Preparing for the Exit

A word of advice for companies thinking about forming a business alliance: Before launching any partnership, make sure both parties agree on how you'll know, and what you'll do, when it's over.

There is no doubt this can be challenging. Like a prenuptial agreement, in which a couple discusses divorce options on their way to the altar, negotiating exit options while still at the formation stage of an alliance seems almost counter to human nature. For one thing, neither partner wants to admit that things could go awry. What's more, there's an eagerness to get the deal done—and a fear that raising the worst-case scenario will undermine the euphoria and trust that often accompany a new deal.

But partners ignore the issue at their own risk. Discussing the trigger points for exiting, as well as the disengagement process itself, while still in the negotiation stage is paramount for an effective partnership. In many cases, exit planning may actually enhance the alliance's performance and longevity.

Interviews with managers who have overseen alliances reveal a pattern that sometimes emerges when a partnership with no adequate separation agreement becomes strained: Partner A grows dissatisfied with the venture and seeks an exit, but can't find any easy options; Partner A then attempts to covertly appropriate as much value as possible from the alliance before the venture goes completely sour, while creating a paper and action trail aimed at placing the blame for the failed venture on Partner B; an angry Partner B discovers the maneuvers, and takes countermoves.

The lack of an agreement is compounded by the fact that when tensions arise between partners, the alliance's managers may be reluctant to alert their superiors back at the partner companies. They fear they may be blamed for the alliance's failure, which would hurt their own careers. So instead, the managers focus their tensions on their alliance counterparts. The typical outcome: a dysfunctional strategic alliance marked by deep animosity between alliance managers. Any ensuing discussions about possible alliance termination are likely to be emotionally charged and ineffective.

THE DISENGAGEMENT PLAN

So, what kind of exit-plan pact works best? One that clearly specifies the point of disengagement, tells both parties what their subsequent rights and responsibilities are, and provides a clear and effective procedural map that minimizes time and capital losses.

More specifically, a successful disengagement plan should comprise the following:

• Clear definitions of what both parties will consider as exit triggers, or events that will set off specific exit provisions.
• A detailed description of each party's rights in a fair separation of the partnership's assets and products, as well as a determination of rights and responsibilities with regard to third parties, such as customers, suppliers and employees of the alliance.
• A detailed description of the disengagement process, including specific strategic options, guidelines for creating the core disengagement team, and clear timelines.
• A communication plan for continuous flow of information to alliance partners, customers, suppliers and other involved parties during the dissolution.

TRIGGERS FOR DISENGAGEMENT

Not clearly stating when an alliance should end can be lethal, even when partners have agreed on how the alliance should end. Partners' perspectives on the timing of dissolution can differ, leading to lengthy and expensive haggling.

This is why the first step in devising a successful exit strategy is to have clear trigger provisions. Triggers may consist of such contingencies as the inability of the alliance to meet certain milestones, performance metrics or service-level agreements; breaches of contract terms; or the insolvency or change in control of one of the partners. When pharmaceutical and biotech companies team up to bring an experimental drug to market, the partners often use milestones as exit triggers, such as whether the drug reaches a particular stage of a clinical trial.

For example, a large U.S. pharmaceutical company we talked to often sets a deadline by which patients must be enrolled in Phase III clinical trials, typically the last round of tests before a drug is submitted to the Food and Drug Administration for approval. Other milestone triggers used in this area include failing to successfully complete Phase III trials, failing to attain approval from the Food and Drug Administration, or, for a drug that is already approved, failing to meet specific sales targets.

In some cases, exit triggers are linked not to goals but to events, such as a change in control of one of the partner companies. One large domestic dairy manufacturer we investigated, for example, when entering alliances, often stipulates that it will end the partnership if its partner's percentage of voting shares in its own company declines without the dairy company's prior consent. The dairy maker makes this requirement to avoid having an undesired firm indirectly obtain a stake in the alliance by buying shares in the partner company.

Once an exit trigger is reached, the next step is dissolving the alliance. This raises the question of each partner's rights and responsibilities. What's the fairest way to split everything up?

Partners can start by breaking things down into two broad categories: stocks, which we'll define as the current products or services sold by the alliance, as well as the physical and intellectual assets used in their production; and flows, which are contractual commitments to third parties and to the partners.

RIGHTS TO STOCKS

Stocks include inventory of products and materials, any land and facilities, as well as intellectual property. These rights are easier to determine the less integration there has been between the partners. The difficulties increase where joint ownership or joint operations are concerned, and even more when the alliance has grown to involve multiple product lines with competing brands and geographically dispersed physical infrastructure.