Business Collaboration – Setting Up of Business Entities and Closure Important Questions

Business Collaboration – Setting Up of Business Entities and Closure Important Questions

Question 1.
Discuss the various advantages of forming a joint venture.
Answer:
Various advantages of forming a Joint Venture are as follows:
1. Risk Sharing: Risk sharing is one of the biggest advantages of forming a Joint Venture, particularly, in those industries where the cost of product development and the likelihood of failure of any particular product is very high.

2. Economies of Scale: Another advantage of forming a Joint Venture is for the industries which have high fixed costs, a Joint Venture with z a larger company can provide the economies of scale necessary to compete locally or globally and can be an effective way by which two z companies can pool resources and achieve critical mass.

3. Market Access: For companies that lack a basic understanding of customers and the relationship/infrastructure to distribute their products to customers, forming a Joint Venture with the right partner can provide instant access to established, efficient and effective distribution channels and receptive customer bases. This is important to a company because creating new distribution channels and identifying new customer bases can be extremely difficult, time-consuming, and expensive activities.

4. Exploring the Global Market: The formation of a Joint Venture can be advantageous to those companies, which are foreseeing an attractive business opportunity in a foreign market. Partnering with a foreign company makes it easy to capture the foreign market.

5. Easy acquisition of other entity or business: When a company wants to acquire another, but cannot do so due to cost, size, or geographical restrictions, or legal barriers, teaming up with a Joint Venture Partner can be an attractive option. The JV is substantially less costly and less risky than complete acquisitions and is sometimes used as a first step to a complete acquisition with the Joint Venture Partner.

6. Cost Efficiency: For a small-scale entity, sometimes it is difficult to set up the infrastructure and the machinery required for product development. In such cases, the joint venture is the perfect solution.

7. Flexible Nature: The joint venture enterprises provide flexibility; each participant has the freedom to continue with their individual businesses. The joint venture participants can only interfere within the participated project and in accordance with an agreement made by them only.

Question 2.
State the different types of strategies that can be adopted to make a joint venture successful.
Answer:
Joint ventures can be very effective for the growth and success of a business. If formed strategically joint ventures can be extremely valuable and chances of their failure can be reduced to a greater extent.

Following are the strategies for forming a successful joint venture:
(a) Identification of prospective Joint Venture Partner: The prospective partner should be strong in terms of business, technology, and resources. Each partner must have specialization in a different area. For example, one entity’s strength is economies of scale and another entity’s strength is strong marketing. Both the entities if formed into JV can have a larger market for their products.

(b) Reliability of Partner: Joint Venture Partner should never be a weak or untrustworthy partner, as it would lead to failure of the joint venture. On the other hand, a joint venture with a strong and trustworthy partner would generate enormous benefits for both the partners and the joint venture entity.

(c) Development of strong joint venture relationship: Partners must strive to develop joint venture relationships that are easy to maintain, financially profitable, intellectually rewarding, and long-lasting. After a necessary period of negotiation and implementation, the joint venture relationship should grow well and quickly, and painlessly.

(d) Equal Contribution: Joint venture partners must make sure that all the partners have equal contributions in the joint venture entity in terms of skills, intellectual resources, marketing resources, capital, and so on. Unbalanced or unequal contributions are never healthy for the success of a joint venture entity.

(e) Written Agreement: The agreement between two or more parties always be written and must clearly define all the terms, rights, and responsibilities of each partner. The language of the agreement must be simple and there should be no ambiguity.

(f) Limiting the scope of joint venture: It is essential that limits and scope of the venture should be defined at the beginning itself. This helps to increase the trust amongst the partners. The scope of the joint venture should be increased with the mutual consent of all the partners.

(g) Well-defined business model: The firms in a joint venture must clearly define the nature of the new venture. A well-defined business model provides a base for the legal and financial frameworks.

(h) Flexibility: The partners in JV should try to be flexible and favor partners who demonstrate the same level of flexibility.

(i) Establishment of exit routes: Joint Venture Partners must establish clear protocols at the beginning itself for amending or unwinding the relation if it fails to meet the expectations or for any dispute that may arise subsequently.

Question 3.
Ram, an NRI resident in Nepal, is interested to invest in shares and convertible debentures of an Indian company. Advice with reference to FEMA. [June 2009 (1 Mark)]
Answer:
A person who is a citizen of Bangladesh/Pakistan or is an entity incorporated in Bangladesh/Pakistan cannot purchase capital instruments without prior approval from the Government of India.

A person who is a citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in sectors/activities other than defense, space, atomic energy, and sectors/activities prohibited for foreign investment.

NRI resident in Nepal is not prohibited in making FDI in India. Thus, Ram can invest in shares and convertible debentures of an Indian company.

Question 4.
Global Education Network, a Pakistan-based Education Company wants to set up equity-based joint ventures in India. As a professional in India, Company seeks your advice about various restrictions under the Foreign Direct Investment (FDI) of the Government of India that a foreign entity may face. Advice. [Dec. 2018 (4 Marks)]
Answer:
Facts of Case: Global Education Network, a Pakistan-based Education Company wants to set up equity-based joint ventures in India.

Provision: As per Rule 6 of the FEM (Non-Debt Instrument) Rules, 2019, a person resident outside India may subscribe, purchase or sell capital instruments of an Indian company in the manner and subject to the terms and conditions specified in Schedule 1.

Some of the conditions in Rule 6 are as follows:
1. A person who is a citizen of Bangladesh/Pakistan or is an entity incorporated in Bangladesh/Pakistan cannot purchase capital instruments without | prior approval of the Government of India.

2. A person who is a citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in sectors/activities other than defense, space, atomic energy, and sectors/activities prohibited for foreign investment.

Conclusion: Thus, Global Education Network, a Pakistan-based Education Company cannot set up equity-based joint ventures in India without obtaining prior approval from the Government of India.

Question 5.
Global Infra Ltd., an Indian Entity, is in the process of drafting a joint venture agreement for forming a Joint Venture (JV) with a foreign company based out of Singapore to expand its business outside India. Advice on the key issues which parties to the agreement should consider while drafting the JV Agreement. [Dec. 2018 (4 Marks)]
Answer:
In India, there is no legally prescribed format of a Joint Venture Agreement. However, in actual practice, the Agreement contains the following components (the list is illustrative and not exhaustive):

  • The business of the new company/LLP.
  • Manner and extent to which resources (financial, manpower, technology, etc.) will be brought in.
  • Provisions relating to allotment and transfer of shares,
  • Constitution of the Board of directors/designated partners,
  • The manner in which decision-making will take place (majority vote or consensus?).
  • The decision regarding the Chairman and Managing Director of the entity, j their rights, duties, and responsibilities.
  • Persons are responsible for managing finances, marketing, production, etc.
  • Dividend distribution policy.
  • Term of office of the nominated directors, the manner of their appointment, and changes among them.
  • Valuation of the company at the time of separation.
  • Dispute resolution mechanism.

Therefore, Global Infra Ltd. has to keep in mind the above points while | drafting the Joint Venture Agreement.

Question 6.
‘Every Equity-based joint venture gives birth to a new entity. Discuss in brief the different types of entities that are permitted by the Government of India to form a joint venture entity. [June 2019 (4 Marks)]
Answer:
(a) Methods of Joint Venture: Joint Ventures can be formed via two modes/ methods:

  1. Equity Joint Venture
  2. Contractual Joint Venture

The equity joint venture is an arrangement whereby a separate legal entity is created in accordance with the agreement of two or more parties.

Different types of entities that can be formed are summed up below:
1. Company: A limited liability company is the most preferred structure for joint venture entities in India. The government also encourages investment being in the form of equity capital of a company incorporated in India. Companies in India are mainly of two types – private limited and public limited.

2. Limited Liability Partnership (LLP)Firm: LLP Firm structure is reg- g planted in India by The Limited Liability Partnership Act, 2008. Foreign investment in LLP Firms was not permitted before November 2015. If the Government of India has now allowed foreign investments in LLP firms subject to certain restrictions. LLP Firms are partnership firms with the limited liability of partners. The two partners can also be appointed as Designated Partners. There is no requirement of minimum capital j contribution to incorporate an LLP Firm.

3. Venture Capital Fund: A duly registered Foreign Venture Capital Investor is allowed to contribute up to 100% in Indian Venture Capital Undertakings/Venture Capital Funds/other companies.

4. Trusts: A foreign company is not allowed to use Trust as a form of a joint venture entity in India. Investment Vehicle – SEBI has introduced regulations for some funds like Real Estate Investments Trusts, Infrastructure Investment Funds, Alternative Investment Funds. Such funds are now permitted to receive foreign investment from a person resident outside India.

5. Other Entities: Foreign companies are not allowed to use any structures other than those mentioned above for the purpose of equity-based Joint venture entities.

Question 7.
‘Joint Ventures can be extremely valuable and chances of their failure can be reduced to a great extent if strategically formed’ – Comment on important strategies of the joint venture. [Dec. 2019 (4 Marks)]
Answer:
Joint ventures can be very effective for the growth and success of a business. If formed strategically joint ventures can be extremely valuable and chances of their failure can be reduced to a greater extent.

Following are the strategies for forming a successful joint venture:
(a) Identification of prospective Joint Venture Partner: The prospective partner should be strong in terms of business, technology, and resources. Each partner must have specialization in a different area. For example, one entity’s strength is economies of scale and another entity’s strength is strong marketing. Both the entities if formed into JV can have a larger market for their products.

(b) Reliability of Partner: Joint Venture Partner should never be a weak or untrustworthy partner, as it would lead to failure of the joint venture. On the other hand, a joint venture with a strong and trustworthy partner would generate enormous benefits for both the partners and the joint venture entity.

(c) Development of strong joint venture relationship: Partners must strive to develop joint venture relationships that are easy to maintain, financially profitable, intellectually rewarding, and long-lasting. After a necessary period of negotiation and implementation, the joint venture relationship should grow well and quickly, and painlessly.

(d) Equal Contribution: Joint venture partners must make sure that all the partners have equal contributions in the joint venture entity in terms of skills, intellectual resources, marketing resources, capital, and so on. Unbalanced or unequal contributions are never healthy for the success of a joint venture entity.

(e) Written Agreement: The agreement between two or more parties always be written and must clearly define all the terms, rights, and responsibilities of each partner. The language of the agreement must be simple and there should be no ambiguity.

(f) Limiting the scope of joint venture: It is essential that limits and scope of the venture should be defined at the beginning itself. This helps to increase the trust amongst the partners. The scope of the joint venture should be increased with the mutual consent of all the partners.

(g) Well-defined business model: The firms in a joint venture must clearly define the nature of the new venture. A well-defined business model provides a base for the legal and financial frameworks.

(h) Flexibility: The partners in JV should try to be flexible and favor partners who demonstrate the same level of flexibility.

(i) Establishment of exit routes: Joint Venture Partners must establish clear protocols at the beginning itself for amending or unwinding the relation if it fails to meet the expectations or for any dispute that may arise subsequently.

Question 8.
Explain with reasons, why the concept of Special Purpose Vehicle (SPV) has gained prominence in India in recent times. Quote example.
Answer:
A Special Purpose Vehicle (SPV)/Special Purpose Entities (SPE) are generally formed for a special purpose. The scope of this kind of company or entity is limited only to those activities which are required to be performed to attain the specific purpose. These companies/entities close their operations once the purpose is attained. The operations of these entities are limited to the acquisition and financing of specific assets. SPVs are generally a subsidiary company whose obligations are secured even if the parent company goes bankrupt.

An SPV /SPE may be formed through limited partnerships, trusts, corporations, limited liability companies, or other entities. SPV may be designed for independent ownership, management, and funding of a company or as protection of a project from operational or insolvency issues. SPVs help companies securitize assets, create joint ventures, isolate corporate assets or perform other financial transactions.

Thus, SPV is an entity that has a distinct identity from its promoters or sponsors or constituents, or shareholders.

To give an example, to implementation the Mission of Smart Cities (a project of the Ministry of Housing & Urban Affairs, Government of India), Special Purpose Vehicle (SPV) is created. The SPV will plan, appraise, approve, release funds, implement, manage, operate, monitor, and evaluate the Smart City development projects. Each smart city will have an SPV which will be headed by a full-time CEO and have nominees of Central Government, State Government, and ULB on its Board. The SPV will be a limited company incorporated under the Companies Act, 2013.

Question 9.
Explain the various benefits of Special Purpose Vehicle (SPV).
Answer:
A Special Purpose Vehicle (SPV)/Special Purpose Entities (SPE) are generally formed for a special purpose. The scope of this kind of company or entity is limited only to those activities which are required to be performed to attain the specific purpose.

Various benefits of Special Purpose Vehicles are given below:
(a) Ownership of Assets: An SPV allows the ownership of a single asset often by multiple parties and allows for ease of transfer between parties.

(b) Minimum Statutory Requirement: Depending on the choice of jurisdiction, it is relatively easy to set up SPV.

(c) Clarity of documentation: It is easy to limit certain activities or to prohibit unauthorized transactions within the SPV documentation.

(d) Tax Benefits: SPVs are often used to make a transaction tax-efficient by choosing the most favorable tax residence for the vehicle. SPVs are a method of financial engineering schemes which have as their main goal, the avoidance of tax.

(e) Legal Protection: By structuring the SPV appropriately, the sponsor may limit legal liability in the event the underlying project fails.

(f) Accounting Reasons: Debts raised through SPV are not reflected in the balance sheet of the sponsor. Losses incurred by SPV are not shown in the balance sheet of the sponsor, so it helps to maintain the healthy picture of the sponsor in the eyes of its stakeholders.

(g) Separation of risk & capital: The key advantage is that it helps in separating the risk and capital. As a result, the SPV and the sponsoring company are protected against risks like insolvency, which may arise during the course of operation.

(h) Securitization of assets: The SPV also allows securitization of assets without disturbing the managerial relationship. Under the arrangement, any predictable income stream generated by secured assets can be securitized.

Setting Up of Business Entities and Closure Questions and Answers

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