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Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Overview Chapter 22 Negotiating a Joint-Venture Contract: The NPV Perspective Overview Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Overview A Simple Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Overview Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Overview A Simple Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Overview Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Overview A Simple Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Overview Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Overview A Simple Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Why do JVs deserve a special discussion? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Not just another NPV calculation: B Once the contract is known, we can compute an NPV , B ... but the contract has to be negotiated keeping in mind the NPV . B Avoiding lots of trial-and-error work, we do negotiation and NPV in one shot How we do it B synergy gains = what can be achieved over and above the no-agreement outcome B idea: split the synergy gains fairly: e.g. the 50/50 rule (Nash, Selton-Rubinstein, practitioners) B solution can always be reduced to simple manipulations of one or two as-if-WOS NPV’s plus some simple additional discounting. Why do JVs deserve a special discussion? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Not just another NPV calculation: B Once the contract is known, we can compute an NPV , B ... but the contract has to be negotiated keeping in mind the NPV . B Avoiding lots of trial-and-error work, we do negotiation and NPV in one shot How we do it B synergy gains = what can be achieved over and above the no-agreement outcome B idea: split the synergy gains fairly: e.g. the 50/50 rule (Nash, Selton-Rubinstein, practitioners) B solution can always be reduced to simple manipulations of one or two as-if-WOS NPV’s plus some simple additional discounting. Why do JVs deserve a special discussion? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Possible ingredients in a JV contract B pure-(cash) equity contract: simple “linear” sharing of in & out B royalty (etc.) going to a partner: non-proportional sharing B equity “in kind” at a negotiated value: share of input 6= share of output or residual output Complicating factors: Case 2: An equity cum License Contract B restrictions on foreign equity ownership in host country, ceilings on admissible royalty percentages, etc. Final Words of Wisdom B differences in taxes across partners (e.g. home, foreign) or type of income (dividends versus other income) B capital-market segmentation, differences in cost of capital across partners Why do JVs deserve a special discussion? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Possible ingredients in a JV contract B pure-(cash) equity contract: simple “linear” sharing of in & out B royalty (etc.) going to a partner: non-proportional sharing B equity “in kind” at a negotiated value: share of input 6= share of output or residual output Complicating factors: Case 2: An equity cum License Contract B restrictions on foreign equity ownership in host country, ceilings on admissible royalty percentages, etc. Final Words of Wisdom B differences in taxes across partners (e.g. home, foreign) or type of income (dividends versus other income) B capital-market segmentation, differences in cost of capital across partners The row to hoe Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom simple proportional contract in a “Step 1” joint-branch framework B focus on economics; no tax games B two cases: – identical tax rates and discount rates for both partners – different tax rates and discount rates for both partners Nonproportional contracts in a “Step-2” framework B Why license contracts? B How analysed? a double Generalisations ANPV approach The row to hoe Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom simple proportional contract in a “Step 1” joint-branch framework B focus on economics; no tax games B two cases: – identical tax rates and discount rates for both partners – different tax rates and discount rates for both partners Nonproportional contracts in a “Step-2” framework B Why license contracts? B How analysed? a double Generalisations ANPV approach The row to hoe Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom simple proportional contract in a “Step 1” joint-branch framework B focus on economics; no tax games B two cases: – identical tax rates and discount rates for both partners – different tax rates and discount rates for both partners Nonproportional contracts in a “Step-2” framework B Why license contracts? B How analysed? a double Generalisations ANPV approach Outline Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Simple Framework for Profit Sharing A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom A Simple Framework for Profit Sharing Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Key numbers: B NPV JV = value created if A and B cooperate B NPV A , NPV B = values created if A and B go it alone B Both A and B must get no less than these alternatives ⇒ NPV A , NPV B are the threat points necessary condition for JV: NPV JV NPV JV − [NPV A + NPV B ] or > def = NPV A + NPV B , synergy gain> 0. The equal-gains rule A’s gain = B’s gain > 0, where A’s gain = [NPV of A’s cash flow from the JV ] − NPVA , B’s gain = [NPV of B’s cash flow from the JV ] − NPV B . Example: NPV A = 200, NPV B = 100, NPV JV = 450. So we give 200+75=275 to A, and 100+75=175 to B. A Simple Framework for Profit Sharing Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Key numbers: B NPV JV = value created if A and B cooperate B NPV A , NPV B = values created if A and B go it alone B Both A and B must get no less than these alternatives ⇒ NPV A , NPV B are the threat points necessary condition for JV: NPV JV NPV JV − [NPV A + NPV B ] or > def = NPV A + NPV B , synergy gain> 0. The equal-gains rule A’s gain = B’s gain > 0, where A’s gain = [NPV of A’s cash flow from the JV ] − NPVA , B’s gain = [NPV of B’s cash flow from the JV ] − NPV B . Example: NPV A = 200, NPV B = 100, NPV JV = 450. So we give 200+75=275 to A, and 100+75=175 to B. A Simple Framework for Profit Sharing Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Key numbers: B NPV JV = value created if A and B cooperate B NPV A , NPV B = values created if A and B go it alone B Both A and B must get no less than these alternatives ⇒ NPV A , NPV B are the threat points necessary condition for JV: NPV JV NPV JV − [NPV A + NPV B ] or > def = NPV A + NPV B , synergy gain> 0. The equal-gains rule A’s gain = B’s gain > 0, where A’s gain = [NPV of A’s cash flow from the JV ] − NPVA , B’s gain = [NPV of B’s cash flow from the JV ] − NPV B . Example: NPV A = 200, NPV B = 100, NPV JV = 450. So we give 200+75=275 to A, and 100+75=175 to B. A Simple Framework for Profit Sharing Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Key numbers: B NPV JV = value created if A and B cooperate B NPV A , NPV B = values created if A and B go it alone B Both A and B must get no less than these alternatives ⇒ NPV A , NPV B are the threat points necessary condition for JV: NPV JV NPV JV − [NPV A + NPV B ] or > def = NPV A + NPV B , synergy gain> 0. The equal-gains rule A’s gain = B’s gain > 0, where A’s gain = [NPV of A’s cash flow from the JV ] − NPVA , B’s gain = [NPV of B’s cash flow from the JV ] − NPV B . Example: NPV A = 200, NPV B = 100, NPV JV = 450. So we give 200+75=275 to A, and 100+75=175 to B. Outline Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Simple Framework for Profit Sharing A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Case 1: a proportional-sharing contract Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Notation φ τX Revt = A’s share in I0 and the later CF t = X (= A or B)’s effective tax rate on branch profits = the year-t sales revenue of the joint branch, cash basis Opext = year-t operating expenses of the branch, cash basis Salest = year-t sales (the amount invoiced) Costt I0 PVX (CF) RX NPVJV,A = year-t costs (the cost of goods sold from P/L) = value of cash and tangible assets invested in the JV P CFt = Tt=0 (1+R )t X = a p.a. compound discount rate that reflects the riskiness of the cash flow to X = PVA (Rev − Opex − Taxes) − I0 = PVA (Rev − Opex − (Sales − Cost)τA ) − I0 , an as-if-WOS value using A’s τ and R NPVJV,B = PVB (Rev − Opex − (Sales − Cost)τB ) − I0 , using B’s τ and R Set-up Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice The proportional joint-branch contract: B two players, A and B B the input I0 is cash, or assets with a clear market value B A and B bring in fractions φ and 1 − φ, resp., of I0 B neither A nor B make any profits on sales, if any, to A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom JV B A and B get fractions φ and 1 − φ of the accounting profit so they pay taxes on that fiscal income B A and B bear/get fractions φ and 1 − φ of the non-profit cash flows What does A get out of the deal? B future cash flows: φ [Revt − Opext − (Salest − Costt )τA ] B NPV PV and gain: A’s share A’s gain = PV (φ [Rev − Opex − (Sales − Cost)τA ]) − φ I0 , = φ (PV[Rev − Opex − (Sales − Cost)τA ] − I0 ) , = φ NPV JV,A . = φ NPV JV,A − NPV A . (1) Set-up Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice The proportional joint-branch contract: B two players, A and B B the input I0 is cash, or assets with a clear market value B A and B bring in fractions φ and 1 − φ, resp., of I0 B neither A nor B make any profits on sales, if any, to A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom JV B A and B get fractions φ and 1 − φ of the accounting profit so they pay taxes on that fiscal income B A and B bear/get fractions φ and 1 − φ of the non-profit cash flows What does A get out of the deal? B future cash flows: φ [Revt − Opext − (Salest − Costt )τA ] B NPV PV and gain: A’s share A’s gain = PV (φ [Rev − Opex − (Sales − Cost)τA ]) − φ I0 , = φ (PV[Rev − Opex − (Sales − Cost)τA ] − I0 ) , = φ NPV JV,A . = φ NPV JV,A − NPV A . (1) The gory details: Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Equal gains: B A’s gain: φ NPV JV,A − NPV A B B’s gain: (1 − φ) NPV JV,B − NPV B B Equal gains: φNPVJV,A − NPVA = (1 − φ)NPVJV,B − NPVB , φ (NPVJV,A + NPVJV,B ) = NPVJV,B + NPVA − NPVB , NPVJV,B NPVA − NPVB + . φ= NPVJV,A + NPVJV,B NPVJV,A + NPVJV,B Special case: equal tax rates, equal CoCa If NPVJV,A = NPVJV,B = NPVJV , then φ= 1 NPVA − NPVB + . 2 2 NPVJV The gory details: Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Equal gains: B A’s gain: φ NPV JV,A − NPV A B B’s gain: (1 − φ) NPV JV,B − NPV B B Equal gains: φNPVJV,A − NPVA = (1 − φ)NPVJV,B − NPVB , φ (NPVJV,A + NPVJV,B ) = NPVJV,B + NPVA − NPVB , NPVJV,B NPVA − NPVB + . φ= NPVJV,A + NPVJV,B NPVJV,A + NPVJV,B Special case: equal tax rates, equal CoCa If NPVJV,A = NPVJV,B = NPVJV , then φ= 1 NPVA − NPVB + . 2 2 NPVJV Interpreting the formula (1) Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Barring tax and CoCa effects ... B deviations from φ = 1/2 should reflect differences in best alternatives (“bargaining strength”) Example: NPV A = 200, NPV B = 100, NPV JV = 450. So we already decided to give 200+75=275 to A, and 100+75=175 to B. HOW? Case 2: An equity cum License Contract Final Words of Wisdom φ= 1 NPVA − NPVB 200 − 100 + = 0.5 + = 0.611 2 2 NPVJV 2 × 450 Check: – A gains 0.611 × 450 − 200 = 275 − 200 = 75 – B gains 0.389 × 450 − 100 = 175 − 100 = 75 Interpreting φ = Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice NPVJV,B NPVJV,A +NPVJV,B NPV −NPV + NPV A +NPVB . JV,B JV,A If A faces a higher tax rate B Effect 1: the first fraction ¿rises above/falls below? 1/2 B Intuition: if one before-tax rupee us worth less to A than to B, A needs more of the before-tax cake B Effect 2—minor: impact of “bargaining position” is affected A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Example: A’s valuation of both JV and best alternative are down NPV A = 150 not 200, NPV B = 100, NPV JV,A = 350 not 450, NPV JV,B = 450. – Old solution: φ= Final Words of Wisdom 1 NPVA − NPVB 200 − 100 + = 0.5 + = 0.611 2 2 NPVJV 2 × 450 | {z } 0.1111 – New solution: 150 − 100 50 450 + = 0.5625 + = 0.625 350 + 450 350 + 450 350 + 450 | {z } 0.0625 – A gains ... φ= – Check: – B gains ... Interpreting φ = Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice NPVJV,B NPVJV,A +NPVJV,B NPV −NPV + NPV A +NPVB . JV,B JV,A If A faces a higher tax rate B Effect 1: the first fraction ¿rises above/falls below? 1/2 B Intuition: if one before-tax rupee us worth less to A than to B, A needs more of the before-tax cake B Effect 2—minor: impact of “bargaining position” is affected A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Example: A’s valuation of both JV and best alternative are down NPV A = 150 not 200, NPV B = 100, NPV JV,A = 350 not 450, NPV JV,B = 450. – Old solution: φ= Final Words of Wisdom 1 NPVA − NPVB 200 − 100 + = 0.5 + = 0.611 2 2 NPVJV 2 × 450 | {z } 0.1111 – New solution: 150 − 100 50 450 + = 0.5625 + = 0.625 350 + 450 350 + 450 350 + 450 | {z } 0.0625 – A gains ... φ= – Check: – B gains ... Outline Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Simple Framework for Profit Sharing A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Final Words of Wisdom A wealth of options Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract A now gets some or all of the following B a royalty tied to sales (sales ×p) or sometimes production B an upfront licensing fee L0 B periodic fixed fees Lt B a share φ in the remaining profit We now have many decision variables and only one constraint, the equal-gains rule. B fix some of these parameters on the basis of other considerations (e.g. fiscal) Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom B use the remaining parameter to achieve the desired division of the synergy gains. B ping-pong until you find a solution that’s acceptable Thus, non-proportional contracts are used when there are other important considerations beside obtaining a fair sharing of the gains. A wealth of options Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract A now gets some or all of the following B a royalty tied to sales (sales ×p) or sometimes production B an upfront licensing fee L0 B periodic fixed fees Lt B a share φ in the remaining profit We now have many decision variables and only one constraint, the equal-gains rule. B fix some of these parameters on the basis of other considerations (e.g. fiscal) Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom B use the remaining parameter to achieve the desired division of the synergy gains. B ping-pong until you find a solution that’s acceptable Thus, non-proportional contracts are used when there are other important considerations beside obtaining a fair sharing of the gains. Why a license contract? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) B Willingness on behalf of the better-informed partner to accept a big share of the risk acts as a signal for the project’s quality B The shareholder with the information disadvantage obtains a license income that is less risky and easier to assess. Limited equity: one partner cannot put up the cash necessary in a pure-equity contract B one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or B there are legal restrictions on foreign equity ownership imposed by the host country PR considerations (e.g. local image) Political risks (lower expropriable investment) Tax considerations — but look at all taxes, i.e. all home and host taxes Why a license contract? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) B Willingness on behalf of the better-informed partner to accept a big share of the risk acts as a signal for the project’s quality B The shareholder with the information disadvantage obtains a license income that is less risky and easier to assess. Limited equity: one partner cannot put up the cash necessary in a pure-equity contract B one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or B there are legal restrictions on foreign equity ownership imposed by the host country PR considerations (e.g. local image) Political risks (lower expropriable investment) Tax considerations — but look at all taxes, i.e. all home and host taxes Why a license contract? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) B Willingness on behalf of the better-informed partner to accept a big share of the risk acts as a signal for the project’s quality B The shareholder with the information disadvantage obtains a license income that is less risky and easier to assess. Limited equity: one partner cannot put up the cash necessary in a pure-equity contract B one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or B there are legal restrictions on foreign equity ownership imposed by the host country PR considerations (e.g. local image) Political risks (lower expropriable investment) Tax considerations — but look at all taxes, i.e. all home and host taxes Why a license contract? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) B Willingness on behalf of the better-informed partner to accept a big share of the risk acts as a signal for the project’s quality B The shareholder with the information disadvantage obtains a license income that is less risky and easier to assess. Limited equity: one partner cannot put up the cash necessary in a pure-equity contract B one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or B there are legal restrictions on foreign equity ownership imposed by the host country PR considerations (e.g. local image) Political risks (lower expropriable investment) Tax considerations — but look at all taxes, i.e. all home and host taxes Why a license contract? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) B Willingness on behalf of the better-informed partner to accept a big share of the risk acts as a signal for the project’s quality B The shareholder with the information disadvantage obtains a license income that is less risky and easier to assess. Limited equity: one partner cannot put up the cash necessary in a pure-equity contract B one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or B there are legal restrictions on foreign equity ownership imposed by the host country PR considerations (e.g. local image) Political risks (lower expropriable investment) Tax considerations — but look at all taxes, i.e. all home and host taxes Why a license contract? Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) B Willingness on behalf of the better-informed partner to accept a big share of the risk acts as a signal for the project’s quality B The shareholder with the information disadvantage obtains a license income that is less risky and easier to assess. Limited equity: one partner cannot put up the cash necessary in a pure-equity contract B one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or B there are legal restrictions on foreign equity ownership imposed by the host country PR considerations (e.g. local image) Political risks (lower expropriable investment) Tax considerations — but look at all taxes, i.e. all home and host taxes Towards the equal-gains rule Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Extra Notation p Lt LPt = the royalty percentage (relative to sales) received by A = the lump sum amount received by A in year t = total license payments received by A in year t; LPt = p × Salest + Lt τA,D = A’s effective total tax rate on dividends (including taxes on the underlying profits) τA,L = A’s effective total tax rate on licensing income τB,D = B’s effective tax rate on dividends (including taxes on the underlying profits) A’s income, PV, and gain Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A’s cash flow from the JV CFA,0 = −φ I0 ; CFA,t>0 = LPt (1 − τA,L ) + φ (Revt − Opext − LPt ) = LPt [(1 − τA,L ) − φ(1 − τA,D )] −φ (Salest − Costt − LPt )τA,D A Framework for Profit Sharing +φ [Revt − Opext − (Salest − Costt )τA,D ]. Case 1: a proportional-sharing contract Case 2: An equity cum License Contract A’s ANPV and gain Why a license contract? Fair sharing Finding φ for a given license contract PV(CFA ) = PVA (LP)[(1 − τA,L ) − φ(1 − τA,D )] = φ NPVJV,A + PVA (LP)[(1 − τA,L ) − φ (1 − τA,D )], = φ NPVJV,A − NPV A +PVA (LP)[(1 − τA,L ) − φ (1 − τA,D )]. +φ{PVA [Rev − Opex − (Sales − Cost)τA,D ] − I0 } Finding an acceptable license deal Final Words of Wisdom A’s gain A’s income, PV, and gain Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A’s cash flow from the JV CFA,0 = −φ I0 ; CFA,t>0 = LPt (1 − τA,L ) + φ (Revt − Opext − LPt ) = LPt [(1 − τA,L ) − φ(1 − τA,D )] −φ (Salest − Costt − LPt )τA,D A Framework for Profit Sharing +φ [Revt − Opext − (Salest − Costt )τA,D ]. Case 1: a proportional-sharing contract Case 2: An equity cum License Contract A’s ANPV and gain Why a license contract? Fair sharing Finding φ for a given license contract PV(CFA ) = PVA (LP)[(1 − τA,L ) − φ(1 − τA,D )] = φ NPVJV,A + PVA (LP)[(1 − τA,L ) − φ (1 − τA,D )], = φ NPVJV,A − NPV A +PVA (LP)[(1 − τA,L ) − φ (1 − τA,D )]. +φ{PVA [Rev − Opex − (Sales − Cost)τA,D ] − I0 } Finding an acceptable license deal Final Words of Wisdom A’s gain B’s side, and the fair-sharing rule Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice B’s cash flow from the JV CFB,0 = −(1 − φ) I0 ; CFB,t>0 = (1 − φ) (Revt − Opext − LPt ) = −LPt (1 − φ)(1 − τB,D ) −(1 − φ) (Salest − Costt − LPt )τB,D A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract +(1 − φ) [Revt − Opext − (Salest − Costt )τB,D ]. B’s ANPV and gain PV(CFB ) −PVB (LP)(1 − φ)(1 − τB,D ) = (1 − φ) NPVJV,B − PVB (LP)(1 − φ)(1 − τB,D ), = (1 − φ) NPVJV,B − NPV B −PVB (LP)(1 − φ)(1 − τB,D ). +(1 − φ){PVB [Rev − Opex − (Sales − Cost)τB,D ] − I0 } Why a license contract? Fair sharing Finding φ for a given license contract = B’s gain Finding an acceptable license deal Final Words of Wisdom Fair sharing: find {φ; p; Lt , t = 0, ..., N} s.t. φ NPVJV,A − NPV A +PVA (LP)[(1 − τA,L ) − φ (1 − τA,D )] = (1 − φ) NPVJV,B − NPV B −PVB (LP)(1 − φ)(1 − τB,D ). B’s side, and the fair-sharing rule Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice B’s cash flow from the JV CFB,0 = −(1 − φ) I0 ; CFB,t>0 = (1 − φ) (Revt − Opext − LPt ) = −LPt (1 − φ)(1 − τB,D ) −(1 − φ) (Salest − Costt − LPt )τB,D A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract +(1 − φ) [Revt − Opext − (Salest − Costt )τB,D ]. B’s ANPV and gain PV(CFB ) −PVB (LP)(1 − φ)(1 − τB,D ) = (1 − φ) NPVJV,B − PVB (LP)(1 − φ)(1 − τB,D ), = (1 − φ) NPVJV,B − NPV B −PVB (LP)(1 − φ)(1 − τB,D ). +(1 − φ){PVB [Rev − Opex − (Sales − Cost)τB,D ] − I0 } Why a license contract? Fair sharing Finding φ for a given license contract = B’s gain Finding an acceptable license deal Final Words of Wisdom Fair sharing: find {φ; p; Lt , t = 0, ..., N} s.t. φ NPVJV,A − NPV A +PVA (LP)[(1 − τA,L ) − φ (1 − τA,D )] = (1 − φ) NPVJV,B − NPV B −PVB (LP)(1 − φ)(1 − τB,D ). B’s side, and the fair-sharing rule Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice B’s cash flow from the JV CFB,0 = −(1 − φ) I0 ; CFB,t>0 = (1 − φ) (Revt − Opext − LPt ) = −LPt (1 − φ)(1 − τB,D ) −(1 − φ) (Salest − Costt − LPt )τB,D A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract +(1 − φ) [Revt − Opext − (Salest − Costt )τB,D ]. B’s ANPV and gain PV(CFB ) −PVB (LP)(1 − φ)(1 − τB,D ) = (1 − φ) NPVJV,B − PVB (LP)(1 − φ)(1 − τB,D ), = (1 − φ) NPVJV,B − NPV B −PVB (LP)(1 − φ)(1 − τB,D ). +(1 − φ){PVB [Rev − Opex − (Sales − Cost)τB,D ] − I0 } Why a license contract? Fair sharing Finding φ for a given license contract = B’s gain Finding an acceptable license deal Final Words of Wisdom Fair sharing: find {φ; p; Lt , t = 0, ..., N} s.t. φ NPVJV,A − NPV A +PVA (LP)[(1 − τA,L ) − φ (1 − τA,D )] = (1 − φ) NPVJV,B − NPV B −PVB (LP)(1 − φ)(1 − τB,D ). Finding φ for a given license contract Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract One story: B Suppose license income is taxed at a lower rate than profits/dividends B So we set p, and Lt at the highest values that do not raise fiscal hackles B Then find φ. If this is infeasible, or otherwise unacceptable, change the license contract etc etc Find φ, given a license deal φ NPVJV,A − NPV A + PVA (LP)[(1 − τA,L ) − φ (1 − τA,D )] Why a license contract? = (1 − φ) NPVJV,B − NPV B − PVB (LP)(1 − φ)(1 − τB,D ). Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom net value, to A, of equity—NVEQ ⇒ }| { z φ [NPVJV,A − PVA (LP)(1 − τA,D )] −NPV A + PVA (LP)(1 − τA,L ) = (1 − φ) [NPVJV,B − PVB (LP)(1 − τB,D )] −NPV B . | {z } net value, to B, of equity—NVEQ Finding φ for a given license contract Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract One story: B Suppose license income is taxed at a lower rate than profits/dividends B So we set p, and Lt at the highest values that do not raise fiscal hackles B Then find φ. If this is infeasible, or otherwise unacceptable, change the license contract etc etc Find φ, given a license deal φ NPVJV,A − NPV A + PVA (LP)[(1 − τA,L ) − φ (1 − τA,D )] Why a license contract? = (1 − φ) NPVJV,B − NPV B − PVB (LP)(1 − φ)(1 − τB,D ). Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom net value, to A, of equity—NVEQ ⇒ }| { z φ [NPVJV,A − PVA (LP)(1 − τA,D )] −NPV A + PVA (LP)(1 − τA,L ) = (1 − φ) [NPVJV,B − PVB (LP)(1 − τB,D )] −NPV B . | {z } net value, to B, of equity—NVEQ Finding φ for a given license contract Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Find φ, given a license deal threat gap partial settlement z }| { z }| { [NPV A − NPV B ] − PVA (LP)(1 − τA,D ) NVEQB φ= + NVEQA + NVEQB NVEQA + NVEQB (2) A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Comments B first ratio is like the fraction of equity values if the license contract had been with an outsider B first ratio still simplifies to 1/2 if A and B are homogenous, τ and R-wise; it is higher is A is disadvantaged B the gap between the alternative values (“bargaining strength”) can be reduced or even closed by the license income B both the threat gap and the side payment get more weight since the numerator is now (twice) the net value of equity not the net value of all cash flows Finding φ for a given license contract Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Find φ, given a license deal threat gap partial settlement z }| { z }| { [NPV A − NPV B ] − PVA (LP)(1 − τA,D ) NVEQB φ= + NVEQA + NVEQB NVEQA + NVEQB (2) A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Comments B first ratio is like the fraction of equity values if the license contract had been with an outsider B first ratio still simplifies to 1/2 if A and B are homogenous, τ and R-wise; it is higher is A is disadvantaged B the gap between the alternative values (“bargaining strength”) can be reduced or even closed by the license income B both the threat gap and the side payment get more weight since the numerator is now (twice) the net value of equity not the net value of all cash flows Finding φ for a given license contract Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Find φ, given a license deal threat gap partial settlement z }| { z }| { [NPV A − NPV B ] − PVA (LP)(1 − τA,D ) NVEQB φ= + NVEQA + NVEQB NVEQA + NVEQB (2) A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Comments B first ratio is like the fraction of equity values if the license contract had been with an outsider B first ratio still simplifies to 1/2 if A and B are homogenous, τ and R-wise; it is higher is A is disadvantaged B the gap between the alternative values (“bargaining strength”) can be reduced or even closed by the license income B both the threat gap and the side payment get more weight since the numerator is now (twice) the net value of equity not the net value of all cash flows Finding an acceptable license deal Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom When used? sometimes φ is dictated by other considerations than pure fair sharing B Desire for maximal control within government-set limits on φ: set φ = max B Tax considerations, no desire for control, severe information disadvantage: set φ=0. Then solve for an acceptable license contract that achieves fair sharing How to use B analytically? cumbersome when you cycle through many parm’s—and then you still have to implement it in a spreadsheet B numerically: chose tentative values for all parm’s. Compute each player’s gain given this set (always copying the parm values from your initialisation cell). Then use SOLVER to equalize the gains. Finding an acceptable license deal Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom When used? sometimes φ is dictated by other considerations than pure fair sharing B Desire for maximal control within government-set limits on φ: set φ = max B Tax considerations, no desire for control, severe information disadvantage: set φ=0. Then solve for an acceptable license contract that achieves fair sharing How to use B analytically? cumbersome when you cycle through many parm’s—and then you still have to implement it in a spreadsheet B numerically: chose tentative values for all parm’s. Compute each player’s gain given this set (always copying the parm values from your initialisation cell). Then use SOLVER to equalize the gains. Finding an acceptable license deal Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Example – Let NPV JV,A = NPV JV,B = 493 τA,D = τA,L = τB,D = .35 NPV A = 152 NPV B = 0 – Company A prefers maximum control subject to the legal limit φ ≤ 0.49, so φ is set at 0.49. – Tentatively, we set Lt = 0. Then PV(LP) = p PV(Sales), where PV(Sales) = 2962. – With these inputs, the royalty percentage should be p = 8.24%. – If that looks too high, set p at an acceptable level (5%?) and solve for e.g. L0 (upfront license fee) or a series of Lt with the same PV, etc etc Outline Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Simple Framework for Profit Sharing A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Case 2: An equity cum License Contract Why a license contract? Fair sharing Finding φ for a given license contract Finding an acceptable license deal Final Words of Wisdom Qualitative summary Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom It’s really quite simple: B First do NPV’s as if the whole project were a wholly owned subsidiary: B partner A analyses the problem using her own tax rate and discount rate on the entire cashflow (NPV JV,A ) B B does the same using his tax rate and his cost of capital (NPV JV,B ) B If one of these NPV ’s is negative, STOP. B If each of these NPV’s is positive, and their sum larger then the summed threat points, we can probably find a fair sharing rule. The only extra info you may need, for non-equity contracts, is PV(sales) (or another similar variable) Generalisations (1) Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Handling asymmetric information? B Each negotiating team can still use its own estimates of the relevant data and compute the implications for JV proposals as a starting point in the bargaining B Or use backwards: given your own alternative and a proposed contract, back out the NPV B that woudl make the contract fair, and then judge its reasonability Handling three or more partners? B Each should get one-Nth of the synergy gains. Equal bargaining strengths and the 50/50 rule? B Easy to adjust for any other division of the synergy gains. B OR: use a specific proposal to back out the implied sharing proportions. Generalisations (1) Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Handling asymmetric information? B Each negotiating team can still use its own estimates of the relevant data and compute the implications for JV proposals as a starting point in the bargaining B Or use backwards: given your own alternative and a proposed contract, back out the NPV B that woudl make the contract fair, and then judge its reasonability Handling three or more partners? B Each should get one-Nth of the synergy gains. Equal bargaining strengths and the 50/50 rule? B Easy to adjust for any other division of the synergy gains. B OR: use a specific proposal to back out the implied sharing proportions. Generalisations (1) Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Handling asymmetric information? B Each negotiating team can still use its own estimates of the relevant data and compute the implications for JV proposals as a starting point in the bargaining B Or use backwards: given your own alternative and a proposed contract, back out the NPV B that woudl make the contract fair, and then judge its reasonability Handling three or more partners? B Each should get one-Nth of the synergy gains. Equal bargaining strengths and the 50/50 rule? B Easy to adjust for any other division of the synergy gains. B OR: use a specific proposal to back out the implied sharing proportions. Generalisations (2) Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Profits on owner’s sales to JV? B Why make profits on intra-group sales rather than obtain dividends or royalties etc.? – tax authorities won’t accept zero-profit sales to a related company A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom – transfer pricing may be used to shift profits from high- to low-tax locations – transfer pricing may be used to obtain a fair sharing of the synergy despite host-country regulations on equity ownership, dividend payments, license fees, etc. B How to handle these profits? – Like royalties. these profits are deductible expenses for the JV, taxable income for the supplier/parent. – Thus, transfer-pricing profits can be added to the formulas in essentially the same way as royalties. Generalisations (2) Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice Profits on owner’s sales to JV? B Why make profits on intra-group sales rather than obtain dividends or royalties etc.? – tax authorities won’t accept zero-profit sales to a related company A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom – transfer pricing may be used to shift profits from high- to low-tax locations – transfer pricing may be used to obtain a fair sharing of the synergy despite host-country regulations on equity ownership, dividend payments, license fees, etc. B How to handle these profits? – Like royalties. these profits are deductible expenses for the JV, taxable income for the supplier/parent. – Thus, transfer-pricing profits can be added to the formulas in essentially the same way as royalties. Generalisations (3) Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Equity in kind, at negotiated valuation B Apart from taxation, this is very similar to finding a fair upfront license income L0 , paid by JV to A, and then ploughed back as equity. Example Example: A wants 50% of the later inflows, but paying only 30% of I0 . Two solutions: – A pays up 30% of I0 in cash, then sells a ”know-how” to JV for 20% of I0 and puts up that money as additional equity- OR – A pays up 30% of I0 , and brings in the know-how for 20% of I0 . Generalisations (3) Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom Equity in kind, at negotiated valuation B Apart from taxation, this is very similar to finding a fair upfront license income L0 , paid by JV to A, and then ploughed back as equity. Example Example: A wants 50% of the later inflows, but paying only 30% of I0 . Two solutions: – A pays up 30% of I0 in cash, then sells a ”know-how” to JV for 20% of I0 and puts up that money as additional equity- OR – A pays up 30% of I0 , and brings in the know-how for 20% of I0 . Summing up Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom A JV can work only if there are synergy gains. The negotiations are not directly about how to share the JV’s NPV but how to share the synergy gains. We use the popular 50/50 rule, but any other one can be adopted. A major insight is that a fair JV agreement should take into account all forms of income: – – – – – – the fraction of profits (φ), any royalty (p) on sales, other types of periodic fees (Lt ) in excess of costs, if any, associated with the service any upfront payment L0 for know-how etc profits on owners’ sales to the JV, or non-cash equity inputs at a negotiated value. Be careful about the other determinants of value (taxes, discount rates) Once we have thought through the contract, the analysis needs only simple as-if-WOS NPV’s, and PV’s of simple things like sales or promised fees. Often, more complicated-looking devices are needed to avoid restrictions on the use of simple devices. Summing up Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom A JV can work only if there are synergy gains. The negotiations are not directly about how to share the JV’s NPV but how to share the synergy gains. We use the popular 50/50 rule, but any other one can be adopted. A major insight is that a fair JV agreement should take into account all forms of income: – – – – – – the fraction of profits (φ), any royalty (p) on sales, other types of periodic fees (Lt ) in excess of costs, if any, associated with the service any upfront payment L0 for know-how etc profits on owners’ sales to the JV, or non-cash equity inputs at a negotiated value. Be careful about the other determinants of value (taxes, discount rates) Once we have thought through the contract, the analysis needs only simple as-if-WOS NPV’s, and PV’s of simple things like sales or promised fees. Often, more complicated-looking devices are needed to avoid restrictions on the use of simple devices. Summing up Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom A JV can work only if there are synergy gains. The negotiations are not directly about how to share the JV’s NPV but how to share the synergy gains. We use the popular 50/50 rule, but any other one can be adopted. A major insight is that a fair JV agreement should take into account all forms of income: – – – – – – the fraction of profits (φ), any royalty (p) on sales, other types of periodic fees (Lt ) in excess of costs, if any, associated with the service any upfront payment L0 for know-how etc profits on owners’ sales to the JV, or non-cash equity inputs at a negotiated value. Be careful about the other determinants of value (taxes, discount rates) Once we have thought through the contract, the analysis needs only simple as-if-WOS NPV’s, and PV’s of simple things like sales or promised fees. Often, more complicated-looking devices are needed to avoid restrictions on the use of simple devices. Summing up Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom A JV can work only if there are synergy gains. The negotiations are not directly about how to share the JV’s NPV but how to share the synergy gains. We use the popular 50/50 rule, but any other one can be adopted. A major insight is that a fair JV agreement should take into account all forms of income: – – – – – – the fraction of profits (φ), any royalty (p) on sales, other types of periodic fees (Lt ) in excess of costs, if any, associated with the service any upfront payment L0 for know-how etc profits on owners’ sales to the JV, or non-cash equity inputs at a negotiated value. Be careful about the other determinants of value (taxes, discount rates) Once we have thought through the contract, the analysis needs only simple as-if-WOS NPV’s, and PV’s of simple things like sales or promised fees. Often, more complicated-looking devices are needed to avoid restrictions on the use of simple devices. Summing up Negotiating a Joint Venture: the NPV Perspective P. Sercu, International Finance: Theory into Practice A Framework for Profit Sharing Case 1: a proportional-sharing contract Case 2: An equity cum License Contract Final Words of Wisdom A JV can work only if there are synergy gains. The negotiations are not directly about how to share the JV’s NPV but how to share the synergy gains. We use the popular 50/50 rule, but any other one can be adopted. A major insight is that a fair JV agreement should take into account all forms of income: – – – – – – the fraction of profits (φ), any royalty (p) on sales, other types of periodic fees (Lt ) in excess of costs, if any, associated with the service any upfront payment L0 for know-how etc profits on owners’ sales to the JV, or non-cash equity inputs at a negotiated value. Be careful about the other determinants of value (taxes, discount rates) Once we have thought through the contract, the analysis needs only simple as-if-WOS NPV’s, and PV’s of simple things like sales or promised fees. Often, more complicated-looking devices are needed to avoid restrictions on the use of simple devices.