Joint ventures end. Sometimes the project is finished, sometimes one partner's priorities change, and sometimes the relationship simply breaks down. How easily you can get out, and what you get for your stake, depends almost entirely on what the joint venture agreement says. If it says nothing useful, a minority shareholder in a private company can find itself holding shares that nobody is obliged to buy and that can't be sold without the other side's co-operation.
How the structure affects exit
In a contractual joint venture, exit means terminating the contract, so the termination rights, notice periods and what happens to shared assets and IP are what count. In a joint venture company or LLP, exit usually means transferring your shares or membership interest, which is controlled by the articles or members' agreement as well as the joint venture agreement. This guide concentrates on the company form, but the same issues come up in each.
Lock-in periods and transfer restrictions
Most agreements prevent either party from transferring its shares for an initial period, often while the venture is being set up, except to companies in its own group. After that, transfers are usually permitted only through the routes the agreement sets out. A lock-in gives both sides stability, but check whether there is any way out during it, for example if the other party is in serious breach, becomes insolvent or undergoes a change of control.
Pre-emption: first offer and first refusal
Before a party can sell to an outsider, it normally has to give the other party the chance to buy. There are two versions, and the difference matters.
A right of first offer requires the seller to offer its shares to the other party first, at a price the seller names or that is fixed by a valuation. If the other party declines, the seller can sell to a third party, usually at no lower price and within a set period.
A right of first refusal lets the seller go and find a buyer, then requires it to offer the shares to the other party on the same terms as the third party's offer. This protects the remaining party more, but it makes the shares harder to sell, because outside buyers know their deal can be taken from them.
Either way, look at the time periods, how the price is set, and whether the remaining party can buy only some of the shares on offer (usually it must take all of them).
Tag-along rights
A tag-along right protects a minority. If the majority agrees to sell its shares, or enough of them to pass control, to a buyer, the minority can require the buyer to purchase its shares too, on the same terms and at the same price per share. Without one, the majority could sell to a stranger and leave you in business with them. Check the trigger (a sale of any shares, or only a change of control) and whether “same terms” includes any deferred or contingent consideration.
Drag-along rights
A drag-along right works the other way. If holders of a set percentage of the shares (often 75% or more, but it is a matter of negotiation) accept an offer for the whole company, they can require the others to sell on the same terms. It stops a small shareholder blocking a sale of the whole business. If you are a minority partner, look for a minimum price or valuation floor, a requirement that the buyer is independent of the majority, and limits on the warranties and indemnities you can be made to give.
Buy-sell clauses
Where the parties are equal and fall out, a buy-sell clause forces a resolution. Under a Russian roulette or shotgun clause, one party names a price and the other must either sell at that price or buy the first party's shares at the same price. Under a Texas shoot-out, both submit sealed bids and the higher bidder buys. These clauses encourage a fair price only where both parties can realistically fund a purchase. If one side is much better resourced, it can name a low price knowing the other can't afford to buy.
Default and compulsory transfer
Many agreements list default events, such as material breach that isn't remedied, insolvency, or a change of control of a party. On a default event the other party can usually buy the defaulting party's shares, sometimes at a discount to fair value. A discount can be open to challenge if it is out of all proportion to any legitimate interest the other party has in the defaulting party performing, so the terms need a commercial rationale. The non-defaulting party may instead be able to sell its own shares to the defaulter, which is useful if the change of control has put the defaulter in the hands of a competitor.
Valuation
Whenever shares change hands under the agreement other than at an agreed price, something has to fix the price. The common options are:
Market value by an independent expert. An accountant or valuer determines the value. The agreement should say how the expert is appointed, what assumptions they must use (for example, a willing buyer and willing seller, and the company as a going concern), and whether their decision is final and binding.
A formula. Net asset value or a multiple of profits. Formulas are certain but can quickly become out of date or produce odd results for a business with few assets or erratic profits.
Discount for a minority stake. A minority shareholding is often worth less per share than a controlling stake. Whether any minority discount applies is one of the most valuable points in the whole agreement for a smaller partner, and it should be dealt with expressly rather than left to the valuer.
Deferred payment
The buyer may not be able to pay the full price at once. Payment in instalments, or a deferred element linked to the joint venture's later performance, can bridge the gap. If you are selling on those terms, you are taking credit risk on the buyer, so ask for security such as a guarantee from the buyer's parent or a charge, and for the balance to become payable immediately if the buyer defaults or sells the business.
Restrictions after you leave
The exiting party is usually restricted from competing with the joint venture, soliciting its customers and hiring its staff for a period after it leaves. The remaining party also has an interest in protecting the goodwill it is paying for. Restrictions like these are enforceable only if they are no wider than reasonably necessary to protect a legitimate interest, and between businesses in the same market they must also comply with competition law. There is no fixed period that is always acceptable. What is reasonable depends on the business, the market and the parties' position, so narrow restrictions tied to what the joint venture actually does are more likely to hold.
Death or incapacity
Where the joint venture partners are individuals, or where a corporate partner depends on one person, the agreement should deal with death and long-term incapacity. The usual approach is an option for the remaining party to buy the shares from the personal representatives at a fair value, sometimes funded by insurance taken out for that purpose. Without such a provision, the shares pass under the deceased's will or intestacy, and the remaining party may find itself in business with the beneficiaries.
Winding up
If the parties decide to close the joint venture rather than one buying the other out, a solvent company is usually wound up by a members' voluntary liquidation, which requires the directors to make a statutory declaration of solvency. The liquidator realises the assets, pays the creditors and distributes what remains to the shareholders in line with their rights. An insolvent company goes into a creditors' voluntary liquidation or another insolvency process instead.
Shareholders in a limited company are not liable for its debts beyond anything unpaid on their shares. A clause requiring the partners to fund any shortfall on winding up changes that, so read it carefully before agreeing to it. The agreement should also say what happens to IP licensed to or developed by the joint venture, and to any ongoing customer contracts, once it ends.
Disputes on exit
Exits produce disputes about whether a trigger has occurred, whether a notice was valid and, above all, about price. A tiered process (negotiation between senior people, then mediation, with expert determination for valuation questions and court or arbitration for everything else) keeps valuation arguments out of court. Make sure the notice provisions are clear, because a notice served to the wrong address or in the wrong form can derail an entire exit.
Checking your exit rights
Read the exit provisions with a particular scenario in mind: you want to leave in two years, your partner wants to sell to a competitor, or your partner is taken over. If the agreement doesn't give a clear answer in each case, it needs work. You can upload it for a joint venture agreement review that sets out your exit options and where the gaps are.
Related: what the joint venture agreement review covers, and a complete sample report.