Under the agreement, expected to be finalised by the end of 2019, the new vehicle will go on global sale in 2022, the German and Chinese car giants said in a joint statement.
The 12-strong board of directors of the new venture will be made up of six executives from each company.
"None of our colleagues at Smart will lose their jobs as a result of these decisions," said Daimler boss Dieter Zetsche in a statement.
"On the contrary. We need the passion and creativity of the Smart team more than ever.
"After all, these changes are not ending for Smart -- but a new beginning." Daimler says USD 562 million will be invested in the Hambach plant, which will assume "an additional role" producing a compact electric vehicle under the new 'EQ' product brand.
"All jobs will be sustained through our new project which will consist of creating a new assembly line for the construction of a Mercedes-Benz electric SUV in Hambach," Serge Siebert, CEO of Smart France, told the Le Republicain newspaper on Wednesday.
Geely is owned by Chinese billionaire Li Shufu, who is also Daimler's main shareholder having acquired nearly 10 percent of shares in the German manufacturer in February 2018.