Joint venture

A joint venture is what gets built when an acquisition is the wrong answer. The capital or the risk is too large for one balance sheet, as with a new plant or an unfamiliar market. Each side holds half of what is needed, one the technology and the other the distribution or the licences. Regulation in some markets requires a local partner, so the choice is a joint venture or no presence. Two incumbents that would never sell to each other can still put two assets into one vehicle.

It also buys information cheaply. A joint venture works as an option on a full acquisition later at a fraction of the capital, and it is far easier to exit than an acquisition is to unwind. The price of all that is a partner who can block you, which is why the reserved matters, deadlock mechanics and exit provisions in the shareholders agreement matter more than the split of the equity.

The accounting consequence is what interviewers test. Under IFRS 11 an arrangement under joint control is one of two things. A joint operation gives the parties rights to the underlying assets and obligations for the liabilities, and each recognises its own share of assets, liabilities, revenue and expenses directly. A joint venture gives the parties rights only to the net assets, and the interest is equity accounted under IAS 28. Proportionate consolidation for joint ventures disappeared when IFRS 11 replaced IAS 31, which is why two groups with economically similar arrangements can present very differently.

Equity accounting means none of the venture's revenue and none of its EBITDA reaches the parent's operating lines. A single line, the share of profit after tax, sits below operating profit. So an enterprise value built from market capitalisation carries the value of the stake while EBITDA carries none of its earnings, and the unadjusted multiple is too high.

Hold the direction, because it is the reverse of the adjustment people are used to. A non-controlling interest is added to enterprise value because consolidated EBITDA already includes all of a subsidiary the parent does not fully own. An equity accounted stake is deducted because consolidated EBITDA includes none of a business the parent partly owns. The more rigorous alternative is to add your share of the venture's revenue and EBITDA to the denominator, which needs disclosure most companies do not give.