joint venture needs an operating model that combines the best capabilities of the partners while maintaining the agile nature of a startup. The combination can be tough to execute in a market that could have incumbent players with no incentive to encourage innovation or disruption. Companies often don’t invest enough time planning for three critical and related components: (i) defining how and where the venture will operate, (ii) the market, and (iii) the venture’s sell capabilities. They should be synthesized into an operating model and governance structure that complement each other.
Keeping the culture flexible. A joint venture culture that adheres to historical affiliations with either or both parents can inhibit how fast the business will achieve growth objectives, especially in customer engagement and go-to-market collaboration. Responding quickly to market needs and developing customer commitments require executives to rethink the optimal culture for joint ventures versus how things have typically been done in the past.
An EY team recently helped an industrial manufacturer and an oil and gas servicer form a joint venture that shared operational capabilities from both parent companies to sell innovative, end-to-end solutions to customers. The joint venture was also considered to have an early-mover advantage to disrupt an untapped and unsophisticated market.
One company had the domain expertise, and both companies had a component of a new market offering. It would have taken each company more time to develop this market offering by itself. Each company’s objective was to strike a balance between managing the risk of going it alone with identifying a partner with a capability that it did not possess.
By coming together, the companies were able to enter new customer markets, deploy new product lines, explore new R&D capabilities, and leverage a resource pool from the parent companies. The joint venture also allowed for greater innovation, given the shared operations and complementary suite of solutions that would not have been available to either parent company without significant investment or risk.
The joint venture was able to function as a lean startup while leveraging two multibillion-dollar parent companies’ resources and expertise and minimizing risk for both parent companies to bring innovative services to the market.
CFOs can play a critical role in helping their companies pursue a joint venture, vet joint venture partners, and then act as an informed stakeholder across stand-up and realization activities. With continued economic and market uncertainty, it may be especially critical for CFOs to identify options like joint ventures that can help companies stay ahead of disruption, spur innovation, and manage risk.
Sonal Bhatia, is principal and Neil S. Desai a managing director at EY-Parthenon, Ernst & Young LLP. Special contributors to this article were Ramkumar Jayaraman a senior director at EY-Parthenon, Ernst & Young LLP, and Caroline Faller, director at EY-Parthenon, Ernst & Young LLP.
The views expressed by the authors are not necessarily those of Ernst & Young LLP or other members of the global EY organization.