THINKING ALOUD (Business&Law) BUSINESS MODEL: Partnerships
No partnership between two independent companies, no matter how well run, can match the speed, effectiveness, responsiveness and efficiency of a solely owned company.— Edward Whitacre,Jr Former Chairman and CEO of General Motors
One man’s opinion: Chén Róng
Partnership comes in different forms and sizes. A joint venture is a form of partnership commonly used by business people. It may be known - although not absolutely apt -- as a period of engagement that leads to a corporate marriage. The venture can be for one specific project. But when the joint venture involves big multinational companies, the consortium expects to eventually engage in a continuing business relationship in marriage -- an alliance or strategic partnership or sort. Sometimes, the marriage happens almost simultaneously, giving the partners no time to test out their relationship as would be the case with a period of engagement much longer.
Two years ago, the world witnessed the marriage of two corporate dynasties -- one from the west and another, east. The Rothschild banking empire, led by Nat Rothschild who used a chunk of his family's business interests to back him in a deal with the politically powerful Bakrie family of Indonesia. A London-listed company founded by Nat was to acquire stakes in two Bakrie-associated coal enterprises. It was a complex deal - a reverse takeover - for cash and share swaps in billions of American currency. It was supposedly a marriage made in heaven. But it was not to be. Barely two years of swift engagement and tying the knot, saw the partners ‘divorced’ amid bitter recriminations and allegations of financial impropriety as shareholders lost much of their money.
It is unfair for outsiders to comment on the various issues that led to the collapse, as only insiders have the correct answers to such a complex venture. Basically, it was a high-stake venture in gaining part ownership of a crown jewel -- the richest coal mines in Indonesia. Nat was aware that he was playing high-strung Grand Slam tennis at the prestigious Wimbledon Stadium. To win the coveted Wimbledon championship trophy, he had to hit the ball close to the lines which requires lots of accuracy, skill and dexterity! The price for losing in the finals can be painful. The writer has only this to say: It was unfortunate that events happened the way they did. The paragraphs that follow have no specific reference to the Rothschild-Bakrie tie-up. The commentaries are just general observations of the writer with regard to joint venture partnerships -- rarely the high-stake ones.
An alliance or strategic partnership
A strategic partnership can be compared to a marriage. A married couple does not become a single entity. Each retains his/her own individuality and join only to build a life together; they unite by shared interests but each partner brings something different to the union. A strategic partnership between two corporate entities sits on the same rationale. Because of substantial cross-holdings of equity, each company acts in the financial interest of the other while keeping their individual identities and corporate culture -- similar to what the Rothschild-Bakrie partnership may have intended on setting up. However, when the partnership equation gets too complex - involving many entities and with billions of dollars at stake - a collapse of the edifice on a less firm foundation is not unforeseen. When partners just met and there was no past working relationship, a breakdown is not unforeseeable. A sudden on-rush of new funds can put people with poor money management skills out of control unless necessary checks and balances are in their proper places.
Try joint venture partnership in single projects instead. Things are a lot more manageable.
Dealing with distrust
Business people coming to an Asian country and holding a view that corruption is rife and frauds are notoriously common will find business partnerships challenging and hard to strike up. Corruption and frauds do exist in many countries. The difference between them lies in the degree of it and the form it takes.
The writer once represented a foreign company in managing a mining project in Indonesia. It started from a green-field stage. We had to talk to contractors and evaluate tenders for trucks. There was a need to build roads and private loading facilities by barges for exporting of mine products. The foreign partner was aware of the language and cultural gap, and local practices were different. Money management methodology and accounting principles are not what a western- trained accountant would expect to see. The local partner required lots of hand holding to get their financial right. We put in place checks and balances not so much we do not trust our partners, but we need to align the accounting data so that partners speak the same financial language. Did the partners pay bribes and plundered the country of a fortune to get things done?
It is always good philosophy to think that heavenly eyes are watching you all the time. No, it is poor business practice to show little regard for the environment -- deforestation, soil erosion and the poisoning of water-sources poor villagers dearly needed. Yes, we chose the most suitable business model -- a joint venture agreement that allowed us to register as a national company, free from rules applicable to a foreign investor. It is true that many foreign operators employed domestic proxies to secure mining permits from local governments for paltry sums. They use local miners to avoid paying taxes and avoid capital normally needed for large-scale mining; and often engage in black-market dealings and rampant smuggling of production out of country.
Miners can engage the local population on a pay-back scheme when choosing a less costly business model. The motto should be: "teach locals how to fish" and help them gain the ability and means to support themselves. We built better roads and dwelling houses in the mining vicinity; and we had our people dug better wells -- not necessarily deeper -- as well-depth can affect both quality and quantity of water.
In a country where the locals find making enough money to keep their family going, it is inevitable that many of them find ways to supplement their meagre wages. As for people in position of responsibility -- officers issuing licences, granting of permits and providing security services -- jobs may be offered to family members. Perhaps let them supply goods and services as contractors or gain gainful employment at the mines and loading terminals. This is just a brief of what was done to discourage the offering of bribes to people in authority. In short, partners have to understand the ground rules within a specific locale. And foreign partners have to take steps to prevent fraud horrors in their ventures abroad. Chances are: good deeds might touch the hearts of some of them and they may leverage you against bad deeds from the die-hards -- an indirect form of checks and balances.
Joint venture partnership
Partnership and its permutations
It is not uncommon for competitors of big oil and gas producers to join forces in a range of levels including sharing of resources on safety measures and equipment e.g. evacuation helicopters. For hospitality industry, the most common form may be in management in the form of a joint venture company to manage hotels under distinctive brands in different market segments in particular regions. Operators of container-ships buy slots or space on vessels the partners own. These ships sail between common global ports on fixed schedules. At other times, they operate joint services, calling at regional ports in various parts of the world. Such partnerships lower operating costs and shored up freight rates. The permutations are infinite for a range of industries. A country like Indonesia will need high-value investment to help local companies move up to the next level of development. Companies in logistics, for instance, are much sought-after because of their information technology infrastructure and management expertise in processes where perishable food products are domestically transported safely and quickly over long distances.
Hands-on vs Hands-off management
Foreign partners need be aware that counterfeiting, brand sabotage, product hijack are unpleasant events reportedly taking place in developing countries Lawyers cannot solve everything and seemingly trusted employees can insidiously bring about a company's downfall. But a foreign partner should make a step-by-step approach to stop such frauds from happening. In other words, it is not good enough to own a substantial stake in a joint venture -- a single purpose vehicle -- and have your appointed directors on the management board. Hands-on participation in its management -- marketing, finance and other key functions - is the key to preventing many frauds. Many frauds take place as off-balance sheet items. Margins may be inflated and receivables only look good on the books with phantom sales. Management participation at these levels is time consuming and which many multinational companies would leave their local partners a free hand in the day-to-day running the joint venture. They thought, it was good enough that they have their share of directors appointed to the board and, therefore, they are free to go globetrotting to pile up more joint venture partnerships to expand the business base.
If a foreign partner were to cede management control, chances are once the business become highly profitable, local partners may set up a parallel business to engage in the same activities as the joint venture company. Eventually, all business clients may be transferred as the joint venture gradually turned from profitable to a loss-making enterprise. Certainly, the approach to management control has to be calibrated to ensure it does not contravene joint venture terms or break local laws.
Begin with a MOU
But it is advisable to enter into negotiation with a memorandum of understanding. It serves as a prelude or blue-print for a joint venture agreement. MOU provides a cooling period where the people involving in the negotiation take it home to discuss with others -- departmental managers, lawyers, accountants and independent directors who may be able to contribute their specialist views.
MOUs are less formal than contracts with fewer details and complexities. Nevertheless, they are more formal than gentlemen-agreements after a face-to-face negotiation Many negotiators use MOUs to create guidelines for each party as they contribute their efforts and resources toward an important project. MOUs are simpler and more flexible and they are generally not legally binding. The purpose is to gauge the intention of the transacting parties before a deal is signed or sealed. Nevertheless, the MOU does not grant either of them any rights. So, in some cases, it is preferred to opt for a softer, non-legal document than a legally binding one.
Rule–of-Law or rule by law
It is always necessary to have a well-draft joint venture agreement in place. But it does not mean that one can sleep peacefully with the notion that you have a bullet-proof vest that protects you against all wrongs -- not in most emerging markets. If something were to go seriously wrong, a written agreement serves only to iron-out unintended wrinkles -- the misunderstandings - and not those intentionally inflicted by your partner. That is the reason many highly-qualified people sent by companies to make deals fail badly in their negotiations and mishandle events when dealt with a bad hand. To be fair -- they may also have to report to even more qualified people in top management; people who do not understand that the same game is being played differently. In many emerging economies, the rule of law means little when your partner can pay his way to getting justice done in his favour. Local courts subservient to a government will decide cases in favour of local enterprises when something goes wrong and rule by law prevails. Generally speaking, a foreign partner should never rush into a joint venture partnership without first testing the waters. If possible, start a relationship with an informal partnership or joint operation that can be easily dismantled by both parties if things do not seem to work out.
When the writer was a young man, he was told why golf games were always important preludes to business ventures. If your partner cheats you in a friendly golf game, he is unlikely to be a trusted partner in business. So next time you want to swat a fly, try a different method instead of aiming straight at it! All sports have their rules; all businesses have theirs too. Business joint ventures are increasing more common in this globalized commercial environment where parties put in their connections, money and special skills into a venture for mutually beneficial. But one has to understand the ground rules.
READ OTHER STORIES AT:
WRITER: Chén Róng
The world needs more entrepreneurs. It is heartening to see more people aspiring to start and run their own small businesses. However, it is different running a small business in a less-developed country vis-a-vis one located in advanced-developing country like Singapore; and they come with dissimilar legal implications for their owners. I have visited less developed countries and walked through many of their streets lined with small businesses; many of these roadside makeshift stores are unlicensed, not to mention legally registered as businesses.
- Licensing of businesses
However, for all advanced developing and developed economies, state rules may require that licenses or permits be in place for starting up when you start a business, typically for tax purposes and sometimes to protect public health and safety. For certain trades and professions— running the gamut from general medical practitioners and lawyers to building contractors— require special licensing.
- Registering sole-proprietorships
Other than licensing requirements, it is relatively easy to start a small business and single-owners generally run them as sole proprietorships. The major advantage of a sole proprietorship is: it is a simple business model and least expensive of all structures - there is really nothing to set up and maintain. In countries like Singapore, the single-owner must register it as a business which requires a yearly renewal for a small fee. In other countries such as USA and Canada, no formal requirements exist unless owners give their business fictitious names in place of their real names.
There is no minimum educational qualification for starting up a proprietorship business. For that matter, many budding entrepreneurs, regardless of their station in life, flocked to open shops retailing household and beauty products; or as tailors and hairdressers, just to name a few. There are still others – freelance artists and contract craftspeople - who prefer to form unincorporated sole proprietorships. Things have changed a lot from the steam locomotive days. Today, many single-owners are university graduates. They made debut at these traditional trades as their own bosses because of dislike for nine-to-five full-time employment. Nevertheless, it is their strength of character and drive which enable them to succeed in a business environment where multinational companies are the new world order.
Regrettably, such confidence in their own resilience may prove to be the weak links in the chain for these single-owners who relentlessly pile in time and resources expanding their businesses. Misplaced self-confidence and ignorance may have pushed some of them to take on risks which should never have been undertaken. For instance, some personal groomers openly offered services like freezing body fat and cellulite removal for clients when such work should only be done by licensed specialists. There are also beauty clinics for general and specific facial makeover- nose job, chin augmentation, skin whitening and Botox-type injections. These clinics should never have formed without the needed qualified staff. What these single-owners do not realise is that they are personally responsible for all liabilities of the business. If someone sues the business for breach of contract, personal injury, or to collect a debt, the court can directly levy the personal bank account and other property of the owner. Personal liability insurance may not fully cover every accidental claim. It is important to read the fine print.
Unfortunately, obtaining insurance coverage may provide people with a false sense of security, thinking that all is well for them. One way they can be protected against creditors or limiting other liabilities is to have the business organised as a private limited company - a legal entity.
- Mocked Partnerships
What happens if the business owner is cash-strapped? A way out of the woods is for the proprietor to rope in partners who may contribute significant capital to his business. This may be a no-win situation where all concerned should tread warily. For instance, if ‘B’ injects cash of US$50,000 as additional capital into a business which ‘A’ runs as a sole proprietorship; and followed by a business name change to “A & B Renovation Contractors”, does that make ‘B’ a partner? The answer is both yes and no. Yes, if the business entity is in a country with no formal rules for unincorporated partnership, ‘B’ may succeed in proving the existence of a partnership. An agreement does not need to be writing. On the other hand, the answer is: No, if registration rules apply in a country like Singapore. In law, the entity has all the trappings of a single-owner business. ‘A’ has rights of a business proprietor. On the flip side, he bears all liabilities incurred by the business. It matters not if all earnings are put ‘into the kitty’ by the partners, there is still no guarantee ‘B’ will get a share of the business profit. If ‘A’ decides on giving ‘B’ a share of business profit, the decision is a gesture of friendship and not one done out of a legal obligation. When push comes to shove, ‘B’ may have to concede that seed capital given ‘A’ was that of a personal loan for ‘B’ has no enforceable rights for profit sharing in the business. Irreconcilable differences are always devastating for all parties; and all the more so for the party who has no legally binding contract to secure his financial interests.
What happens if there is a partnership agreement signed by the parties? Do not consider this as an option; it will not work if a particular country has published rules for its operation. Laws may require the partnership to be registered and run under prescribed rules, and (in some cases) the partnership agreement filed and made available for public inspection. If these rules are not followed, the terms of the partnership agreement between the parties are unenforceable. The business partnership is then one based on mutual trust. It runs afoul of the law. Customers may be misled into thinking that the business is financially stronger under ‘A & B Renovation Contractors’; this arrangement in law remains a sole-proprietorship regardless of the name change. As each partner is not responsible for the full amount of all liabilities of the business, a creditor cannot collect the full amount of a debt of the presumed partnership from the party that is the easiest to collect from.
- General and Limited Partnerships
A general partnership is preferred if participants intent on setting up a low-key, low-profile business. It increases the probability of attracting external funding and the recruitment of talented staff. In a place like Singapore, government initiatives have enabled citizens, permanent residents and employment pass holders to register general partnerships; hence opening an easier path for people wishing to run small businesses.
However, business owners should understand that general partnership, the basic form in common law countries, may not be recognised as a legal entity. What it means is that each partner is personally answerable for all risks, debts and losses of the business; a scenario similar to that of a sole proprietorship. As an alternative, the parties may consider a Limited Partnership as the business structure. A limited partnership places one of two partners as the General Partner, the second, a Limited Partner. The General Partner assumes management control of the business and, therefore, he receives a proportionate share of profits. The Limited Partner is responsible for debts incurred by the business but limited to the extent of his registered investment in the partnership. This arrangement leaves the General Partner with the responsibility for paying off all outstanding debt.
- Joint Venture Partnerships
A joint venture agreement (both in its oral and written form) is a business arrangement between two or more parties. Nowadays, this term means two or more companies come together to work on commercial projects. In the majority of cases, a new stand-alone company manages this single project. Nevertheless, there is no law to preclude partners as individuals to organise a joint venture partnership (JVP) between them for purpose of running a single business project.
Hence, if both parties wish to give their intended partnership a test-run: a one-time business venture may be the answer to see if they can work together amicably and profitably as partners. Perhaps put the intended partnership to a test? Put in a joint bid for a home renovation project since the partners have the necessary operating licences for different skill-sets - one partner taking over all works pertaining to general masonry and the other sanitation and electrical fittings. In Singapore, this practice is not uncommon. Under such an arrangement, one partner is in fact a sub-contractor to the other partner who serves as the main contracting person for presenting a comprehensive renovation quotation to the homeowner for approval. It is instructive if both partners enter into a written agreement to define their rights and obligations. While ‘putting it in writing’ may not be necessary for a legally binding contract to exist, it may be harder for the partners to prove what terms were agreed upon orally should a dispute arise between them.
Thank you for following my thoughts so closely. The preceding paragraphs are just my thoughts spoken out loud. You should never take it as legal advice. Business owners should always consult their own corporate lawyers on the special circumstances of their own before entering into any form of business partnerships. Besides, different countries have dissimilar laws governing sole proprietorship and partnership businesses.
Chén Róng's little Chinese-English Dictionary
running the gamut = guǎng fàn de fàn wéi nèi
their station in life =yǒu zī gé zài qí néng lì fàn wéi nèi zuò de shì qíng
made their debut = kāi shǐ xíng dòng de guò chéng zhōng
Weak links in the chain = dǎ gè bǐ fāng: zài yī gè zǔ zhī de bó ruò diǎn huò rén
Rope in = shuō fú bié rén tóu zī yè wù
should tread warily = bì miǎn zuò rèn hé kě néng dǎo zhì kùn nán
false sense of security = yǐn lǐng mǒu rén xiāng xì, yī qiè dōu hěn hǎo.
Putting profits into the kitty = bǎ lì rùn tóu rù gòng tóng zī jīn
push comes to shove = yì sī jiù shì: miàn lín zuì hòu jǐn yào guān tóu, méi yǒu rèn hé huí xuán yú de shí kè.
The writer makes no warranty of any kind with respect to the subject matter included herein or the completeness or accuracy of this article which is merely an expression of his own opinion. The writer is not responsible for any actions (or lack thereof) taken as a result of relying on or in any way using information contained in this article and in no event shall be liable for any damages resulting from reliance on or use of this information. Without limiting the above the writer shall have no responsibility for any act or omission on his part. Readers should take specific advice from qualified professionals when dealing with specific situations.