A joint venture is a tactical partnership where two or more people or companies agree to put in goods, services, and/or capital to a uniform commercial project.
Types of joint venture:-
The contractual joint venture (CJV)
- The contractual joint venture might be used where the organization of a detached legal entity is not needed or the creation of such a separate legal entity is not feasible.
- There is an agreement to work together but there is no agreement to give birth to an entity owned by the parties who are working together.
- For example, a foreign company may have a Technology Collaboration agreement with an Indian company whereby the foreign company controls all key aspects of running the business.
- In such a case the foreign company may like to retain the option of taking equity at a future date in the Indian company run by its technology.
- This will mean that though to begin with the venture is a contractual joint venture, the parties may convert it into an equity based joint venture at a later date.
Contractual joint ventures are therefore typically used when:-
- a consortium is putting in a bid for a specific contract with a view to forming a more permanent joint venture if the bid is successful (particularly common for construction contracts or for respondents for large public-sector tenders)
- the participants are co-operating on a defined project for a defined period of time, eg:
- construction projects – each participant typically provides different parts, eg one party may provide the land, another the design skills, another the project management skills and a fourth may actually do the building; or
- supply of hi-tech equipment to a third party’s order – the participants may each provide a different component and one of their number may assemble the components into a finished product
- The participants wish to co-operate on a specific research and development project
- The parties are entering into some other type of short-term horizontal co-operation agreement, e.g. a specialization agreement – the distinction between horizontal and vertical agreements is particularly relevant to competition law.
- A horizontal agreement is generally an agreement between parties that operate at the same level of a supply or distribution chain (eg two manufacturers); a vertical agreement is an agreement between parties that operate at different levels of a supply or distribution chain (eg a manufacturer and a distributor).
The three main advantages of a contractual joint venture are:
- Independence – as a contractual joint venture does not involve any structural changes
- Lower costs – for the same reasons as above, together with there being no formalities; this may be vital when little money is available at the start-up of the venture
- Simplicity – a contractual joint venture does not usually involve any transfer of assets at the start of a project, nor on a project’s termination.
Equity Based Joint Venture (EJV)
- The equity joint venture is an understanding whereby an independent legal entity is created in accordance with the agreement of two or more parties.
- An equity joint venture agreement is one in which a separate business entity, jointly owned by two or more parties, is formed in accordance with the agreement of the parties.
- The form of business entity may vary – company, partnership firm, trusts, limited liability partnership firms, venture capital funds etc.
- From the point of a foreign company, the most preferable form of business entity is either a company or a limited liability partnership firm.
- However, the division of profits and losses is not the only characteristic of an equity-based joint venture.
- For example, there are often agreements where one of the parties is investing but has no say in the management of the joint venture (JV) company.
- There are also situations where a foreign company may want to exercise management control even though it is not investing in the JV Company.
- Typically, if a foreign company is providing technology and other knowledge-based inputs, it may want to ensure that the JV Company is managed as per its directions.
- In such cases the foreign company may retain an option to invest in the JV Company at a future date.
- Such a structure may also be used by a foreign company to create a foothold for itself in a sector where Foreign Direct Investment (FDI) is not allowed.
Who Can Set Up Equity Based JV
In India Generally speaking, any non-resident entity can set up an equity based joint venture in India. However, some entities face restrictions under FDI Policy1 of Government of India. The restrictions are as follows:
- Citizen or entity of Pakistan can invest only after approval of Government of India. They cannot invest in defense, space, atomic energy and sectors prohibited for foreign investment.
- Citizen or entity of Bangladesh can invest only after approval of Government of India. However, there are no barred areas as in the case of entities from Pakistan.
- NRI residents in Nepal and Bhutan as well as citizens of Nepal and Bhutan can invest on repatriation basis subject to investment coming in free foreign exchange (USD or EURO) through normal banking channels.
- A Foreign Institutional Investor (FII) can invest only under the Portfolio Investment Scheme which limits the individual holding of an FII to 10% of the capital of the company and the aggregate limit for FII investment to 24% of the capital of the company.
- This aggregate limit of 24% can be increased to the sectoral cap / statutory ceiling, as applicable, by the Indian Company concerned through a resolution by its Board of Directors followed by a special resolution to that effect by its General Body and subject to prior intimation to Reserve Bank of India.
- The aggregate FII investment, in the FDI and Portfolio Investment Scheme, should be within the above caps.
- A Foreign Venture Capital Investor (FVCI) duly registered in India may contribute up to 100% of the capital of an Indian Company under the automatic route and may also set up a domestic asset management company to manage the fund.
- Such investments are subject to the relevant regulations and FDI policy including sectoral caps, etc.
- SEBI registered FVCIs are also allowed to invest under the FDI Scheme, as non-resident entities, in other companies, subject to FDI Policy and other regulations.
- Forms of Equity Based JV
Every equity based joint venture gives birth to a new entity. Government of India permits certain type of entities and frowns upon some others. Different types of entities and the government’s attitude to them are summed up below:
- A limited liability company is the most preferred structure for joint venture entities in India.
- Government also encourages investment being in the form of equity capital of a company incorporated in India.
- Companies in India are mainly of two types – private limited and public limited. After the coming into force of Companies Amendment Act, 2015 there is no minimum share capital prescribed either for private limited company or public limited company.
- Earlier, the minimum prescribed share capital for a private limited company used to be Rs. 100,000- and for a public limited company it used to be Rs. 500,000-.
- A private limited company must have at least two shareholders, while a public limited company must have seven shareholders.
- The only exception to this is a one-person company. The shareholders may be foreign citizens or foreign companies. Companies Act 2013 makes it mandatory that at least one director of every company is resident of India.
- Such an entity is not permitted for joint ventures by foreign residents in India in most of the cases. Exceptions are made in case of Non Resident Indians or Persons of Indian Origin residing out of India.
- However, such exceptions are subject to various conditions. Generally speaking, a foreign company should not think of using partnership firm as a vehicle for a joint venture.
- LLP Firm structure is regulated in India by The Limited Liability Partnership Act, 2008. Foreign investment in LLP Firms was not permitted before November 2015.
- Government of India has now allowed foreign investments in LLP firms subject to certain restrictions. LLP Firms are partnership firms with limited liability of partners.
- An LLP Firm combines the convenience of a partnership firm with the limited liability feature earlier found only in a company.
- An LLP Firm needs minimum two partners. It also requires minimum two Designated Partners out of which at least one should be resident of India.
- The two partners can also be appointed as Designated Partners. There is no requirement of minimum capital contribution to incorporate an LLP Firm.
- Venture Capital Fund – A duly registered Foreign Venture Capital Investor is allowed to contribute up to 100% in Indian Venture Capital Undertakings /Venture Capital Funds / other companies.
- Trusts – A foreign company is not allowed to use Trust as a form of a joint venture entity in India.
- Investment Vehicle – SEBI has introduced regulations for some funds like Real Estate Investments Trusts, Infrastructure Investment Funds, Alternative Investment Funds. Such funds are now permitted to receive foreign investment from a person resident outside India.
- Other Entities – Foreign companies are not allowed to use any structures other than those mentioned above for the purpose of equity based joint venture entities.
To sum up one can say that the most acceptable and convenient forms of equity based joint venture in India are a limited liability company and a limited liability partnership (LLP) firm.
Before signing a joint venture contract the below points must be properly assessed:
- Applicable law
- Shareholding pattern
- Composition of board of directors
- Management committee
- Frequency of board meetings and its venue
- General meeting and its venue
- Composition of quorum for important decision at board meeting
- Transfer of shares
- Dividend policy
- Employment of funds in cash or kind
- Change of control
- Restriction/prohibition on assignment
- Non-compete parameters
- Break of deadlock
- Jurisdiction for resolution of dispute
- Termination criteria and notice
Procedure for setting up a Joint Venture
The broad steps involved in setting up a joint venture company in India are outlined as under:
Step-1: Locate an Indian partner
Step-2: Venture Agreement setting out the rights and responsibilities of the Parties Form a Joint
Step-3: In case the Joint Venture Company is a new company, incorporate a new company (public or private) and invest in agreed ratio. However, in case the investment is being made in an existing company by acquisition of shares by the foreign company, complete the share acquisition procedure.
Step-4: Commence Joint Venture Business
Advantages of Joint Venture
A Joint Venture Company is one of the most preferred forms of entry model for foreign companies for doing business in India. A joint venture may entail the following advantages for a foreign investor:
- Accessible financial resource of the Indian partners.
- Established contacts of the Indian partners which help in smoothening the process of setting up of operations.
- Established distribution/ marketing set up of the Indian partner.