alliance structures

Alliance Structures

STRATEGIC ALLIANCE PRACTICE

Discussion draft

July 1995

CONFIDENTIAL/INTERNAL ONLY

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ALLIANCE STRUCTURES

The purpose of this document is to help CSTs understand the full range of alliance structures that are available to clients, and provide frameworks for selecting among alliance, M&A, and arms-length contractual options.

This draft document has been developed as part of a broader, ongoing practice effort on negotiating and structuring alliances. The document has four sections:

1. Typology of alliance structures

2. Frameworks for selecting structures

3. Alliance structures: definitions and examples

4. Illustrative structures.

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ScopeWhat is in the alliance?

GovernanceHow can we manage it effectively?

Legal/financialWhat should be the ownership and financial arrangements?

Focus of this document: types of alliance structures

MgmtBoard composi-tion

Valuation and ownershipshares

Capitaliza-tion and financing

Type of alliance

Exit provisions

SkillsGeographiesProducts Assets/activities

Roles of parents, JV Board, JV CEO

This document focuses on clarifying types of alliances; for a broader perspective on developing alliance structures, see “Core Beliefs – Designing Successful Alliance StrategiesÝ or “Best Practices and End Products – Developing Successful Alliances,Ý or contact David Ernst (DC) or Trond Riiber Knudsen (OL) for results from a current practice project

Focus of this document

1. TYPOLOGY OF ALLIANCE STRUCTURES

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What is a strategic alliance?

Elements Comments

Joint contributions Each partner contributes capabilities, e.g., skills, access to markets, assets

Influence without full ownership

Partners are able to influence assets without full ownership

Shared control, ownership, risk, and reward

Parents share control and/or ownership of business system, leading to shared risks or rewards

Exclusivity There is typically some degree of exclusivity

Temporary Strategic alliances are typically intermediate strategic vehicles

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Strategic alliance: a definition

Intermediate strategic vehicle involving substantial shared risk, cost, or reward without full control, and with a significant degree of exclusivity

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Not all corporate relationships are strategic alliances

Acquisitions

Mergers

Joint ventures

Partial equity investments• One-way minority stakes• Cross-equity stakes

Contractual agreements(parent-to-parent)

Corporate relationships

No

Rarely

Yes

Only if combined with JV or contractual alliance

May be alliances, depends on level of shared risk, reward, exclusivity

Are they strategic alliances?

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“Partial acquisition” JV – one parent takes substantial stake in other company (often contributing cash and skills or technology) while a new “JVÝ entity is created

One-way or two-way minority investments with JV or contractual alliancesMinority investments – without JV or contractual alliance

Startups in which both parents contribute assets, technology, people, other capabilities

Formation of JV in which parents contribute ongoing business, significant assets, capabilities

Formation of “shell” JV – small management or marketing/sales company which uses other business elements that remain with parents

Mergers in which a single combined entity retains ownership and control after the deal

Broad types of alliances are

based on ownership, contributionsStrategic alliances

CORPORATE RELATIONSHIPS

Acquisitions

Mergers

Minority equity investments between parents

Contractual agreements

Mergers in which both parents retain significant ownership and control, e.g., merger of business units, held as 50-50 JV after the deal*

Contractual alliances with substantial shared risk/reward

or exclusivity**• R&D partnerships• Exclusive licensing• Strategic outsourcing

• Franchise• Production swap• Co-production

• Exclusive supply• Exclusive distribution• Co-branding• Joint bidding

• Long-term purchase agreement

• Buying cooperatives

Arms-length agreements withoutsubstantial shared risk/reward or exclusivity**

* Debatable, these are mergers at BU level; JV at parent level

** Specific terms of each contractual agreement determine whether they are strategic alliances. Contractual alliances

are often referred to as joint ventures; in our definition a joint venture must include the creation of a separate entity.

Joint ventures

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Each structure has distinct features

Control None/limited Shared None Unified control (but few true mergers of equals)

Acquiror gains full control

Ownership None Shared ownership of JV entity

Typically 10-20% Unified Complete

Influence of parents

Can be substantial Substantial(one JV)

Some, may receive Board seats

Depends on power balance

Complete

Pooling of assets

No Yes, for assets in JV No Yes Yes

Legal relationship

Contract New corporate or partnership entity created

None except minority shareholder rights

Single entity Single entity

Governance, dividend policy

Not an issue Must be determined in advance

Per minority shareholder rights

Typically determined in advance

Acquiror decides

Capital expenditure/ cash outlay

None except per contract

Partners typically share capex for startup, continuing operations

Cost of minority stake Capex of both companies combined

Cash outlay include premium, full capex to both companies

Valuation/premium

None No premium; partner with lesser value must compensate for value gap or accept <50% ownership

None No premium Substantial premium

* Without associated JV or contractual alliance

Feature

Contractual alliances

Joint ventures Minority stakes*

Mergers Acquisitions

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Startups in which both parents create a new business by contributing assets, technology, people, other capabilities

Formation of JV in which parents contribute ongoing business, significant assets, capabilities

Formation of “shell” JV – small management or marketing/sales company that uses other business elements that remain with parents

Many structuring options within each type of alliance

Example: JV structures

OPTIONS FOR STRUCTURING JVS

Ownership

“Mechanics”

Majority/minority (typically in range of 20/80 to 80/20)

50/50

3-party, usually 2 large, even shareholders, 1 small (e.g., 49/49/2%)

Mergers in which both parents retain significant ownership and control, e.g., merger of business units, held as 50-50 JV after the deal

“Partial acquisition” JV – one parent takes substantial stake in other company (often contributing cash and skills or technology) while a new “JV” entity is created

Partnership

CorporationLegal form (U.S.)

GeneralLimitedCSLimited liability corporation

Scope

Business systemFullPartialLimitedUnlimited

ExistingNewLimited scopeAll products

Geographic

Products/technologies

Governance

Financial flows

Other elements

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Many important, sensitive governance choices

GOVERNANCE

Board

Who

Roleof parents

Staffingof JV

Other governance elements

ILLUSTRATIVE

How many

Balance

Voting

All insiders

Insiders plus outsiders

Even number, parents equally represented (with conflict resolution mechanisms)

Odd number

Majority vote – all issues

Veto power or supra-majority voting on key issues

Specific issues delegated to each partner

One parent has majority

Parents have equal numbers,

tiebreaker vote held by outsider

JV highly independent, treated as autonomous unit by both parents

JV treated as division of one parent

CEO

Other key

appointments

Insider

OutsiderAppointed by one parent

Selected by both parents

Determined by JV CEO with approval of Board

Specific spots (e.g., CFO) reserved for parent selection

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Choice of structures depends on objectives and business environment

Contractual alliances

Joint ventures Minority stakes

Mergers Acquisitions

2. FRAMEWORKS FOR SELECTING STRUCTURES

• Desire for full control

• Core business, geography

• Difference in partner size, strength

• Need for scale

• Predictable environment

• Need for integration

• Business not yet fully concentrated

• “Monolith” is winning model

• Desire to influence rather than own

• New business or geography

• Similar partner size/strength

• Need for complementary capabilities

• Unpredictable environment

• Need to bridge multiple businesses, technologies

• “Web” is winning model

Use M&AUse JV/contractual alliance

Corporate relationships

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Objective drives choice of specific alliance type

Objective Specific alliance type

PRELIMINARY

Combine complementary resources

Enter new markets/channels JV, franchising, co-branding, out-licensing, co-production, distribution

Create new business JV, othersAccess specific products,assets, functions

JV, in-licensing co-production, franchise

Develop technology jointly JV or parent-to-parent R&D partnerships

LearnTechnology JV, licensing, R&D partnerships

Skills JV; minority stake; R&D partnerships

Manage rivalryDevelop industry standards R&D partnerships

Rationalize capacity Production swap, co-production, JV; minority equity interests, joint bidding, merger of units as JV, M&A

Position to acquire or sell

Acquire JV or minority stake in parent, depending on desired scope of acquisition/divestitureSell

Improve effectiveness of vertical relationships

“Lock up” supply source/ customers

Minority equity, e.g., Keiretsu (effectiveness is questionable); supply contract, long-term purchase agreements

Improve supplier/manufacturer/ customer linkages

Supply contracts, strategic outsourcing, buying cooperatives, long-term purchase agreements, minority equity (effectiveness is questionable)

Gain scaleLeverage existing capabilities with complementary partners

Licensing, co-branding, distribution JV, others

Consolidate for synergy M&A, JV combining specific functions

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Environmental conditionsContractual

alliance JVMinority

stake Merger Acquisition

Uncertainty (e.g., regulatory, political)

Need to bridge multiple businesses or technologies

Business already global/highly concentrated (few acquisition targets)

Target business is small part of partners) total business

Large difference in size with potential partners

Differing perceptions of importance of target business to partners core businesses

* Acquisition of target business unit

** JV may be appropriate as step toward acquisition

*** Minority stake taken by larger company in smaller company

Business environmentaffects choice of vehicle

Highly appropriate

Neutral

Inappropriate

*

**

FOR DISCUSSION

**

***

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Structures offer different levels of influence, ownership, risk-sharing

Inc

rea

sin

g i

nfl

ue

nc

e

One-off arms-length transactions

NO SHARED RESOURCES, OR EQUITY; LIMITED SHARED RISK

Shared resources, no equity Cross-equity investments

Shared equity Owned equity

Franchises

Production swap

Co-production

Long-term purchase agreement

Buying cooperatives

Joint bidding agreement

Exclusive supply contract

Strategic outsourcing

Co-branding

Exclusive distribution

Exclusive licensing

R&D partnerships or consortia

Increasing ownership and shared outcome

Keiretsu

JVs

Merger of units as JV

Acquisitions

Minority stakes with operating alliance

Minority stakes – financial only

PRELIMINARY

INFLUENCE ASSETS WITHOUT OWNING THEM; SHARE RISK

Full mergers

Strategic alliances

OWN ASSETS ABSORB FULL RISK

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Alliance selection driven by need

to share or divide business elements

MarketingTechnology development

Product development

Sourcing ManufacturingSales and distribution

Sharing business elements

Buying cooperatives

Manufacturing JV Co-marketing

Bidding consortia

Research and development consortia

<Text> Co-branding

Dividing business elements

Research and development consortia, each partner specializing (e.g., airframes)

Long-term purchase agreements


Co-production; production swaps

Exclusive sales and distribution licenses

Technology licensing Exclusive supply contract

Technology/ manufacturing licenses

Joint ventures

Joint ventures

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Choice of structure influenced by need for integration, need for flexibility

Ne

ed

fo

r in

teg

rati

on

M&A

Need for flexibility

PRELIMINARY

High

Low

Low High

JVs

R&D partnerships

Exclusive licensing Exclusive distribution Strategic outsourcing Exclusive supply

Co-brandingOther long-term nonequity agreements

One-off arms- length transactions

Strategic alliances

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TAX/LEGAL FACTORS

General partnership

Limited partnership “C” corporation “S” corporation*

Limited liability company

Pass-through** taxation?

Yes (most taxes passed through to each venturer)

Yes No, double taxation on dividends

Yes Possible, depending on structure

Subject to franchise taxes?

No No Yes Yes Yes

Is flexible allocation of revenues, deductions between partners permitted?

Yes Yes No No Yes

Flexibility in exit strategies?

No; venture may terminate for tax purposes if >50% interest transferred within a 12-month period

Yes (merger, consolidation, tax-free reorganization, etc.)

Yes No

Are shareholders liable for debts, liabilities of alliance?

Yes, personal liability of each venturer for all debts, liabilities

No (limited partners not liable)

No No No

* Shareholders must be individuals, estates, trusts; “SÝ corporations cannot be members

of an affiliated group, therefore not relevant to large corporations

** Taxes apply only to corporate owners on distribution of dividends

Note: McKinsey does not provide tax advice; clients should consult their own tax advisors

Choice of specific JV structure should take tax, legal factors into account (U.S.)

PRELIMINARY/

INTERNAL ONLY

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Corporation ownership*

Partnership<20% 20-50% >50%

Can assets, revenues be consolidated (for accounting purposes)?

No No Yes Typically based on proportion of ownership, but can be allocated based on other methods

How is net income reported?

As minority interest, using equity method

Using equity method

100% of net income reported; carve-outs reported as negative minority interest

Typically based on proportion of ownership but can be allocated based on other methods

* Test is based on control, not ownership percentage


Ownership share of JV affects financial impact on parents (U.S.)

PRELIMINARY/

INTERNAL ONLY

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Tax issues Liability Consolidation

• Partnership – normally the most tax-efficient structure; no intercompany dividend taxes

• Corporate structure – dividends taxed

– 80% exclusion of dividends from taxes if ownership is >50-80%

– 70% exclusion from dividends if ownership is 20-50%

• JV partners may face unlimited liability if partnership structure used

• Corporate structure limits liability of each partner in JV

• For accounting purposes, control is required (voting rights, board representation)

• For tax purposes consolidation occurs at 80% ownership

Summary: tax, financial issues (U.S.)PRELIMINARY/

INTERNAL ONLY


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Type of alliance Definition Example

CONTRACTUAL ALLIANCES

• Franchise agreement

A license agreement which includes the right to conduct business using the name, logos, and trademarks of the franchiser

McDonalds

• Production swap agreement

A contractual agreement between two or more entities producing similar products wherein each agrees to specialize in a certain product which is then exchanged for equivalent value of other products; this type of cooperation is often used to reduce transport costs

Oil, commodities

• Long-term purchase agreement

Agreements spanning several years, typically committing supplier to meet specific design or delivery standards and committing buyer to minimal levels of purchases; may involve shared investment

Coors and Anchor Glass have a 10-year partnership to make glass bottles. Coors contributes staff and equipment. Anchor will invest $54 million to modernize a plant and increase capacity by a third.

• Buying cooperative Several companies pool purchasing to increase bargaining power with suppliers

Bell Atlantic, Nynex, and Pacific Telesis say they will pool their orders for roughly $800 million in set-top boxes to reduce costs of the devices

• Exclusive supply contract

A contractual agreement between two or more entities binding each in an exclusive supplier/customer relationship for given products in given markets

Sony will use IMAX as its exclusive supplier of the IMAX giant-screen movie systems in NY, Berlin, and San Francisco. Sony will build the theaters, produce IMAX format movies, purchase IMAX projection technology and pay IMAX a percentage of box office receipts.

Alliance structures

3. ALLIANCE STRUCTURES: DEFINITIONS AND EXAMPLES

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Joint bidding agreement

• A contractual association of independent entities formed for bidding on one or more contract opportunities

• Successful contract bids may be subdivided among participants or delegated to one of the entities for completion on behalf of the consortium

• The agreement is a strategic alliance if it provides for an ongoing commercial relationship after the project is subdivided

• TNT Express Worldwide and Schenker International will jointly bid for logistics business in Asia and North America. Schenker deals in large freight and cargo; TNT deals in overnight small package delivery.

• Offshore drilling consortia are another example


A long-term agreement whereby one company transfers to another, and purchases, a service or product formerly made internally

EDS reportedly signed a 10-year, $800 million agreement to manage Lucas Industries internal information services

Co-branding Two or more entities combine brands for one or more products

Blockbuster and Visa jointly issue credit card

Exclusive licensing agreement

A contractual agreement between two or more entities granting one entity exclusive access to and use of technology or intellectual property developed by the other, usually coupled with authorization to produce, distribute, or service products

Schering-Plough has access to Fareston (breast cancer treatment) produced by Orion, in return for an undisclosed upfront fee plus milestone payments

Alliance structures (continued)

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Exclusive distribution agreement

Agreement under which one company gains the right to distribute (and possibly manufacture) a product using the technology, patent, or brand owned by another company

Budweiser beer is distributed by Antarctica in Brazil on an exclusive basis. Anheuser-Busch also bought a 10% stake in Antarctica for $105 million with an option to increase to 35%.

R&D partnership agreement

A contractual agreement between two or more entities wherein each agrees to fund a specified type of research in return for mutual benefit from the end products; the technology developed can be licensed to one or both of the participants, or an outsider

GE (U.S.) and IHI Heavy (Japan) have a $400 million alliance to co-develop a jet engine for use in 80-seat planes; GE will fund 75% of development costs, IHI will fund 25%

Consortia • A combination of three or more entities in which all parties work together toward a common goal, without creating a formal JV entity

• Consortia participants typically share risk (while reducing risk for each participant), benefit from different skill sets of the partners, and gain benefits of scale

• Consortia can be used to share activities (e.g., R&D consortia), or divide activities (e.g., aircraft and jet engine consortia)

Airbus


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EQUITY ALLIANCES

• Keiretsu Sets of companies linked together by minority equity stakes and semi-exclusive supply arrangements

Toyota, Koyo Seiko, others

• Minority equity stake with operating agreements

Minority investment of one company in another, with other agreements creating shared risks or rewards

Boehringer Ingleheim invested $28 million for an 8% stake and provided a $40 million credit line to ISIS, a biotech company; the two companies are conducting joint research on cell adhesion, and Boehringer has option to raise its stake to 15%

• Joint venture • A contractual agreement between two or more entities creating a new equity-based entity to carry on an economic activity

• Ownership, control, and decision making are shared and both (or all) partners typically contribute to the operating entity

Siemens and Swatch have created a JV to jointly develop mobile phones to be sold under the Swatch name

• Merger of units as joint venture

JV where two (or more) parents merge overlapping assets and capabilities into a single entity, but neither parent cedes control, e.g., merging business units where each parent holds 50% interest

Rhone-Poulenc, Hoechst merged their South American polyester and nylon fiber businesses into Fairway Filamentos, to be headquartered in Brazil


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Stand-alone joint venture INTERNAL ONLY

EastCo

NewCo

• 50/50 joint venture

• Private-label merchandise sold via new channels to existing customers of WestCo and EastCo

– Multimedia marketing

– International expansion

PeopleProductsCustomersOperationsCapital

WestCo

PeopleProducts

CustomersOperations

Capital

Pros• Equal ownership• NewCo able to

develop own identity• Performance easy to

measure

Cons• Potential conflict over

transfer pricing for services provided by parent

• Potential conflict with core parent businesses in new geographies, unless geographic scope limited

4. ILLUSTRATIVE STRUCTURES

JV Board(WestCo/EastCo)

Oversight

Sanofi/Sterling alliance structurePartial merger/JV plus development partnership

* Japan excluded

100%

Joint clinical development(project-based)

Elf Acquitaine(49% French government)

Sanofi(discovery)

100%

100%

Territory A JV(Europe, Asia*, Africa)

51% Sanofi/

49% Sterling managed by Sanofi

Local subsidiaries

Local subsidiaries

100%

Territory B JV(Americas, Australia)

51% Sterling/

49% Sanofi managed by Sterling

Drugs sold through worldwide Sanofi/Winthrop joint production, distribution, marketing

Kodak

Sterling Drug(discovery)

CONFIDENTIAL/

INTERNAL ONLY

CONFIDENTIAL/

INTERNAL ONLYSterling/Sanofi alliance

Guiding principles…

• Maximize synergies (e.g., capture full merger effect at country level)

• Create indifference to which products are sold post deal

• Ensure that each partner receives fair value

– “Existing” product profits shared based on ingoing contributions

– “New” product profits and synergies shared 50/50

• Optimize tax/financial effects of alliance

• “Equal” control over combined activities

• Retain control of basic research

• Create a manageable structure

…drove structure

Separate upstream research; joint product development, separate JVs for manufacturing, marketing, sales, distribution

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x x (Subsidiary A)

50/50 JV created by merger

of two metal mining subsidiaries

NewCo International

JV

NewCo board

BrazilCo(parent)

SAFCo(parent)

NewCo Brazil

NewCo South Africa

BrazilCo(Subsidiary B)

SAFCo(Subsidiary B)

Supply ofadministrative

servicesat cost

(Subsidiary A)

Transfer of all assets,

employees and activities;

subsidiary then

terminated

Equity of Brazmine,investments

Equity of SAFmine, investments

Dividends Dividends

CONFIDENTIAL

INTERNAL ONLY

100% equity 100% equity

Supply ofadministrative servicesat cost

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JV plus minority stake –

P&C Insurance Co. and fund management firm

CONFIDENTIAL

INTERNAL ONLY

Brinson Partners(Fund mgmt firm)

Before After

YFM(P&C Co)

Brinson JapanYFM investment subsidiary

Brinson Partners

YFM

YasudaKasai Brinson (YKB)(P&C fund mgmt JV)

YKB Chicago

YKB London

100% 100% 60% 40%

15%

100%

Minority acquisition

Strategic needs

P&C Co• Enhance investment-

management capability• Enter Japanese pension fund

management

Fund mgmt firm• Enter Japanese pension fund

management• Realize capital gain from sales

of shares (for partners)Source: FAC Practice

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Japanese/foreign JV structures where

ownership has shifted to foreign partner

CONFIDENTIAL

INTERNAL ONLY

Joint venture

Post-joint venture

Comments

Pfizer – TaitoYokogawa – Hewlett-Packard BOC – Osaka Sanso

J/V

F J

50% 50%

J/V

F J

49% 51%

J/V

F J

50.5% 49.5%

F(Jsub)

F J

100%

J/V

F J

75% 25%

J(sub)

F J

100%

F gradually increased share and finally acquired

J acquired 840,000 shares of HP itself

• BOC provided special gas technology to Osaka

• BOC initially acquired 15% of J and increased its ownership to 42%

42%

Source: FAC Practice

alliance structures

Documents

provide tax

tax advisorsdc

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joint venture

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contractual

equity method