Associate and Joint Ventures - Essay Example

ASSOCIATE AND JOINT VENTURES Joint ventures have become a vital strategic option for many businesses and this fact is mainly due to increased globalization, the increase of modern technology as the means of conducting business, and by far the most important of all improved international travel. So it can be said that businesses are now operating in a world without borders, notwithstanding any cultural and language issues. A joint venture is a condition in which economically independent entities agree to work as combined organization. In general, the officially permitted form of a joint venture is likely to be determined by a number of factors including size of enterprise, the expected length of the venture, the identity and location of the entities and the objectives of the participants. The reason behind this strategic alliance between the companies is not a single one in fact there are many. Companies engage in these activities to benefit more and reduce the risk involved with competition and failure. Here are a few advantages which the companies seek in order to maintain growth and expansion due to a Venture. Risk is shared because as the companies form a venture the organizations pool their resources and therefore if a company bears a loss then the pooled capital will decrease not the company’s. By forming a joint venture a company can easily expand their business and could possibly cover more market share in the market. This is because the company has more resources, greater capacity, a better distribution channel A joint venture also makes a company more flexible because a joint venture are formed for a limited life span and also it only covers part of company’s processes, therefore joint ventures limits both the company’s commitment and the business exposure in the existing market. Joint ventures are also very advantageous in creating a more globalize world which might cause countries to decrease the imposition of legal laws on foreign businesses. The joint venture could earn more profits if a venture is operated in a more formal and an organized pattern. Even though joint venture seems to be very beneficial to companies in expanding their businesses but it also create problem for companies in managing the joint ventures. Due to different corporate cultures and management styles colliding the joint ventures result in poor co-operations, poor integration between workers, bad communication etc Each member of the venture has different plans to operate the joint ventures which cause conflicts between the members. By forming a joint venture the business objects and plans are exposed to the other members in the joint ventures which could cause the company to expect competition between the members in the future. Due bad relationship in the beginning the members of the venture don’t provide sufficient leadership which could cause the venture to experience some losses in the start. Since different businesses have different size of business, therefore by forming a joint venture with a small business with a larger business the smaller business is not able to invest or bring in more assets into the venture as compare to the larger business, this results in an imbalance in the joint venture. There can be many forms of a joint venture or an association but three basic legal structures can be used, these can be: 1. partnership or limited partnership 2. limited liability company; 3. purely contractual co-operation agreement A simple and easy to form venture is a partnership. It is the relation which exists between persons carrying on a familiar business. There are also certain mixtures of mediums or arrangements, such as limited liability partnership. However tax and commercial factors may sometimes lead to the use of an unincorporated system, e.g. a partnership or limited partnership, the stream of ventures is mostly between companies or those entities which are recognized well. The most acceptable ventures are between companies. A company is a generally recognized medium and gives a strong identity for transactions with third parties; 1. It can fulfill a thorough employee and management structure; 2. It carries limited liability and has an ability to finance more; and 3. If a change in ownership occurs, it will not affect the venture or the entity. The simplest form of association for joint ventures is an agreement under which the participants consent to associate as autonomous contractors rather than shareholders in a company or partners in a legal partnership. This is often referred to as a consortium or co-operation and is apposite where the parties wish to steer clear of the formality and intransience of a corporate identity. In this situation the privileges and duties of participants and the extent of their legal association will be derived from the stipulation of the joint venture contract, any associated agreements and general common law rules. Such a consortium should set out the requirements and commitments of the partners and how a return on the current venture will be achieved. Although no corporate system is concerned and the venturers will not be associates in a legal sense, it is likely for them to be exposed to claims and liabilities because of the activities of their co-participants on a contractual basis. Therefore, a guarantee should be incorporated in the contract under which one party will cover the other for any losses that are caused through the dealings of the co-participants. Joint venture transactions require vivid and sound drafted documentation. Basic legal documents for a joint venture acquisition are: • A Contract of the joint venturer; and • The memorandum and articles of association of the residing company. What about the shareholder is an important concern within a venture issue therefore a shareholders’ agreement should be turned in. this agreement will fulfill basic rights and obligations of the parties and to make sure that the company and its business are established and run in lieu with the participants’ objectives. A further purpose is to prescribe for what will happen if difficulties occur. An important point to be discussed regarding shareholding is the net worth of the company and shareholders are dependant upon this value. As a fact what the shareholders look for is a better P/E ratio, usually between 7 and 10, and a healthy EPS so that future income is guaranteed. The P/E ratio (Price Earning Ration) is simply a division of the Market Price of the share by its EPS. EPS (Earnings per share) is calculated by dividing the Earnings by the total issued quantity of the shares. What actually happens as a Venture is carried out is that while combining the resources, or in better words pooling them, companies state the non-original profit that is the profit of the venture not their own share which tends to be high and thereby gives a higher EPS figure which in turn is quite misleading. There fore the P/E will fall as the denominator (EPS) rises. Firms need to make sure that certain rules are followed in the disclosing of final accounts so as to make the stakeholder thoroughly aware of the present circumstances. In the situation of non-corporate joint venture structures, the critical objectives of any formal agreement between the participants will be significantly similar to that of a shareholders’ agreement with important differences reflecting where appropriate the absence of a separate legal system and the fact that the joint venture may relate to a project of finite duration. The case considered is from within Hong Kong as it is rapidly growing area of business interest and many Multinationals are seeking opportunities to exploit their abilities in Hong Kong because it promises a lucrative future. Firms are trying to merge into the system through the integration with other local firms such that they are able to understand the requirements of the given industry. Before moving ahead one should be able to identify the tools involved in financing of the venture capital. An issue to be considered is how the joint venture company is to be funded both initially and in the future. The undertaken option of funding method will be influenced by the existing and future cash requirements of the joint venture company. The following factors should be considered: Basic contribution of ordinary shares or probably of different classes is the simplest and most common method for new ventures. Consideration for the preliminary issue of shares by the joint venture capital may be cash but can also the transfer of assets is another tool. The participants may settle on that the initial finance for the joint venture company should be injected to a large extent as loan capital. The parties must also consider the way in which any future finance is to be directed. Participants should be of the same opinion in advance as far as practicable whether or not they are willing to be committed to supply further finance. These should generally be written down in the shareholders’ contract and factors to be borne in mind include: If there is to be no obligation on a joint venturer to endow with future finance, this should be specifically stated. In international joint ventures the likelihood of exchange control in one or other country upsetting the execution of these obligations must be appropriately considered. Now to understand the obligations involved with the disclosure requirements Consolidation agreement is the main idea to be borne in mind. The purpose of proportionate consolidation means that the ‘balance sheet’ of the venturer includes its share of the asset possession jointly and its liability holdings for which it is jointly responsible. The income statement of the venturer includes its share of the income and expenses of the jointly controlled entity. Many of the actions appropriate for the function of proportionate consolidation are parallel to the procedures for the consolidation of investments in subsidiaries. In practice, different reporting formats can be used to give effect to balanced consolidation. The participant may combine its share of each of the assets, liabilities, income and expenses of the mutually controlled body with the similar items, line by line, in its financial statements. In a situation, for instance, it may merge its share of the jointly controlled entity’s inventory with its inventory and its share of the jointly controlled entity’s property with its property. Alternatively, the participant may include separate line items for its share of the assets, liabilities, income and expenses of the jointly controlled body in its financial statements. In this situation, for instance, it may show its share of a current asset of the jointly controlled entity separately as part of its current assets; it may show its share of the property, plant and equipment of the jointly controlled entity separately as part of its property, plant and equipment. Both cases discussed can be tuned in effectively in the reporting of identical amounts of profit or loss and of each major classification of assets, liabilities, income and expenses. Whatever technique is used in effect to proportionate consolidation, it is unsuitable to offset any assets or liabilities by the deduction of other liabilities or assets or any income or expenses by the deduction of other expenses or income, unless there is a permissible right of set-off exists and the offsetting represents the expectation as to the realization of the asset or the settlement of the liability. Keeping these aspects in mind we move on to a joint venture present in Hong Kong between SES systems Pvt. Ltd. Singapore and INFA technologies Hong Kong. The venture consists of HK7.1 million. This venture consists of 70% ownership to SES and the remaining 30% to INFA. The Venture is to be called as INFATECH and will thereby have equity capital of HK7.1million with common shares. The net assets are worth about 18 million this means that the gearing is high in this firm. Coming to P/E and EPS it is important to know that previously INFA made smaller profits due to lack in capital so its shareholders experienced a smeller EPS. With the addition of investment by SES the earnings are said to quadruple and therefore the EPS will rise if the accounts are not shown as part of a venture. It is considered important to show the percentage standings with respect to the ownership and therefore the shareholders should not, in any case, by mislead. Therefore it is imperative for joint ventures to set up a mutually adequate policy regarding the transferability of shares. The parties entering into a joint venture do not normally anticipate the other party to give away its shareholding to a third party since the outcome could well be that two mismatched parties are thrown together. Therefore a common condition for joint ventures to adopt legal arrangements restricting free transferability distinctive of providing that: 1. The transfer of shares without permission of the other parties to the joint venture is either forbidden until further notice or is barred for a stated period or is made subject to board approval. 2. The shareholders are to be given a pre-emption right. A looser form of association is a strategic alliance falling short of any particular jointly-owned system. Some alliances may simply set up a ‘friendly’ link between the parties as a structure for future co-operation on a project-by-project basis. Others may establish more material business links. This purely resides on the contractual agreement. An example can be equity investment. This is not a cooperative venture organization for a particular project or business, but it can provide an overall association against which specific business ventures between the parties can later be developed and supported. Such links and alliances have become a attribute, particularly, in the telecommunications field and other industries where participants are concerned to develop global networks. Conclusion It is important for firms to show exactly where they stand in terms of ownership otherwise the shareholders are deemed to making erroneous decisions. In case of the INFATECH the ownership is very well distributed that is the main entitlement goes to the SES Singapore. Therefore the former owner should explicitly state in his balance sheet that what are his rights and how much of the net assets he owns. The IFRS has tried hard and implemented rules to safeguard the interests of the shareholders and moreover the probable investors who are to prop up the entire industry. If any dissatisfaction arises then the venture capital might fell short of the desired requirements. The most important ratios for comparability of to companies are the P/E and EPS as they are the easiest to calculate and nearly show the true picture of the organization. A P/E ratio of around 7 and 10 is said to sustain maturity stage whereas a high P/E ratio states that the firm is expanding. Bibliography 1. Andrade, Gregor, Mark Mitchell, and Erik Stafford, 2001, “New Evidence and 2. Perspectives on Mergers,” Journal of Economic Perspectives, 15 (No. 2, Spring), 103-120. 3. Anslinger, Patricia L. and Thomas E. Copeland, 1996, “Growth through Acquisitions: AFresh Look,” Harvard Business Review, 74 (No. 1, January/February), 126-135. 4. Dave Hall, Carlo Raffo , Business Studies 2nd edition Causeway Press Ltd. 5. Dechow, P. M., Kothari, S. P., & Watts, R. L. (1998). The relation between earnings and cash flows. Journal of Accounting and Economics, 25, 133–146. 6. 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Fred, 1953, The Role of Mergers in the Growth of Large Firms, Berkeley and Los Angeles, CA: University of California Press. Read More