Negotiating a Joint-Venture Contract: The NPV Perspective
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- Moses Sims
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1 Overview Chapter 22 Negotiating a Joint-Venture : The NPV
2 Overview Overview A Simple Framework for Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal
3 Overview Overview A Simple Framework for Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal
4 Overview Overview A Simple Framework for Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal
5 Overview Overview A Simple Framework for Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal
6 Why do JVs deserve a special discussion? Not just another NPV calculation: Once the is known, we can compute an NPV,... but the has to be negotiated keeping in mind the NPV. Avoiding lots of trial-and-error work, we do negotiation and NPV in one shot How we do it synergy gains = what can be achieved over and above the no-agreement outcome idea: split the synergy gains fairly: e.g. the 50/50 rule (Nash, Selton-Rubinstein, practitioners) solution can always be reduced to simple manipulations of one or two as-if-wos NPV s plus some simple additional discounting.
7 Why do JVs deserve a special discussion? Not just another NPV calculation: Once the is known, we can compute an NPV,... but the has to be negotiated keeping in mind the NPV. Avoiding lots of trial-and-error work, we do negotiation and NPV in one shot How we do it synergy gains = what can be achieved over and above the no-agreement outcome idea: split the synergy gains fairly: e.g. the 50/50 rule (Nash, Selton-Rubinstein, practitioners) solution can always be reduced to simple manipulations of one or two as-if-wos NPV s plus some simple additional discounting.
8 Why do JVs deserve a special discussion? Possible ingredients in a JV pure-(cash) equity : simple linear sharing of in & out royalty (etc.) going to a partner: non-proportional sharing equity in kind at a negotiated value: share of input share of output or residual output Complicating factors: restrictions on foreign equity ownership in host country, ceilings on admissible royalty percentages, etc. differences in taxes across partners (e.g. home, foreign) or type of income (dividends versus other income) capital-market segmentation, differences in cost of capital across partners
9 Why do JVs deserve a special discussion? Possible ingredients in a JV pure-(cash) equity : simple linear sharing of in & out royalty (etc.) going to a partner: non-proportional sharing equity in kind at a negotiated value: share of input share of output or residual output Complicating factors: restrictions on foreign equity ownership in host country, ceilings on admissible royalty percentages, etc. differences in taxes across partners (e.g. home, foreign) or type of income (dividends versus other income) capital-market segmentation, differences in cost of capital across partners
10 The row to hoe simple proportional in a Step 1 joint-branch framework focus on economics; no tax games two cases: identical tax rates and discount rates for both partners different tax rates and discount rates for both partners Nonproportional s in a Step-2 framework Why license s? How analysed? a double ANPV approach Generalisations
11 The row to hoe simple proportional in a Step 1 joint-branch framework focus on economics; no tax games two cases: identical tax rates and discount rates for both partners different tax rates and discount rates for both partners Nonproportional s in a Step-2 framework Why license s? How analysed? a double ANPV approach Generalisations
12 The row to hoe simple proportional in a Step 1 joint-branch framework focus on economics; no tax games two cases: identical tax rates and discount rates for both partners different tax rates and discount rates for both partners Nonproportional s in a Step-2 framework Why license s? How analysed? a double ANPV approach Generalisations
13 Outline A Simple Framework for Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal
14 A Simple Framework for Key numbers: NPV JV = value created if A and B cooperate NPV A, NPV B = values created if A and B go it alone 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 A + NPV B, or NPV JV [NPV A + NPV B] The equal-gains rule A s gain = B s gain > 0, def = synergy gain> 0. where A s gain = [NPV of A s cash flow from the JV ] NPV A, 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 =275 to A, and =175 to B.
![A + NPV B] The equal-gains rule A s gain = B s gain > 0, def = synergy gain> 0.](/docs-images/49/18103304/images/page_14.jpg "where A s gain = [NPV of A s cash flow from the JV ] NPV A, B s gain = [NPV of B s cash flow from the JV ] NPV B.")
15 A Simple Framework for Key numbers: NPV JV = value created if A and B cooperate NPV A, NPV B = values created if A and B go it alone 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 A + NPV B, or NPV JV [NPV A + NPV B] The equal-gains rule A s gain = B s gain > 0, def = synergy gain> 0. where A s gain = [NPV of A s cash flow from the JV ] NPV A, 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 =275 to A, and =175 to B.
![A + NPV B] The equal-gains rule A s gain = B s gain > 0, def = synergy gain> 0.](/docs-images/49/18103304/images/page_15.jpg "where A s gain = [NPV of A s cash flow from the JV ] NPV A, B s gain = [NPV of B s cash flow from the JV ] NPV B.")
16 A Simple Framework for Key numbers: NPV JV = value created if A and B cooperate NPV A, NPV B = values created if A and B go it alone 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 A + NPV B, or NPV JV [NPV A + NPV B] The equal-gains rule A s gain = B s gain > 0, def = synergy gain> 0. where A s gain = [NPV of A s cash flow from the JV ] NPV A, 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 =275 to A, and =175 to B.
![A + NPV B] The equal-gains rule A s gain = B s gain > 0, def = synergy gain> 0.](/docs-images/49/18103304/images/page_16.jpg "where A s gain = [NPV of A s cash flow from the JV ] NPV A, B s gain = [NPV of B s cash flow from the JV ] NPV B.")
17 A Simple Framework for Key numbers: NPV JV = value created if A and B cooperate NPV A, NPV B = values created if A and B go it alone 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 A + NPV B, or NPV JV [NPV A + NPV B] The equal-gains rule A s gain = B s gain > 0, def = synergy gain> 0. where A s gain = [NPV of A s cash flow from the JV ] NPV A, 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 =275 to A, and =175 to B.
![A + NPV B] The equal-gains rule A s gain = B s gain > 0, def = synergy gain> 0.](/docs-images/49/18103304/images/page_17.jpg "where A s gain = [NPV of A s cash flow from the JV ] NPV A, B s gain = [NPV of B s cash flow from the JV ] NPV B.")
18 Outline A Simple Framework for Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal
19 Notation φ τ X Rev t Opex t Sales t Cost t I 0 PV X (CF) R X = A s share in I 0 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 = year-t operating expenses of the branch, cash basis = year-t sales (the amount invoiced) = year-t costs (the cost of goods sold from P/L) = value of cash and tangible assets invested in the JV = P T t=0 CF t (1+R X ) t = a p.a. compound discount rate that reflects the riskiness of the cash flow to X NPV JV,A = PV A (Rev Opex Taxes) I 0 = PV A (Rev Opex (Sales Cost)τ A ) I 0, an as-if-wos value using A s τ and R NPV JV,B = PV B (Rev Opex (Sales Cost)τ B ) I 0, using B s τ and R
20 Set-up The proportional joint-branch : two players, A and B the input I 0 is cash, or assets with a clear market value A and B bring in fractions φ and 1 φ, resp., of I 0 neither A nor B make any profits on sales, if any, to JV A and B get fractions φ and 1 φ of the accounting profit so they pay taxes on that fiscal income A and B bear/get fractions φ and 1 φ of the non-profit cash flows What does A get out of the deal? future cash flows: φ [Rev t Opex t (Sales t Cost t)τ A] NPV and gain: PV A s share = PV (φ [Rev Opex (Sales Cost)τ A]) φ I 0, = φ (PV[Rev Opex (Sales Cost)τ A] I 0), = φ NPV JV,A. A s gain = φ NPV JV,A NPV A. (1)
21 Set-up The proportional joint-branch : two players, A and B the input I 0 is cash, or assets with a clear market value A and B bring in fractions φ and 1 φ, resp., of I 0 neither A nor B make any profits on sales, if any, to JV A and B get fractions φ and 1 φ of the accounting profit so they pay taxes on that fiscal income A and B bear/get fractions φ and 1 φ of the non-profit cash flows What does A get out of the deal? future cash flows: φ [Rev t Opex t (Sales t Cost t)τ A] NPV and gain: PV A s share = PV (φ [Rev Opex (Sales Cost)τ A]) φ I 0, = φ (PV[Rev Opex (Sales Cost)τ A] I 0), = φ NPV JV,A. A s gain = φ NPV JV,A NPV A. (1)
22 The gory details: Equal gains: A s gain: φ NPV JV,A NPV A B s gain: (1 φ) NPV JV,B NPV B Equal gains: φnpv JV,A NPV A = (1 φ)npv JV,B NPV B, φ (NPV JV,A + NPV JV,B) = NPV JV,B + NPV A NPV B, NPV JV,B NPVA NPVB φ = +. NPV JV,A + NPV JV,B NPV JV,A + NPV JV,B Special case: equal tax rates, equal CoCa If NPV JV,A = NPV JV,B = NPV JV, then φ = NPVA NPVB 2 NPV JV.
23 The gory details: Equal gains: A s gain: φ NPV JV,A NPV A B s gain: (1 φ) NPV JV,B NPV B Equal gains: φnpv JV,A NPV A = (1 φ)npv JV,B NPV B, φ (NPV JV,A + NPV JV,B) = NPV JV,B + NPV A NPV B, NPV JV,B NPVA NPVB φ = +. NPV JV,A + NPV JV,B NPV JV,A + NPV JV,B Special case: equal tax rates, equal CoCa If NPV JV,A = NPV JV,B = NPV JV, then φ = NPVA NPVB 2 NPV JV.
24 Interpreting the formula (1) Barring tax and CoCa effects... 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 =275 to A, and =175 to B. HOW? Check: φ = NPV A NPV B = NPV JV = A gains = = 75 B gains = = 75
25 Interpreting φ = NPV JV,B + NPV A NPV B. NPV JV,A +NPV JV,B NPV JV,A +NPV JV,B If A faces a higher tax rate Effect 1: the first fraction rises above/falls below? 1/2 Intuition: if one before-tax rupee us worth less to A than to B, A needs more of the before-tax cake Effect 2 minor: impact of bargaining position is affected 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: New solution: φ = NPV A NPV B = NPV JV {z } = φ = = = {z } Check: A gains B gains...
26 Interpreting φ = NPV JV,B + NPV A NPV B. NPV JV,A +NPV JV,B NPV JV,A +NPV JV,B If A faces a higher tax rate Effect 1: the first fraction rises above/falls below? 1/2 Intuition: if one before-tax rupee us worth less to A than to B, A needs more of the before-tax cake Effect 2 minor: impact of bargaining position is affected 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: New solution: φ = NPV A NPV B = NPV JV {z } = φ = = = {z } Check: A gains B gains...
27 Outline A Simple Framework for Why a license? Fair sharing Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Finding φ for a given license Finding an acceptable license deal
28 A wealth of options Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal A now gets some or all of the following a royalty tied to sales (sales p) or sometimes production an upfront licensing fee L 0 periodic fixed fees L t a share φ in the remaining profit We now have many decision variables and only one constraint, the equal-gains rule. fix some of these parameters on the basis of other considerations (e.g. fiscal) use the remaining parameter to achieve the desired division of the synergy gains. ping-pong until you find a solution that s acceptable Thus, non-proportional s are used when there are other important considerations beside obtaining a fair sharing of the gains.
29 A wealth of options Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal A now gets some or all of the following a royalty tied to sales (sales p) or sometimes production an upfront licensing fee L 0 periodic fixed fees L t a share φ in the remaining profit We now have many decision variables and only one constraint, the equal-gains rule. fix some of these parameters on the basis of other considerations (e.g. fiscal) use the remaining parameter to achieve the desired division of the synergy gains. ping-pong until you find a solution that s acceptable Thus, non-proportional s are used when there are other important considerations beside obtaining a fair sharing of the gains.
30 Why a license? Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) 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 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 one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or 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
31 Why a license? Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) 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 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 one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or 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
32 Why a license? Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) 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 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 one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or 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
33 Why a license? Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) 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 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 one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or 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
34 Why a license? Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) 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 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 one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or 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
35 Why a license? Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Risk sharing: a partner who is closer to financial distress definitely prefers low-risk income. Information asymmetries (e.g. size of the market; costs) 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 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 one partner is unwilling to borrow (costs of financial distress) or to issue equity (loss of independence), or 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
36 Towards the equal-gains rule Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Extra Notation p L t = the royalty percentage (relative to sales) received by A = the lump sum amount received by A in year t LP t = total license payments received by A in year t; LP t = p Sales t + L t τ A,D τ A,L τ B,D = A s effective total tax rate on dividends (including taxes on the underlying profits) = A s effective total tax rate on licensing income = B s effective tax rate on dividends (including taxes on the underlying profits)
37 A s income, PV, and gain A s cash flow from the JV CF A,0 = φ I 0 ; CF A,t>0 = LP t(1 τ A,L ) + φ (Rev t Opex t LP t) A s ANPV and gain φ (Sales t Cost t LP t)τ A,D = LP t[(1 τ A,L ) φ(1 τ A,D )] +φ [Rev t Opex t (Sales t Cost t)τ A,D ]. Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal PV(CF A ) = PV A (LP)[(1 τ A,L ) φ(1 τ A,D )] +φ{pv A [Rev Opex (Sales Cost)τ A,D ] I 0 } = φ NPV JV,A + PV A (LP)[(1 τ A,L ) φ (1 τ A,D )], A s gain = φ NPV JV,A NPV A +PV A (LP)[(1 τ A,L ) φ (1 τ A,D )].
38 A s income, PV, and gain A s cash flow from the JV CF A,0 = φ I 0 ; CF A,t>0 = LP t(1 τ A,L ) + φ (Rev t Opex t LP t) A s ANPV and gain φ (Sales t Cost t LP t)τ A,D = LP t[(1 τ A,L ) φ(1 τ A,D )] +φ [Rev t Opex t (Sales t Cost t)τ A,D ]. Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal PV(CF A ) = PV A (LP)[(1 τ A,L ) φ(1 τ A,D )] +φ{pv A [Rev Opex (Sales Cost)τ A,D ] I 0 } = φ NPV JV,A + PV A (LP)[(1 τ A,L ) φ (1 τ A,D )], A s gain = φ NPV JV,A NPV A +PV A (LP)[(1 τ A,L ) φ (1 τ A,D )].
39 B s side, and the fair-sharing rule Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal B s cash flow from the JV CF B,0 = (1 φ) I 0 ; CF B,t>0 = (1 φ) (Rev t Opex t LP t) (1 φ) (Sales t Cost t LP t)τ B,D = LP t(1 φ)(1 τ B,D ) +(1 φ) [Rev t Opex t (Sales t Cost t)τ B,D ]. B s ANPV and gain PV(CF B ) = PV B (LP)(1 φ)(1 τ B,D ) +(1 φ){pv B [Rev Opex (Sales Cost)τ B,D ] I 0 } = (1 φ) NPV JV,B PV B (LP)(1 φ)(1 τ B,D ), B s gain = (1 φ) NPV JV,B NPV B PV B (LP)(1 φ)(1 τ B,D ). Fair sharing: find {φ; p; L t, t = 0,..., N} s.t. φ NPV JV,A NPV A +PV A (LP)[(1 τ A,L ) φ (1 τ A,D )] = (1 φ) NPV JV,B NPV B PV B (LP)(1 φ)(1 τ B,D ).
40 B s side, and the fair-sharing rule Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal B s cash flow from the JV CF B,0 = (1 φ) I 0 ; CF B,t>0 = (1 φ) (Rev t Opex t LP t) (1 φ) (Sales t Cost t LP t)τ B,D = LP t(1 φ)(1 τ B,D ) +(1 φ) [Rev t Opex t (Sales t Cost t)τ B,D ]. B s ANPV and gain PV(CF B ) = PV B (LP)(1 φ)(1 τ B,D ) +(1 φ){pv B [Rev Opex (Sales Cost)τ B,D ] I 0 } = (1 φ) NPV JV,B PV B (LP)(1 φ)(1 τ B,D ), B s gain = (1 φ) NPV JV,B NPV B PV B (LP)(1 φ)(1 τ B,D ). Fair sharing: find {φ; p; L t, t = 0,..., N} s.t. φ NPV JV,A NPV A +PV A (LP)[(1 τ A,L ) φ (1 τ A,D )] = (1 φ) NPV JV,B NPV B PV B (LP)(1 φ)(1 τ B,D ).
41 B s side, and the fair-sharing rule Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal B s cash flow from the JV CF B,0 = (1 φ) I 0 ; CF B,t>0 = (1 φ) (Rev t Opex t LP t) (1 φ) (Sales t Cost t LP t)τ B,D = LP t(1 φ)(1 τ B,D ) +(1 φ) [Rev t Opex t (Sales t Cost t)τ B,D ]. B s ANPV and gain PV(CF B ) = PV B (LP)(1 φ)(1 τ B,D ) +(1 φ){pv B [Rev Opex (Sales Cost)τ B,D ] I 0 } = (1 φ) NPV JV,B PV B (LP)(1 φ)(1 τ B,D ), B s gain = (1 φ) NPV JV,B NPV B PV B (LP)(1 φ)(1 τ B,D ). Fair sharing: find {φ; p; L t, t = 0,..., N} s.t. φ NPV JV,A NPV A +PV A (LP)[(1 τ A,L ) φ (1 τ A,D )] = (1 φ) NPV JV,B NPV B PV B (LP)(1 φ)(1 τ B,D ).
42 Finding φ for a given license Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal One story: Suppose license income is taxed at a lower rate than profits/dividends So we set p, and L t at the highest values that do not raise fiscal hackles Then find φ. If this is infeasible, or otherwise unacceptable, change the license etc etc Find φ, given a license deal φ NPV JV,A NPV A + PV A(LP)[(1 τ A,L) φ (1 τ A,D)] = (1 φ) NPV JV,B NPV B PV B(LP)(1 φ)(1 τ B,D). φ net value, to A, of equity NVEQ z } { [NPV JV,A PV A(LP)(1 τ A,D)] NPV A + PV A(LP)(1 τ A,L) = (1 φ) [NPV JV,B PV B(LP)(1 τ B,D)] NPV B. {z } net value, to B, of equity NVEQ
43 Finding φ for a given license Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal One story: Suppose license income is taxed at a lower rate than profits/dividends So we set p, and L t at the highest values that do not raise fiscal hackles Then find φ. If this is infeasible, or otherwise unacceptable, change the license etc etc Find φ, given a license deal φ NPV JV,A NPV A + PV A(LP)[(1 τ A,L) φ (1 τ A,D)] = (1 φ) NPV JV,B NPV B PV B(LP)(1 φ)(1 τ B,D). φ net value, to A, of equity NVEQ z } { [NPV JV,A PV A(LP)(1 τ A,D)] NPV A + PV A(LP)(1 τ A,L) = (1 φ) [NPV JV,B PV B(LP)(1 τ B,D)] NPV B. {z } net value, to B, of equity NVEQ
44 Finding φ for a given license Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Find φ, given a license deal φ = threat gap partial settlement z } { z } { NVEQ B [NPV A NPV B] PV A(LP)(1 τ A,D) + (2) NVEQ A + NVEQ B NVEQ A + NVEQ B Comments first ratio is like the fraction of equity values if the license had been with an outsider first ratio still simplifies to 1/2 if A and B are homogenous, τ- and R-wise; it is higher is A is disadvantaged the gap between the alternative values ( bargaining strength ) can be reduced or even closed by the license income 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
45 Finding φ for a given license Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Find φ, given a license deal φ = threat gap partial settlement z } { z } { NVEQ B [NPV A NPV B] PV A(LP)(1 τ A,D) + (2) NVEQ A + NVEQ B NVEQ A + NVEQ B Comments first ratio is like the fraction of equity values if the license had been with an outsider first ratio still simplifies to 1/2 if A and B are homogenous, τ- and R-wise; it is higher is A is disadvantaged the gap between the alternative values ( bargaining strength ) can be reduced or even closed by the license income 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
46 Finding φ for a given license Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Find φ, given a license deal φ = threat gap partial settlement z } { z } { NVEQ B [NPV A NPV B] PV A(LP)(1 τ A,D) + (2) NVEQ A + NVEQ B NVEQ A + NVEQ B Comments first ratio is like the fraction of equity values if the license had been with an outsider first ratio still simplifies to 1/2 if A and B are homogenous, τ- and R-wise; it is higher is A is disadvantaged the gap between the alternative values ( bargaining strength ) can be reduced or even closed by the license income 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
47 Finding an acceptable license deal Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal When used? sometimes φ is dictated by other considerations than pure fair sharing Desire for maximal control within government-set limits on φ: set φ = max Tax considerations, no desire for control, severe information disadvantage: set φ=0. Then solve for an acceptable license that achieves fair sharing How to use analytically? cumbersome when you cycle through many parm s and then you still have to implement it in a spreadsheet 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.
48 Finding an acceptable license deal Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal When used? sometimes φ is dictated by other considerations than pure fair sharing Desire for maximal control within government-set limits on φ: set φ = max Tax considerations, no desire for control, severe information disadvantage: set φ=0. Then solve for an acceptable license that achieves fair sharing How to use analytically? cumbersome when you cycle through many parm s and then you still have to implement it in a spreadsheet 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.
49 Finding an acceptable license deal Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal Example Let NPV JV,A = NPV JV,B = 493 τ A,D = τ A,L = τ B,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 Tentatively, we set L t = 0. Then PV(LP) = p PV(Sales), where PV(Sales) = 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. L 0 (upfront license fee) or a series of L t with the same PV, etc etc
50 Outline A Simple Framework for Why a license? Fair sharing Finding φ for a given license Finding an acceptable license deal
51 Qualitative summary It s really quite simple: First do NPV s as if the whole project were a wholly owned subsidiary: partner A analyses the problem using her own tax rate and discount rate on the entire cashflow (NPV JV,A) B does the same using his tax rate and his cost of capital (NPV JV,B) If one of these NPV s is negative, STOP. 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 s, is PV(sales) (or another similar variable)
52 Generalisations (1) Handling asymmetric information? 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 Or use backwards: given your own alternative and a proposed, back out the NPV B that woudl make the fair, and then judge its reasonability Handling three or more partners? Each should get one-nth of the synergy gains. Equal bargaining strengths and the 50/50 rule? Easy to adjust for any other division of the synergy gains. OR: use a specific proposal to back out the implied sharing proportions.
53 Generalisations (1) Handling asymmetric information? 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 Or use backwards: given your own alternative and a proposed, back out the NPV B that woudl make the fair, and then judge its reasonability Handling three or more partners? Each should get one-nth of the synergy gains. Equal bargaining strengths and the 50/50 rule? Easy to adjust for any other division of the synergy gains. OR: use a specific proposal to back out the implied sharing proportions.
54 Generalisations (1) Handling asymmetric information? 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 Or use backwards: given your own alternative and a proposed, back out the NPV B that woudl make the fair, and then judge its reasonability Handling three or more partners? Each should get one-nth of the synergy gains. Equal bargaining strengths and the 50/50 rule? Easy to adjust for any other division of the synergy gains. OR: use a specific proposal to back out the implied sharing proportions.
55 Generalisations (2) Profits on owner s sales to JV? 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 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. 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.
56 Generalisations (2) Profits on owner s sales to JV? 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 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. 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.
57 Generalisations (3) Equity in kind, at negotiated valuation Apart from taxation, this is very similar to finding a fair upfront license income L 0, 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 I 0. Two solutions: A pays up 30% of I 0 in cash, then sells a know-how to JV for 20% of I 0 and puts up that money as additional equity- OR A pays up 30% of I 0, and brings in the know-how for 20% of I 0.
58 Generalisations (3) Equity in kind, at negotiated valuation Apart from taxation, this is very similar to finding a fair upfront license income L 0, 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 I 0. Two solutions: A pays up 30% of I 0 in cash, then sells a know-how to JV for 20% of I 0 and puts up that money as additional equity- OR A pays up 30% of I 0, and brings in the know-how for 20% of I 0.
59 Summing up 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 (L t) in excess of costs, if any, associated with the service any upfront payment L 0 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, 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.
60 Summing up 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 (L t) in excess of costs, if any, associated with the service any upfront payment L 0 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, 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.
61 Summing up 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 (L t) in excess of costs, if any, associated with the service any upfront payment L 0 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, 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.
62 Summing up 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 (L t) in excess of costs, if any, associated with the service any upfront payment L 0 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, 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.
63 Summing up 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 (L t) in excess of costs, if any, associated with the service any upfront payment L 0 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, 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.
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