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I am negotiating a deal and I really need some advice on the pros and cons of the deal that has been suggested to me.

I have a startup company with radically innovative technology. I want to merge with a larger company, which has an interesting customer base and credibility in the market.

We cannot agree on a price of a merger as none of us know the value of the technology (notoriously difficult to put value on). Their suggestion is then as follows.

We create a joint venture together that we own 50-50, be being the CEO and them having the Chairman of the Board. The joint venture will not own any technology and any technology developed will automatically belong to my company. The joint venture can however freely sell my software, paying a royalty to my company for each sale. Their company will finance will put financial resources into this company so it can grow quickly.

My questions are pros and cons with regards to the following issues:

  • How will the price of an exit be affected by this structure?
  • How will it affect my company becoming a partner with for example a competitor of their company?

Any other potential issues with such a structure?

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3 Answers

up vote 6 down vote accepted

These kind of deals are actually common when doing business internationality. Some of the Pros and Cons include:

Pros

  • Investment from another company does not dilute your company
  • The deal is separate and therefore failure is more manageable
  • The investing company does not control your company
  • More focus on building the business as opposed to funding an additional division.

Cons

  • The reselling deal and how competitors are dealt with. There will be a strong desire to make it captive.
  • Who really owns IP improvements and the customer base
  • Product support and maintenance responsibilities
  • The value is less since the entity owns no IP (Well, it might own some rights).
  • Restrictions on selling to your partners competitors

The price of an exit may go down because this entity owns no IP but if rights are assigned, then that might make up for it. Other than that, the exit may be complicated in terms of what is really being sold. Your exit options will also be limited since a competitor of your partner will not be a likely acquirer.

Your partner will want protection from competitors and that will complicate the deal. The framework has to include a method to resolve issues that arise from new opportunities or uses for the technology.

You should also look into how the financing affects the companies evaluation and how control will work over time. If this new company does funding rounds, then your partner can dilute you out and take control, which might be a bad thing.

Anyway, sounds like an interesting deal. Let us know how it turns out.

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up vote 4 down vote

Why not just have them be a reseller? Same thing, less complicated.

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1  
+1, nut apparently then they don't get some of the development costs funded – TimJ♦ Mar 30 '10 at 20:53
1  
Sure, but a tit-for-tat deal sounds like a winner. They provide $X in return for a Y% royalty on a base price of $Z .. or something like that. I don't see any need for a joint company, that's all. It's just more hassle. – Bopinder Abu Morpalinder Singh Mar 31 '10 at 1:04
You have a good point, Bopinder Abu Morpalinde, though what do you mean by "$X in return for a Y% royalty on a base price of $Z" – David Mar 31 '10 at 13:29
Meaning they fund further development and get a good commission. The base price was to ensure that they don't compete with you for lower prices. But there is no reason to stick to a percentage. Just let them buy it from you for $X and sell it at whatever price they want. – Bopinder Abu Morpalinder Singh Apr 1 '10 at 13:49
up vote 1 down vote

It sounds like a reasonable solution to your problem, but my impression is that royalty and JV deals have something of a bad rep in the technology world.

First, I would think of the other company as a channel partner and make sure you have a good channel strategy thought out. Don't assume they'll put real effort behind your product simply because you have a JV. Mark Suster has a good discussion on channel strategy: http://www.bothsidesofthetable.com/2010/02/23/the-fallacy-of-channels-startups-beware/.

Second, VisiCalc, the original developers of the spreadsheet, had a distribution deal that didn't go very well because the incentives weren't really aligned. It's mentioned in Founders at Work. You might want to look into that and other case studies to get a feel for some of the fuzzier issues involved.

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