Key considerations for finance startups embarking on joint ventures

Joint ventures can be a profitable endeavour for startups wanting to break new markets, especially in a challenging global economy. A survey last year of global executives found 58% preferred joint ventures to mergers and acquisitions due to economic uncertainty.

A joint venture is two or more parties coming together for a specific business purpose. Joint ventures are a more agile form of business collaboration, which is why it’s favourable to both large institutions, and the startups who are seeking to get their venture off the ground. The startup model is inherently risky, and a joint venture allows investment from a larger company in their product, but also the ability for them to bow out more easily if the startup fails.

In the financial sector, it could simply be the financial institution lending money to the startup for a new product and taking security.  At a more complex level, a joint venture could include a startup and financial institution embarking on a technology project to build financial services technology.  As part of this joint venture, the parties will negotiate the project including (but not limited to) funding, resources, risk sharing, and liability. As startups are in a less stable position, it’s important to protect their interests and it’s worth considering the below points before embarking on a venture with a larger financial institution.

Lending and borrowing

In its simplest form a financial institution assesses the startup business and decides whether they are a suitable business to lend its money, to ensure that the startup repay the money at a later date and for the bank to make a profit on the lending.

For startups, security is generally also required and personal guarantees from the owners may be required (especially for startups without significant capital). A facility agreement is effectively a loan agreement setting out the terms and conditions the lender (in this case the financial institution) is prepared to make a loan facility available to the borrower (the finance startup). It is important for the facility agreement to be in a form acceptable to the borrower to mitigate risk and prevent any onerous terms coming back to bite them.

Conditions precedent

Conditions Precedents (CPs) are a significant part of any facility agreement.  Whilst the financial institution will have made a lending decision, in principle, at the outset based on certain high level factors, the CPs usually provide that further detailed information is supplied to lender to properly assess the startups financial position and ongoing revenues (amongst other things) in order that the borrower is in the best position to repay the loan.

CPs produced by the lender will always be wide. However, as a borrower the finance startup should consider the following:

1. Clarity: a borrower will want terms in CPs to be clear and unambiguous.
2. Objectivity: a borrower should require a lender to exercise any discretion ‘reasonably’.
3. Timing: a borrower should seek to agree the form of documentary CPs prior to signing the facility agreement.
4. Third-party co-operation: these should be prioritised where required to ensure any information is produced in a timely manner. 
5. Lender notification: a borrower should require the lender to be obliged to notify them once all CPs are satisfied.
6. Fees: a borrower will want to avoid paying any lender fees until they are able to borrow.

Project-based joint venture

Where there is a prospect of entering a project based joint venture, for example in relation to building software for a financial institution, the rewards can be high, but so is the risk.  As with dealing with any large corporates, financial institutions will assess the commercial risk of entering into a commercial venture with a startup, similar to the financial institutions assessment of lending criteria.   

Dealing with large financial institutions means that decisions are not made quickly and the lead time can be anywhere between twelve months and two years.

Usually, financial institutions have already considered the specific criteria to be covered by the joint venture and these may not be negotiable by the startup, as they may include regulatory and compliance requirements, this may include specific insurance requirements, say £5million professional indemnity cover, only using sub-contractors approved by the financial institution (if the startup is smaller in scale) and compliance with internal policies.

For the startup, it is the highest priority to ensure that firstly it can deliver the project on time and on budget.  Once the parties are at a contract stage, it is vital to set out clearly the services deliverable by each party, timescales, costs, and liability.

The startup will need to check their commercial insurance to ensure that they have the relevant insurance in place in the worst case scenario.  Otherwise, the contract will need to checked for any other liabilities and appropriate limitations of liability for the startup will require negotiation.

If new software is being developed for a financial institution, they will want to ensure that the intellectual property is being assigned to them as they are paying for all of the development.  If the startup proposes to use its existing software, then care will need to be taken when drafting the contract to ensure that there is no assignment of the pre-existing software, however the additional elements being developed specifically for the financial institution is up for negotiation. 

The balance of bargaining power between a financial institution and a startup is clearly very imbalanced as the financial institutions will have significant resources if issues arise during the joint venture, however for a startup to land a financial institution as a joint venture partner, it may very well cause the startup to grow significantly.