How Zimbabweans should approach the business of joint ventures, and foreign direct investment

The local Zimbabwean venturer (partner) may place more concern on growing the business from the Zimbabwean geographic base and expect profits to be re-invested back into the local enterprise, whereas the investing foreign venturer (partner) may be for repatriation of profits to distribute to own contributing shareholders, writes Brian Manyathi Image source: www.wealthandfinance-news.com

 

By Brian Tawanda Manyati

 

Joint Ventures with foreign direct investment (FDI) partners are one of the key business routes that will prove valuable to Zimbabwean businesses in a new dispensation, and the re-industrialisation phase we are in.

Here is all that you need to know about joint operations and joint ventures, as well as accounting for joint ventures in Zimbabwe specifically, the challenges that arise from joint ventures, and issues to address in joint venture contracts or memorandums of agreement, as well as distinguishing joint ventures from joint bids and consortia.

Are joint ventures a source of perfect partnerships?

Let me quote Geoff Gravil`s great advice in answering the question above and the rest. This fellow finance professional wrote in his 2001 article to student accountants, and in it identified joint ventures as a means of rapidly expanding geographically by using other companies`s resources.
It permits tapping into existing skills, knowledge and finance, as well as accessing customer groups.
You should be aware that to the investors bringing FDI to Zimbabwe, formation of joint ventures is a swift and cheap route to development of a foreign business they are involved with here in Zimbabwe, than if it were to rely solely on their own resources and efforts to launch and fully operate.

Distinguishing joint bidding, joint ventures and consortia

These are a number of ways for the con-joining firms to combine resources. A joint bid agreement can be helpful for a contractor who specialises in one skillset, for example, live music streaming, and wants to work with another specialist to complete a project.

Most heavy construction companies have continued to use this international expansion strategy whenever opportunities come up e.g the last 2010 World Cup hosted in South Africa. South African local firms were best placed during that World Cup preparation phase to bid, and be awarded huge construction projects.

Therefore, a foreign firm could best come in as a joint bidder. With this new dispensation, Zimbabwean companies in turn, are best placed in winning bids to a number of invitation-to-tenders for major local infrastructural developments.

However, it is wise to submit those bids up as joint bids, of course with the local entity leading.

In comparison, a joint venture is whereby two firms or more join forces for manufacturing, financial and marketing purposes and each has a share in both the equity and management of the business.

Parts of companies are joined to achieve specific, limited objectives. Joint ventures are attractive to smaller or risk averse firms or where expensive technologies are being researched and developed, for instance, aerospace and car industries.

The advantage of a local joint venture is that the Zimbabwean government`s interference is limited if your local firm is involved. Therefore, this is a risk reduction strategy through synergy as one firms`s production or technological expertise can be supplemented by the other`s marketing and distribution or production plant facility.

Initial capital outlay is also shared, the same with operational costs of the business. According to Institute of Chartered Secretaries and Administrators (ICSA) joint ventures are common in the Middle East and Asia, where legislation prevents or makes it difficult to gain a hundred percent foreign ownership of firms.

With a consortia, organisations co-operate on specific business areas such as purchasing or research. Consortia are therefore, a good way of tapping from cash inflows of a foreign operation without excessive involvement in the day to day running of the operations.

Challenges arising from joint ventures

There can be difficulties in operating within joint ventures especially those that involve foreign firms where language, business culture and even different perspectives on business ethics can generate misunderstanding and even mistrust between the distant partners.
Cultural differences may arise in management, attitude towards equal opportunities, employee empowerment, commercial practice, and short and long term planning.
Therefore, it is of importance to clarify at contract inception stage, any potential areas of conflict.
The partners or venturers may have fundamental disagreements as a result of different objectives. The local Zimbabwean venturer (partner) may place more concern on growing the business from the Zimbabwean geographic base and expect profits to be re-invested back into the local enterprise, whereas the investing foreign venturer (partner) may be for repatriation of profits to distribute to own contributing shareholders.
The local partner may, as the RBZ and Zimbabwe Ministry of Finance are encouraging, be hoping to generate exports into other geographical areas yet this may not be of interest to the foreign investor whose size may already have given them export business in those same targeted areas.
So they will distract their local joint venture partner for not wanting to share those export markets.
Issues of disagreement may arise over transfer pricing arrangements. With the foreign venturer transfering expertise, technology and components to the Zimbabwean partner, they probably may look to charge the highest price possible entailing any profit will 100% belong to them.

Creation of synergies

However, with local partner wanting a lower transfer price to eke some profit, there will, inevitably be room for disagreement.
Profit allocation and distribution is generally a source of argument if not well handled. It is a source of trust destruction on its own to most small to medium sized joint ventures.
Though we commonly expect benefits of a joint venture to suffice from the creation of synergies through complementary knowledge, expertise and resource sharing of the venturers.
A danger arises in instances where the partners may have strengths in the same areas of expertise, or possess almost similar weaknesses.
At the very basic level we however expect the local venturer or partner to provide marketing knowledge along with an existing customer base, while the foreign partner brings technological expertise and extensive know-how to the joint arrangement provided they are carefully selected.
Smooth co-ordination and control may not be easy with joint ventures resulting in no clear pattern for decision making say due to a lack of overall steering leadership. It is important that for your joint venture not to suffer from management paralysis, you should allocate each joint venturer, or partner responsibilities for decision making.
Partners in a joint venture must come to an agreement at conception and agreement signing as to who the partners conjoining hands are and if use of sub-contractors are readily accepted.
If one party uses sub-contractors at random, this may have a detrimental impact on quality product or service delivery and in turn destroy trust and harmony.
The best way to protect the joint venture is to right from the beginning design together a minimum criteria for appointing sub-contractors and standard service delivery agreements that sub-contractors must sign up and have copies shared.

Issues to address in the memorandum of agreement or contract document of a joint venture

Clearly indicate parties to the joint venture in the MOA. This minimizes the risk of lower quality suppliers being brought into the chain as a result of uncontrolled sub-contracting.
It is important to pay respect to the demands of Zimbabwe Corporate Governance code (ZimCode) and enshrining some of the provisions into the joint venture`s conduct of day to day business, eg on identification and dealing with significant risks, internal controls of the joint venture arrangement, remunerating of executives, and meetings.
Other codes of corporate governance that the FDI partner may also be willing to make reference to e.g the UK Corporate Governance code, Germany`s Chrome code or South Africa`s King 4 report, should have their provisions considered in conjunction with our ZimCode.
You should have a clear specification of the purpose of the joint venture, setting out clear cut duties of each partner and expectations from each partner. Doing so helps to minimize conflicts of interest and avoid accusations of greed or short-termism against any of the partners.
It is important to ensure you include a clause specifically addressing the issue of transfer pricing of the joint venture`s goods and services to or from the FDI or local partner`s other related party entities and for the supply of components or expertise to the joint venture from the FDI partner.
Territories covered by the joint venture should be unambiguously defined so as to avoid arguments as to whether the local Zimbabwean partner has a right to export joint venture products to compete in markets or countries already served by the FDI venturer.

Time scales to joint venture contracts

Within the contract or MOA there should be a clause with a precise statement as to the merchandise and product areas to be covered within the joint venture.
For instance, the FDI venturer company may not be willing to share technology over its whole product range, whereas the local Zimbabwean partner may be expecting much broader co-operation. Therefore, it is important to define clearly the scope of the agreement to all parties involved with the joint venture.
You should put up an agreement as to how profits are to be shared, what proportion should be ploughed back into the joint venture firm, and how much should be repatriated. Make sure to execute this part as a must as it is a source of more conflict and animosity if not well done right from the start.
If possible, put up a time scale to the joint venture contract. This serves to permit separation moments than being locked up in a lengthy joint arrangement where it is clearly not working well or serves for contract renewal or MOA extension where things are going quite fine.
Ensure to set out in contractual format on how costs are to be shared. It is easy to have certain cost incurrences disputed, be it promotional material, R&D or administration costs. It is therefore, necessary to itemize such costs and to allocate responsibility for their payment.
In order to avoid the danger of a lack of overall leadership of the joint venture, it may be sensible that one of the partners should be invested with the responsibility to make decisions on behalf of all and thereby minimize or zerorize paralysis due to inadequate command and reporting structure.
Lastly, there should be some agreement from the start as to the arbitration or conflict resolution procedures, should a dispute between the partners arise and is not capable of amicable resolution.

Accounting for joint ventures in Zimbabwe

We make use of IFRS 11 Joint Arrangements to account for joint ventures. This accounting standard defines a joint venture as a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.
A joint arrangement basically is an arrangement of which two or more parties have joint control whereas a joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.
Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.
There are some of you who are senior citizens and last learnt old accounting standards, it is my belief that this article will help you a great deal to recap.
The same help is due to any who only learnt joint ventures at basic accounting level. At basic levels of accounting which most of this article`s readers will have had a chance to do, define a joint venture as a temporary partnership between two or more people. This may easily mislead you.

The proportionate consolidation method

We should rather better state it at that basic level as a form of a partnership between two or more people or firms to their mutual advantage and is limited to a particular ongoing transaction.
The proportionate consolidation method is no longer permitted for joint ventures. You qualified office accountants will understand this. IFRS 11 replaced IAS 31 Interests in Joint Ventures and SIC 13 Jointly Controlled Entities – Non-Monetary Contributions by Venturers.

The proportionate consolidation method is however, still applicable to a joint operator given that there is a requirement for a joint operator to recognise on a line-by-line basis, its share of assets, liabilities, revenues and expenses of the joint operation.

Take note that there is a difference in accounting for a joint venture and accounting for a joint operation but both qualify to be called joint arrangements.

This article is placing focus on a joint venture and not the joint operation. You should see below how these two arrangements are distinguished in order to remain with a joint venture, as guided by the relevant accounting standard IFRS 11.

On the other hand IFRS 12 Disclosure of Interests in Other Entities now gives you the disclosure requirements for subsidiaries, joint ventures, associates and “structured entities.” It replaced the requirements previously included in IAS 27, IAS 31, and IAS 28.

Though IAS 31 has been rendered obsolete or repealed we still use a revised IAS 27 and IAS 28. The latter, which is IAS 28, requires all investments in associates and joint ventures to be accounted for using the equity method, unless the investment is classified as “held for sale” in accordance with IFRS 5.

Your accounting and finance departments should stop use of the equity method from the date on which the joint venturer (you) ceases to have joint control over, or have significant influence on, a joint venture.

According to IFRS 11 whether a joint arrangement is a joint venture or a joint operation requires careful judgment using the following criteria where you ask and answer questions from the first to the last, only if each of the first two questions gives a no answer.

You should ask:

Does the legal form of the separate vehicle formed give the parties rights to the assets and obligations for the liabilities relating to the arrangement? If the answer is yes you have a joint operation, if no, carry on to the second question.

Do the terms of the contractual arrangement give the parties rights to the assets and obligations for the liabilities relating to the arrangement? If the answer is yes you have a joint operation, if no, carry on to ask the third and final question.

Do other facts and circumstances give the parties rights to the assets and obligations for the liabilities relating to the arrangement? If the answer is yes, at last you have a joint operation, if no, absolutely you have a joint venture.
B

y separate vehicle it is meant that the arrangement has a separately identifiable financial structure, including separate legal entities or entities recognized by statute, regardless of whether those entities have a legal personality e.g an incorporated (pvt) ltd company, or a private business corporation (pbc).

On the annual financial reporting side you should cross check or ensure that the consolidated statement of financial position, formerly your balance sheet, is prepared by first including the interest in the joint venture at its carrying amount, that is, cost plus share of post-acquisition total comprehensive income and secondly including the group share of the post-acquisition total comprehensive income in group reserves.
Furthermore, the consolidated statement of profit or loss and other comprehensive income (your income statement) will need to include firstly, the group share of the joint venture’s profit or loss and secondly the group share of the joint venture’s other comprehensive income.

By way of conclusion

In conclusion you generally should have noted from the above that in Zimbabwe we make use of International Financial Reporting Standards (IFRS) produced by the International Accounting Standards Board (IASB) and adopted by the Institute of Chartered Accountants in Zimbabwe (ICAZ) or the Practicing Auditors and Accountants Board (PAAB).

The IFRS are used in line with local regulations as provided for by for instance the Companies Act Chapter 24:03, even if it is accounting for joint ventures. Should you be a local investor joining hands with a foreign investor, it is advisable that you quickly save your face by approaching joint venture deal signings with a qualified accounting and finance advisor who would have briefed you of key issues involving day to day joint venture accounting and yearly financial reporting.

Someone also conversant with the challenges involved with joint ventures and how they can be addressed on signing up contracts or a MOA.

Most foreign investors being from nations relatively developed will to a greater extent be well aware or may be similarly accompanied by paid accounting and finance consultants and will be sure to take time to observe that some of the things we shall discuss in this article are showing in contractual clauses of memorandum of agreements (MOAs). Thank you.

 

 

Brian Tawanda Manyati is a qualified Chartered Secretary and Administrator and a Certified Accounting Technician, IFRS Expert & Content Reviewer who writes and makes, entrepreneurial, business, socio-economic and political analyses from a business and economic angle in his own personal capacity. He is contactable on +263772815211 or tawandamanyati@gmail.com, and on facebook.

Comment on this report: Call/text/whatsapp: (+27) 834767918

Twitter:@realdigitalnews

Facebook: Zimbabwe Digital News