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“Russian roulette,” allows each side to
define in the investment agreement those
preconditions of price and valuation
under which it would be a buyer or seller.
Provisions for binding mediation or
arbitration would be a third possibility.
The last resort for either side is a courtmandated
dissolution of the venture.
Most private equity and venture investment
models currently use either “drag-along”
or “tag-along” rights. In the former, the
investors can require company management
to participate when they find a buyer for
their stake; in the latter, if a buyer is found
for a certain percentage of the investment,
both sides can sell that percentage of their
ownership stakes. Because such opportunities
can arise suddenly, Marx urges boards to
commission an annual company valuation
by an outside accounting firm. “Most
A Meeting of Equals
When large corporate equals create a joint
venture investment, many of these same
control and valuation issues should be
addressed initially. “Both parties contribute
something to such a venture,” Hertlein
observes, “and establishing issues of fair
value and depreciation upfront is essential
to a successful transaction, particularly if
the contribution of assets is not equal.”
If the venture is not administratively selfsufficient,
one or both sides must provide
management services and value them
appropriately.
Intellectual property rights are frequently
central to large company ventures. The
parties must decide from the start whether
technology is given or licensed to the venture,
and either option has significant implications
for IP ownership. To address the issue of who
Technology Ventures: The Need for Flexibility
As lead counsel in many software manufacturing business combinations, Charles F.
Hertlein Jr. urges clients to build maximum flexibility into transaction
documentation because the industry changes so rapidly. “Technology ventures
often evolve in unexpected directions, and either partner may find that the fully
developed venture is significantly different than they anticipated,” he explains.
“Once that happens, it is extremely difficult to renegotiate venture terms.”
In one example, an engineering design company had created a new category of
workflow management software. Because software was not its core business, the
company entered a joint venture with another industry participant to develop the
product. Five years later, the software had become a significant growth business,
and the company could only bring it back in-house by engaging Hertlein to
negotiate a new agreement with significantly higher valuation—which could have
been avoided by clear growth and control definitions in the original agreement.
companies do a single valuation at the start
of a venture and never update it, which
often creates valuation disputes later,” he
says. “An annual valuation brings issues
such as underfunded pension plans to the
surface, so they can be resolved before
they become due diligence problems when
selling an investment stake.”
gets control of intellectual property developed
by the venture itself, Hertlein and Marx
suggest that the parties agree to license
technology from the venture, with clear
definition of ownership expiration rights.
Particularly if the joint venture owners are
public companies, there should be clear
agreement on what and how much each
party can consolidate from the venture into
its own financial results. That includes
the extent to which either side can derive
tax benefit from losses and depreciation.
Financial agreement should also include
agreement on the extent to which either
side may buy back its own or the other
side’s investment stake. “In all these
considerations, it is essential that the parties
anticipate and resolve negative eventualities
beforehand,” Hertlein warns. “If a dispute
arises, it is harder to force an exact division
of asset ownership in a joint venture than it
is in a marital divorce.”
The Fundamental Rule
Hertlein and Marx agree that one
fundamental rule applies to all investment
agreements, no matter what the size of
the parties or the nature of their business
relationship: Make every effort during
negotiations to anticipate future disputes.
“The eagerness to get a deal done creates
the temptation to minimize the likelihood
of problems,” Hertlein warns. “Thinking
through negative eventualities and how to
address them is one of the surest ways to
avoid them.”
Dinsmore & Shohl LLP is a full-service
law firm with more than 300 attorneys
practicing in nine offices. For the past 99
years, Dinsmore & Shohl has provided a
broad range of integrated services to
meet the needs of both large and small
businesses as well as institutions,
associations, governments, professional
firms and individuals.
Article Participants:
Charles F. Hertlein Jr.
Partner, Corporate
chuck.hertlein@dinslaw.com
Peer Review Rated
James A. Marx
Partner, Corporate
james.marx@dinslaw.com
JULY 2007
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