Which term refers to a new entity that is created when two or more separate firms come together to share development and or production costs?

Determining the best course of action for growing a business is a challenge many corporate finance professionals must face. Is it better to develop organically by investing in projects within the company or expand by acquiring other firms?

The latter option—inorganic growth—is achieved through mergers and acquisitions. It’s also one that many firms are currently pursuing.

According to a survey by Deloitte, 92 percent of executives at U.S. corporations and private equity firms expect merger and acquisition deal volume to increase or stay the same over the next 12 months.

Despite this optimism, these deals can be fraught with complications. Before examining these transactions’ potential risks, it’s important to understand what mergers and acquisitions are and how they differ.

What Are Mergers and Acquisitions?

Mergers and acquisitions (M&A) refer to the process of consolidating companies or their assets. The terms “merger” and “acquisition” are often used interchangeably but have different meanings.

What Is a Merger?

A merger occurs when two companies agree to consolidate into a new entity. For instance, Company A and Company B join to create a new entity, Company C.

One example is the 1999 merger of Exxon Corporation and Mobil Corporation. These two leading oil production companies created a joint entity, Exxon Mobil Corporation.

What Is an Acquisition?

An acquisition is a process whereby an existing company purchases and assumes ownership over another firm or asset. For instance, Company A acquires Company B, and the two companies continue to operate as an existing entity, Company A.

A well-known example is e-commerce giant Amazon’s purchase of Whole Foods for $13.7 billion in 2017. As a result of the acquisition, Amazon now holds ownership of Whole Foods and its assets. A more recent example took place in February 2022 when Frontier Airlines acquired Spirit Airlines for $6.6 billion.

Both types of M&A transactions can enable organizations to expand their reach and increase market share.

Examples of Mergers and Acquisitions

Mergers and acquisitions happen frequently. According to the Institute of Mergers, Acquisitions, and Alliances (IMAA), there’ve been nearly 800,000 such transactions worldwide, worth an estimated $57 trillion.

Some other well-known examples of mergers and acquisitions include:

• The Walt Disney Company’s acquisitions of several companies, including Miramax Films (1993), Fox Family Worldwide (2001), The Muppets (2004), Pixar (2006), Marvel (2009), Lucasfilm (2012), and 21st Century Fox (2019)
• Google’s acquisitions of YouTube (2006), DoubleClick (2007), and Waze (2013)
• The 2018-19 merger between CVS and Aetna
• The 2015 merger between Kraft FoodsGroup Inc. and the H.J. Heinz Company

Risks of Mergers and Acquisitions

While mergers and acquisitions can lead to tremendous growth opportunities, they can also come with substantial drawbacks—such as integration risks. Here’s a look at four risk factors associated with M&A deals and when they can arise.

Before the Merger or Acquisition

1. Lack of Due Diligence

Due diligence is critical to preparing for M&A transactions. When purchasing preexisting assets, it’s the seller who holds much of the information. Prior to the transaction, your company should learn as much as possible about the selling firm’s financials, contracts, customers, insurance, and other pertinent information to ensure it has an in-depth understanding of the deal on the table.

Without a thorough information-seeking process, your firm could get caught up in obligations it’s not yet ready to assume, such as litigation issues and complicated tax matters.

2. Overpayment

Overpayment is a common pitfall of mergers and acquisitions. There can be a lot of pressure from several sides when preparing for such significant transactions. In addition to the seller, you may be urged by intermediaries involved in the agreement, along with teams within your own company. This could force your organization to overpay to simply push the deal through, rather than work out an arrangement that creates value while avoiding additional costs.

After the Merger or Acquisition

3. Miscalculating Synergies

Several problems can arise if your organization completes a transaction with misguided notions about realizing synergies, or ways in which the two companies combined are more valuable than they are individually.

Firms often enter a deal overly optimistic about the impending payoff and underestimate how long synergies take to come to fruition. Consolidating workforces and operational processes takes time. Excess costs can also be accrued if there are unrealistic expectations around when the integration will be complete.

Synergy miscalculations can also feed overpayment, as they may be rolled into the purchase price so your company gains control over assets before fully reaping benefits from them.

4. Integration Issues

Significant integration issues can crop up after a merger or acquisition—both operationally and culturally. A merger or acquisition is a major organizational change with the potential to alter the processes underlying how both businesses operate.

If a detailed integration plan isn’t in place when a transaction is made, the companies involved may function separately for longer than anticipated, resulting in increased costs.

Differences in company culture may also pose a challenge. According to research by McKinsey, approximately 95 percent of executives say cultural fit is vital to an integration’s success.

While one company may be more entrepreneurial and innovation-focused, the other may be more traditional and results-driven. If a transaction involves acquiring an international business, employees may suddenly find themselves coordinating with or managing a global team.

Without a robust integration strategy that takes each organization’s values, norms, and assumptions into account, collaboration issues may arise that impede efficiency and delay the consolidation process.

How to Mitigate Risks in Mergers and Acquisitions

Mergers and acquisitions can be a boon to corporate growth. A common issue underlying many of the risks that come with negotiating M&A deals is the tendency to involve finance too late in the process.

The finance department is often perceived as the gatekeeper for capital allocation, and many business professionals tend to hold off on its involvement for fear of halting proceedings. The earlier you consider financial implications, the better equipped you’ll be to avoid the common pitfalls of mergers and acquisitions.

With knowledge of finance and risk assessment, you can help your company navigate these complex transactions and increase its market share.

Do you want to develop a toolkit for making smarter financial decisions? Explore Leading with Finance—one of our online finance and accounting courses—and discover how you can identify ways to create and measure value in your organization.

This post was updated on July 28, 2022. It was originally published on July 25, 2019.

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 Whether you own a multi-million dollar business or are a small business owner, you’ve likely considered pursuing a joint venture, given the financial gains such a partnership has the potential to generate. Among the many advantages and benefits of a joint venture agreement is that they allow participants to pool resources, thus maximizing profits with minimal or no new investment. But there are several types of joint venture as well as many similarities to partnerships and other types of business agreements. 

Take the time to understand this type of business relationship and study some joint venture examples. You’ll find the clarity you need to make strategic business decisions for your company’s long-term health.

Discover your own business identity to create the ideal joint venture

The classic definition of a joint venture is a business arrangement in which two or more companies combine resources on a project or service. The length of the agreement and what resources it will include will vary. Participant companies typically agree to split any profits the venture creates. As a result, joint ventures are potentially advantageous for companies in need of expanded resources with minimal (or no) infusion of capital.

Beyond the legal definition, what is a joint venture, really? The key is trust. You’ll be working with unknown entities from different companies, and in order to accomplish your shared goals you’ll need to trust them. Trust must be earned. You will be working closely with these individuals for what could be a lengthy amount of time. Are they the sort who might betray you? You’ll need to do your homework when the prospect of a partnership first arises and decide whether or not they deserve your trust.

There are a few types of joint venture, but none of them qualify as a partnership. The main difference between a partnership and a joint venture is that a joint venture is limited to one particular venture while a partnership is not. Joint ventures can also include corporations or entities, while partnerships are only between two or more persons.

Joint ventures are also formed for a specific amount of time while partnerships are usually built for the long term. How long can a joint venture last? It depends on the terms of the agreement and the goals of the joint venture. This type of business deal is formed with a specific goal – to enter a new market, create a new product or enhance a service. The joint venture ends when the goal is reached, so the time can vary. They are usually formed for anywhere from five to seven years.

Another way joint ventures are different from partnerships is that they are governed under the laws of business formation and dissolution, whereas partnerships in the U.S. fall under the laws of their state, usually within contract law. In a joint venture, each party also retains ownership of their property and is only responsible for expenses specific to the agreement. That’s a major benefit, among others.

The benefits of this type of business relationship center on the acquisition of (shared) resources without an (excessive) outlay of capital. This sharing of resources facilitates companies’ expansion into new markets, allowing for relatively low-risk, scalable business growth. 

Joint ventures are also highly flexible. Those who participate don’t need to form a new business entity to create the venture’s collaborative product. The partners are also not bound to one another after the expiration of the initial partnership contract; each business retains its unique identity and autonomy, and each may carry on business activities unrelated to the joint venture. As such, joint venture arrangements streamline the process of business innovation while minimizing its risks.

A joint venture could be the right choice for you if you want to enter a new geographic market or improve your visibility among a certain target audience. They are also useful to gain technical expertise or intellectual property that you otherwise wouldn’t be able to access or to improve the advertising and marketing strategies of both companies. What is a joint venture if not an opportunity to pool resources?

No business venture comes without risk. The main risk of a joint venture is that when something goes wrong, both parties are held accountable, rather than only the party who was at fault. While most businesses entering joint venture agreements are limited liability companies (small businesses), each participant is equally responsible for legal claims arising from the joint venture, regardless of its level of involvement (or profit) from the venture. 

So are joint ventures 50:50? Not necessarily. Each party retains ownership of their property, and depending on the terms of the joint venture contract, you and your partners may contribute resources unevenly. This can lead to problems if the profit-sharing arrangement doesn’t adequately compensate one side or the other. 

Engaging in a joint venture may limit your opportunities to interact with other organizations, particularly if your contract contains non-competition or non-disclosure clauses or limits the use of non-specified vendors. This can end up stifling the constant innovation your company needs to continue producing value and creating the ultimate customer experience.

Whether a joint venture is worth it depends on your risk tolerance. If you do decide to enter into this type of agreement, make sure you choose your partners carefully so that you don’t drag down the quality of your own company. Teaming up with people who don’t share your company’s core values can negatively impact the way your business operates and lead to trouble with the products you produce on your own. And always take the time to draw up a detailed and specific contract.

Those who enter into a joint venture need a contract that spells out the parameters of their involvement. This joint venture agreement describes the purpose of the arrangement and sets up everything both parties need to start their shared venture. This includes profit and loss details, ownership allocations and a termination clause. Other parts of the agreement can include how the venture is staffed and structured, the scope of the venture and what determines the success of the venture.

Do you need an exit strategy in your joint venture agreement? It’s tempting to think you do not – because joint ventures are made to reach a certain goal, you may think that reaching your goal automatically terminates the agreement. But you still need a strategy for how you will divide profit and loss, new assets and increased market reach once you reach your stated goals. You can choose to sell the business created by the joint venture or restructure it into a new organization. Large joint ventures can even transition ownership to employees.

What is a joint venture from a tax perspective? Unlike a partnership, a joint venture is not recognized as a taxing entity by the IRS. Instead, the joint venture agreement determines how taxes will be paid. If the venture operates as a separate business entity, it will pay income taxes just like any other type of business. In the agreement, the parties involved specify how they will split profits and losses and how they will pay any taxes that are due.

There are two major types of joint venture that two or more companies might participate in. These joint ventures might affect one particular product or an entire product or service line.

1. Personnel-based joint venture

This type of partnership covers both the people themselves and the expertise they bring to the table. Several staff members from Companies A and B are placed on a project. Think multiple programmers to design or upgrade an app, or several architects to refurbish an out-of-date building.

2. Equipment-based joint venture

This type of venture involves technology or machinery. For example, Company A lacks the manufacturing technology to produce its new furniture line. It partners with Company B, which has the necessary equipment but lacks designers. The advantages of a joint venture agreement in this example are clear: the collaboration allows Company A to create its desired innovation without an outlay of capital, while Company B gains a percentage of profits without incurring development costs.

To really understand the answer to the question “What is a joint venture?” and create your own successful agreement, you must model the best. These joint venture examples involve some of the world’s most famous businesses.

• Caradigm (Microsoft Corporation + General Electric)

One of the better-known joint venture examples is the Caradigm venture between Microsoft Corporation and General Electric (GE) in 2011. The Caradigm project was launched to integrate a Microsoft healthcare intelligence product with various GE health-related technologies. 

• Hulu

Another famous example is Hulu, which began life as a joint venture between NBC Universal, Providence Equity Partners, News Corporation and then The Walt Disney Company. Launched in 2007, Hulu was originally conceived to run programming from these four companies and their respective subsidiaries. Hulu has since developed its own programming. 

• Barnes & Noble + Starbucks

You’ve probably noticed all of the Starbucks placed within Barnes & Noble bookstores – but did you know that’s actually a joint venture example? Both companies win: Starbucks sells more coffee, and Barnes & Noble provides an excellent customer experience with its in-store cafes. 

• Fiat Chrysler + Google 

Fiat Chrysler and Google formed a joint venture in 2016 to develop self-driving cars. Why does it work? Google is a tech giant, but they’re not an automaker. The deal with Fiat-Chrysler more than doubled its self-driving automobile assets.

• Samsung + Spotify

In 2018, Samsung and Spotify struck a deal to make it easier to use Spotify on Samsung devices. A year later they expanded that agreement and began including Spotify as a pre-installed app on many Samsung phones – even giving consumers six months free. 

• SABmiller + Molson Coors Brewing Company 

This joint venture example involves entering new geographical markets: MillerCoors is a joint venture between Molson and SABMiller intended to distribute all their beer brands in Puerto Rico and the United States. 

Ford + Toyota

Ford and Toyota began working together in 2011 to develop hybrid trucks. Toyota brings the hybrid technology knowledge, while Ford brings its leadership in the American truck market – the perfect example of a joint venture created for access to expertise and intellectual property. 

Participating in a joint venture partnership requires your absolute A-game. Whether you’re just about to jump into business as a joint venture or have been in business for years, Business Mastery is the experience you need to grow your company and drive your success. Enroll today to discover more success tomorrow.

A successful joint venture depends on the ideal pairing of strengths and weaknesses. Take the Business Identity Quiz today to determine yours.