Beware the Sirens’ Call: Joint Ventures and Strategic Alliances

By John L. Douglas, Alston & Bird

During the past six years there has been an explosion of strategic alliances, joint ventures, marketing agreements, and other arrangements involving technology companies as key participants. The financial sector has avidly pursued these relationships, hoping to capture the skills and expertise of these providers to enhance their own product offerings.

Reasons for such ventures vary. Some involve banks pooling resources to do something jointly that no bank could afford to do alone. Some involve trying to assemble the necessary mass of banks required for business success, or to create a de facto standard. Some involve trying to capture technological or other skills allegedly possessed by nonbank providers (typically technology companies) that banks somehow lack. Some are reactions to perceived threats; others reactions to perceived opportunities. Whatever the reason, however, relatively few of these ventures succeed.

Some obviously fail as a result of business conditions. Not all new businesses succeed, and there is no guarantee that a new business will succeed even if it counts a bank among its owners. On the other hand, my experience is that most fail for other reasons, primarily a difference in understanding among the owners as to what they are getting into. Once the business begins to operate, those differences become magnified, exacerbated, and result in the types of conflicts that will invariably kill the business.

Lawyers cannot stop this from happening, but they can, however, assist their clients in thinking through the relevant issues associated with third-party ventures.

Here is our top 10 list of common mistakes for such ventures:

1. Too Many People at the Table. There appears to be an almost irresistible temptation to get as many people as possible as owners of the venture. Whether the temptation arises from a desire to share costs among a broader base, or the belief that greater numbers provides greater marketplace impact, in our view the more participants, the more likely that there will be conflicts among the owners. All new ventures are speculative, difficult undertakings. Discord among the owner group is deadly.

2. The Wrong People at the Table. Allowing the wrong parties to join invites the same sort of discord. Think long and hard about the motivation and needs of your proposed partners. Permitting a technology company that is providing key development services to be a voting equity owner makes free and candid discussions at the board level difficult. It makes it almost impossible to make different technology choices, even where the marketplace would demand an alternative.

3. Failing to Assure Complementary, If Not Common, Goals and Objectives. It is not necessary that every party in a venture have the same motivation. It is essential, however, that those goals at least be complementary. One party that wants a product to be developed for the sole use of the ownership group will have a difficult time dealing with another party that views the product as a possible public platform for industrywide application and use. A party with an exit strategy involving a public IPO with the associated financial rewards will have a difficult time reaching consensus with one who is not interested in losing control over the company or its future. These issues are best surfaced on the front end, for virtually every decision the company makes going forward will be affected by those perspectives.

4. Failing to Provide for Adequate Funding. Each participant should be prepared to commit at least the amount reasonably anticipated to fund the venture (hopefully with a generous cushion), but when more funds are needed, there must be a way to allow those able and willing to continue to do so. Nothing creates more problems than money, and there are few ventures that do not reach the point where they are having to address the need for more.

5. Failing to Anticipate the Peculiar Problems of Your Partners. For example, having a bank as a partner is a mixed blessing. Banks can provide funds, credibility, and access to a variety of relationships. On the other hand, having a bank partner generally means limiting activities to those permissible for the bank, and the bank’s regulators will generally assert the right to examine your operations. While these factors are not necessarily problematic, it is best to allow them to surface and understand these issues in advance.

6. A Poor Decision-Making Framework. These ventures are typically contractual creations, and the whole issue of who decides what will receive a lot of attention. In our experience, potential owners will want to assert control over a variety of decisions and protect themselves from issues they believe are fundamentally important. Invariably, these desires lead to the owners’ direct involvement with a number of provisions, rather than charging management with the day-to-day running of the business. It also leads to a large number of decisions requiring unanimity or some supermajority of the owners. While some of this may be appropriate, the danger is that the owners are so protected that the business cannot operate. Most successful ventures are allowed to operate as real businesses, with management making the decisions with a view towards making the business succeed. Owners have other interests.

7. Failing to Think Through the Exit. Not every venture will succeed, and not every venture that succeeds will necessarily succeed for you. Further, regardless of how things appear on the front end, circumstances will change for you and your partners. As careful as you are on the front end in choosing your partners, things may happen that may cause you or them to reconsider. For example, someone that might have been perfectly prepared to enter into a strategic alliance with a technology company may have different thoughts if that company is acquired by Microsoft. What happens? Can you exit? Can you buy them out? Can they buy you out?

8. Failing to Address Rights to Key Technologies. Many of these ventures depend upon access and use of technology that has already been developed, or, more often, technology to be developed as part of the venture. What happens if the technology is not available, or doesn’t work, or, potentially worse, infringes on the rights of another party? Have you made adequate provisions to assure that you can use the technology for what you intend to do with it? For example, do you need to be able to license or sublicense the technology as part of the venture? Can the others use the technology in a way that frustrates either your objectives or the agreed-upon objectives of the venture?

9. A Poor Dispute Resolution Mechanism. Inevitably disputes will arise, and one key to the successful venture is whether those disputes can be resolved quickly and effectively. In our view, a relationship that leaves litigation as the only avenue for dispute resolution is a venture quickly headed for failure. Litigation is costly; litigation is slow; litigation requires lawyers; and litigation involves public airing of what generally should be private disputes. The parties should insist that disputes be quickly aired at senior business levels, consider requiring mandatory mediation, and strongly consider a rapid, binding arbitration process.

10. Failing to Be Flexible. No matter how carefully you plan on the front end, actual events have an uncanny way of overtaking theory. You must go into a venture with the understanding that difficult decisions will need to be made and that successful ventures, like all successful businesses, will succeed based upon how well they react to the unforeseen challenges.

The incredible variety of mistakes that can be made are part of what makes ventures such a challenge. There is no question that the rewards of a successful venture can be compelling. This makes working through the potential obstacles all the more important.

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