Startup founders should be aware of the legal pitfalls joint ventures and strategic alliances can cause when trying to conserve cash now that tech valuations are falling.

Any agreement represents an opportunity for both parties to pursue their strategic objectives without the risk of acquisition. But the relationship needs the right structures in place for both parties to benefit, which also means flexibility to deal with changing circumstances.

Falling growth projections have hit startup valuations hard and reduced the amount of capital expected to flow into the tech sector for the foreseeable future.

The layoffs that have been rumored in the United States have hit Australian shores. Neobank Volt has decided to close shop (Daily start) after failing to secure new capital. There’s probably more of that to come.

The message from VCs to Australian and US startups has been clear: conserve as much cash as possible to help you through this downturn.

As a result, we expect to see an increase in joint ventures and strategic alliances (JVs) within the Australian startup community, as companies look for ways to save money, retain talent and maintain strategic roadmaps in an environment where investors’ purse strings are tighter. .

To quickly set the scene, a JV is a transaction where two companies agree to combine certain resources and leverage their respective tactical and strategic strengths for a specific project. It could be a similar product or service to what one or both are offering, or it could even be the creation of an entirely new business with a core business or market. different.

Joint ventures are common in certain sectors such as the resource industry, rain or shine. The harvard business review reports that companies such as Rio Tinto and Shell depend on joint ventures for up to 25% or more of their revenue. HBR also names Amazon, GlaxoSmithKline, Lockheed Martin, Siemens and Volkswagen as frequent users.

JVs can take different forms. In an incorporated joint venture, a new company is registered with the parties involved being shareholders of the new company. A shareholders’ agreement will define the rights and obligations of the parties and the operating mechanisms of the joint venture. This is really akin to a two-founder startup situation.

Strategic alliances are based on a similar principle, but the parties do not establish a separate entity to own the combined business. These agreements can include distribution partnerships and referral agreements, or sometimes even joint research and development agreements. We’ve already seen an increase in the number of companies looking to secure new distribution deals as they rapidly seek new revenue streams.

The big appeal of JVs is access to the expertise, pool of capital, or other resources held by a JV partner without the risks associated with a takeover or merger. This can be especially useful during downturns.

But there are three main reasons why joint ventures and strategic alliances don’t work; an inability to properly define inputs and outputs for each JV partner; misalignment of the incentives of the JV and each of its partners; and an inability to anticipate external changes.

The probability of success of a joint venture will be determined during the negotiation phase. Successful joint ventures will have defined and aligned on a series of high-level issues, including their contributions to the joint venture, their rights to the benefits produced by the joint venture, and the extent to which each partner can continue to operate freely outside or even in competition. with the JV.

3 things to consider

First, companies considering JVs as a strategic option need to find the right partner(s). Selection criteria should be based on actual need. For example, a startup may have lots of talent and ideas but lack capital and infrastructure, which means their best JV partner is likely to be a BigCo likely to have both. However, companies must also ensure that the partner is culturally appropriate as well. While this should by no means be a deal breaker, parties should recognize that a cultural disconnect may exist and seek alignment on governance rules and structures to avoid or minimize friction across the board. line.

Second, parties must clearly define the types and values ​​of their contributions. The success of the joint venture will depend on its having access to sufficient human capital, financial capital and other assets (including intellectual property) to sustain it, given its anticipated business plan. While some contributions are easily assessed in current dollars, others such as intellectual property licenses and non-competition agreements will also need to be assessed to ensure that the parties are each contributing their agreed proportionate share.

Third, the partners must define the structure and operating model of the joint venture. It is essential for a joint venture to have a detailed management structure, operating model and performance measures and for the partners to ensure that all parties have respective incentives that are properly aligned with the overall success of the joint venture. the company. This includes mechanisms to ensure the resilience of the joint venture in the face of changing business conditions.

Finally, the parties must adequately think through how to leave the joint venture in a way that everyone can agree on from the start. Sometimes that means redemption rights. In other cases, it means that the parties can separate from the business.

Joint ventures fail when the parties are not aligned. While joint ventures can be a crucial and timely tool for reducing cash burn while maintaining momentum during a downturn, they do require some care and forethought to ensure the project gets started and stays on point.

Founders who take the time to properly conceptualize and negotiate joint venture legal structures with the right partner may find that the economic downturn becomes a blow in the rearview mirror sooner than their peers.

  • Anthony Bekker is founder and MD, APAC, of ​​Australian-American technology legal consultancy BizTech Lawyersb & Chris Spillman is MD, Americas, at BizTech Lawyers