Nine must-ask questions before you enter a joint venture: HoldenCAPITAL
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Just what are the nine must-ask questions you nee to consider before you enter a joint venture?
1. “Needs V Wants?” – A successful Joint Venture or “JV” is typically formed on the basis that the JV parties are contributing complimentary skills and or value to the alliance. The question for the Developer to ask himself is are the skills/value that the other party brings to the deal i) needed; and ii) cannot be better satisfied by other means such as paying an external consultant. A JV partner generally comes at a price such as an agreed profit share based on the contributions each party makes to the “Project”, which results in the Developer giving away a large percentage of his profits.
2. Trust – What do you know about the party/ies you are about to enter into a JV with? Have you done business with them previously or do you know other Developers who have and if so, what was the outcome? How did they perform against initial expectations? Past performances can provide you with a valuable indication of what to expect in terms of behaviour, work ethic, and integrity. Its just as important to undertake thorough due diligence on a potential JV partner as it is on the metrics of the project.
3. Incorporated or Contractual JV? – There are pros and cons for both, so its important to understand the features of each and decide which best suits the participants and the project. Appropriate legal and taxation advice upfront is strongly recommended; i.e. the Corporations Law allows parties to look behind the corporate structure of an incorporated JV and attach liability to individuals. On the positive side, the transfer of an interest in an incorporated JV can be done via a simple transfer of shares, which is useful where a JV evolves and needs to take on a different shape from that first envisioned. A contractual JV may be a quicker and simpler structure to establish, but documenting it can still be quite cumbersome. There are potential tax benefits in a Contractual JV allowing tax losses to be affectively offset against income outside the JV, while an Incorporated JV quarantines them within the incorporated entity. Again, it is recommended that the parties seek independent legal and taxation advice having regard to their respective interests, prior to establishing the JV.
4. Decision Making – It is important to understand and agree how key decisions will be made. In some JV’s decisions will be made by one party only (where the other parties are considered “silent partners”), whereas in most JV arrangements, decisions are made jointly. It is important to establish from the outset, who will be responsible for making key decisions that affect the project.
5. Who will do what? - a simple way to determine each parties responsibilities is to list the tasks/responsibilities that need to be completed throughout the development process and assign a lead role and a peer review role. A suggested way to simplify this is detailed below:
This is obviously a simplified list, but by allocating responsibility for the macro tasks, that party is then responsible for allocating the appropriate sub-tasks with peer reviews undertaken by the secondary party to ensure compliance as a double check.
6. Tracking Performance – From the outset it is important to establish clear performance targets for all JV parties and then ensure that these measures are tracked and reported. Regular meetings between the JV parties should be scheduled and performance against the agreed measures should be discussed to ensure the project remains satisfactorily on track. Identifying poor performance early and acting to resolve any issues is critical to the projects success.
7.Profit sharing – It is critical that the distribution of profits and risks borne fairly represent the contributions made by each party based on their contributions - skills and financial. These contributions can change over the life of a JV and it is therefore important that there are agreed mechanisms to allow changes to the profit distributions to reflect those changes. Typically, this occurs where there is a requirement for subsequent equity contributions, particularly where only one party has the capacity or will to participate. The agreement should contemplate this and provide for appropriate adjustments to entitlements to reflect the change in contributions/risk. Poorly structured agreements inevitably result in a dispute situation and if a party is not adequately incentivised, this could impact their performance and in turn the project success.
8.Disputes – All agreements should include appropriate dispute resolution clauses to ensure the project is not stalled where an impasse is reached on key issues. To avoid the cost in time and money, it is important to clearly articulate the dispute resolution procedures and most good JV Agreements will include a suite of tailored clauses. Typically, they will provide for a number of pre-agreed outcomes but also where a critical dispute cannot be resolved using those clauses; the agreement will should either have a deadlock or mediation process. Ultimately, if mediation fails it could result in expensive litigation, which is to be avoided at all cost.
9.Ending a JV arrangement – Unlike a “partnership” a JV is not a legal entity and is typically an agreement between two or more parties to form a strategic alliance for the purpose of a single or specific number of projects. Therefore the dissolution of a JV is reasonably straightforward, doesn’t typically require any further legal documentation and will end on completion of the project/s. This is why JV’s are quite common in property development as they can be formed for the purpose of a single project, should contemplate various exit solutions to deal with situations where the project fails meet the original expectation and allow for the JV parties to move on at completion.
This article was written by Dan Holden of HoldenCAPITAL, who are a bespoke construction finance firm, they arrange construction finance and invest in projects through their equity fund, Queen Street INVEST. To discuss your project finance requirement please call (07) 3171 4200 or visit HoldenCAPITAL here.