7 tips for a rock-solid JV agreement

Everything was good—until it wasn’t. Sam knew how to make the product; John understood how to run the business. Together they were going to make a pile of money.

And they did—for a time. But John started slipping: He missed meetings, lost accounts, and did not fully document expenses. And then Sam’s wife filed for a divorce, demanding half of Sam’s stake in the business plus a voice in how it operated. John, in turn, wanted nothing to do with Sam’s marital dramas, and asked that Sam and his wife buy out his interest.

What a mess. But Sam and John’s experience is more common than you might think. People miscommunicate. People underperform. And people get divorced. When one of these, or a myriad of other difficulties arise, what should happen? If you have a thorough joint venture agreement, then you’ll know the answer well before the difficulty arises. But if you are like most businesses, then the answer is anyone’s guess.

So, what should Sam and John have done? You got it: When they started their business, they should have documented how they would handle key issues and other common scenarios.

Below are seven key issues and common scenarios that your JV agreement should address.

First, and most important, the agreement should explain the relationship between the parties. In other words, what is each person’s role in the company? In Sam and John’s case, for instance, Sam made the product while John handled operations and accounting.

This category can go a step further and specify the level of duty that each party owes to the other. In most cases, the partners will merely need to act in good faith toward each other. But, in other cases, the parties may have a fiduciary duty (where they must act in the interest of the other party—even at the expense of their own interest).

To see why the standard matters, consider an example. Assume that John learned of an exciting business opportunity that was in the JV’s wheelhouse. Can John pursue the opportunity without bringing the opportunity to the JV first? It depends. If he has a fiduciary duty, then he needs to present the opportunity to the JV. But if there’s no fiduciary duty, then he can seize the opportunity on his own.

Second is similar to the first: decision-making. What can each partner (and key employees) do by themselves? And what things require greater approval? For example, it’s common to require majority (or super-majority) approval from the partners before the JV borrows money, settles a lawsuit, buys a different business, sells significant JV assets, or fires a senior employee.

Third, the JV agreement should list what each partner is contributing to the venture. The most-obvious example is how much cash they invest. But partners can contribute in other ways too. Maybe one partner invests land or equipment while another contributes their expertise, network, or reputation.

Fourth, the venture will eventually make money—or lose it. And, so, the JV agreement should say how profits and losses will be apportioned. Will each partner receive an amount proportional to their ownership interest in the JV? Or will profits and losses be divvied up in a different fashion?

Fifth, as sure as rainbows follow rain, one of the partners will want to cash out their chips at some point. So, the JV agreement should say whether a partner can sell and, if so, how. Maybe the selling partner needs to give the non-selling partners a chance to buy the selling partner’s interest. Perhaps the selling partner can shop his interest to outside parties, and then once he has an offer, give the non-selling partners the chance to match the offer. Or maybe something else.

Sixth, humans disagree. It’s in our nature. JV partners are no different. Thus, it’s wise for a JV agreement to explain how intractable disputes will be handled. Normally, people prefer some combination of mediation and arbitration over litigation for resolving disputes because mediation and arbitration are confidential and faster than litigation.

Seventh, nothing good lasts forever, including profitable joint ventures. And, so, JV agreements should plan for the end at the beginning. For instance, under what circumstances will the venture end? When a partner dies? When someone violates the JV agreement in a significant way? And if such an event occurs, will the venture automatically end?

Listing events that can end the venture is advisable. But making those events automatic triggers for terminating the venture is not. That’s because automatic dissolution can lead to unintended consequences. Better to give the partners discretion when key events happen.

If you’ve read this far, and address the seven points above in your JV agreement, you’ve gone a long way toward establishing clear expectations and avoiding disputes. But just because this article makes a JV agreement sound simple does not mean that they are. To the contrary, they involve dozens, if not hundreds, of important decisions. In short, they are not a do-it-yourself endeavor. Please get help from an attorney who specializes in business contracts.

This column is for informational purposes only and is not intended to be taken as legal advice. For your specific case, consult a lawyer.