Thinking of forming a joint venture? Here's what you need to know

Many businesses enter into cooperative endeavors with other companies. For example, two small companies might pool their financial resources for a project, either because the endeavor is too large for either to pursue alone or so that each business can overcome its weaknesses by tapping into the strengths of the other.

If you are considering such a cooperative project, you need to know your options in forming a joint venture.

Joint venture basics

A joint venture is a business arrangement between two or more business entities to cooperate in a particular business enterprise, either for a limited time or ongoing. Each entity may continue to engage in other business activities that are not part of the joint venture. The arrangement is not the same as a merger, in which one or both of the companies cease to exist as a separate entity.

A business entity that enters into a joint venture is referred to as an original entity, which may be organized as a limited liability company (LLC), a sole proprietorship, some form of partnership, or a corporation.

It is also possible for two or more original business entities to enter into a less formal cooperative agreement known as a strategic alliance, in which the companies collaborate in some manner that is expected to be mutually beneficial but without contributing resources or forming a separate entity.

For example, the three separate companies Disney, NBC Universal, and News Corp formed a joint venture by creating a new entity called Hulu. Ford Motor Company and Eddie Bauer entered into a strategic alliance whereby they used each other's brand recognition to gain new customers but without creating a separate entity or pooling their financial resources: Ford placed the Eddie Bauer logo on its upscale SUVs, while Eddie Bauer placed the Ford logo on a set of luggage.

However, there is no legal definition of strategic alliance, and there is no distinct line separating a strategic alliance from a joint venture. The exact nature of cooperation varies with the nature of the businesses involved and their venture.

Forming a joint venture

Just as an original entity can be organized in one of several ways, a joint venture can be set up as a partnership, LLC, or corporation. Or, rather than form a separate entity, a joint venture can be created as a contractual relationship.

For example, if ABC Enterprises LLC and XYZ Corporation wish to cooperate in a joint venture, there are two ways in which they can do so:

1. Form a new entity. ABC and XYZ could choose to form A&X Corporation, in which some shares of stock are owned by ABC and some shares owned by XYZ. However, the new entity may just as easily be an LLC or some form of partnership, in which case ABC and XYZ are each members of the joint venture LLC or have a partnership agreement between them.
2. Remain separate, but enter into a contract for the joint venture. This is commonly called a joint venture agreement or joint venture contract. If this option is chosen, appropriate representatives of ABC and XYZ sign a contract outlining the nature and goals of the joint venture, the contributions to be made by each entity, how the entities will share in the profits or losses, how the project will be managed, and other details.

Choosing the form of a joint venture

A joint venture that is organized as a separate entity is almost always organized as either a corporation or an LLC due to the limited personal liability offered for the owners. This is especially important if any of the original business entities are organized as a sole proprietorship or as some form of partnership that does not give all partners limited liability. Any original business entity that is an LLC already has limited liability for its members, while any original entity that is a corporation already has limited liability for its shareholders.

However, even if an original entity is set up as an LLC or a corporation, it can still be a good idea to organize the joint venture as an LLC or a corporation. Doing so may offer the original entity some protection for its assets that are not contributed to the joint venture.

For taxation purposes, a joint venture formed as a corporation is taxed as a corporation. Similarly, a joint venture formed as an LLC is taxed as a partnership, unless it elects to be taxed as a corporation.

Determining whether a joint venture is best created by an agreement or by forming some type of separate entity requires consideration of various factors, including the nature of the joint venture, management structure, limitation of liability, and taxation. If you need further help deciding which options is best for you, consider seeking professional advice from a business attorney or tax consultant.