CHAPTER 12
Financing and Insuring the JV LIKE ANY NEW BUSINESS,
a JV will require sufficient funding to conduct its operations. Generally, the primary source of initial financing will be the partners themselves. However, it may be necessary for the JV to borrow money from commercial lending institutions or public financing agencies. External financing of the JV obviously creates a number of issues relative to the operation of the business. For example, the need to repay amounts received from outside funding sources will create a burden on current cash flow. It will almost always require that the parties agree to a security interest on the assets and properties of the JV, and to various restrictions on the prerogatives of the parties as owners and managers with respect to the business activities of the JV. In addition, external financing may be contingent on the availability of guarantees from each of the parties, a factor that should be taken into account at the outset of the JV. Finally, external financing may impair the ability of the parties to remove profits from the JV in the form of dividends.
Partners’ Contributions A primary motivating factor for forming a JV is the ability to access financing from one party to the JV. In many cases, the operations of the JV could, in fact, be wholly funded by one party; however, such a funding strategy may divert needed capital from other projects and create unacceptable levels of financial risk. The parties inevitably find themselves discussing the amount of equity capital that should be contributed to the JV, and the relative obligations of each of the parties with respect to such contributions. It is worth noting that some amount of equity capital is necessary to induce outside lenders to make loans to the JV. Equity is the cash cushion that lenders look to protect their own funds in the event that cash flow from operations is not sufficient to repay the loans. A common place to begin the contribution discussions is with the anticipated funding that will be needed to begin operations. As the parties develop their strategic plan, consideration must be given to the amount of cash that will be needed to fund the launch of the JV and to take it through to the point where operations can be funded through retained earnings and bank borrowings. Once this amount is determined, the parties need to decide how the capital burden will be allocated. The decision of the JV partners cannot be made without taking into account the value of other contributions that the parties might be making to the JV. For example, one of the partners might be providing valuable technology to the JV and, if so, the partner will want appropriate credit for the capital contribution in determining its overall equity interest in the JV. In light of these intangible assets, it is not uncommon for the ratio of cash contributions to vary substantially from the ratio of equity ownership agreed on by the parties for purposes of allocation and distribution of profits.
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