Evaluate the Risks of Joint Ventures Carefully
Sometimes a construction project is just too big or complex for one general contractor to handle alone. Joint ventures (JVs) enable two construction companies to temporarily partner up to distribute risk, apportion resources and, one hopes, share profits.
There are other reasons to consider a JV. You might need to secure additional bonding capacity or meet affirmative action compliance for a government contract. A JV may also be a good way to enter a new geographic area or market segment. Of course, there are some risks to consider.
Arguably, the biggest risk of a JV occurs in the beginning of the process. If you choose the wrong partner, the arrangement may be doomed to failure no matter how sound the legal and financial details.
The best JV partners complement each other’s skills and resources, as well as possessing similar goals, values and company cultures. They also must establish clear channels of communication. Only when these elements match should you move forward toward formally setting forth a legally binding agreement.
Structure and Details
JVs typically are set up as partnerships, limited liability companies or corporations. Each entity type has different tax implications, levels of liability protection and financial reporting requirements.
An agreement should outline insurance, identify bonding and tax strategies, and provide for dispute resolution procedures such as mediation or arbitration. It should lay out day-to-day procedures and clearly describe assignments for each partner — including who’s responsible for:
- Managing daily operations,
- Ensuring safety protocols,
- Obtaining permits and licenses,
- Procuring supplies and materials, and
- Handling accounting, billing and cash transactions.
If the JV is set up for one project, then it obviously terminates on completion. But a detailed termination process should be agreed on and included in the agreement. The outline for the closeout phase needs to fully define the warranty period and when final partner distributions will occur.
When it comes to finances, you may be able to establish rates to charge the JV for the cost of items such as labor, equipment, overhead and insurance. If you can do so, include the rates in the agreement. Rates may be based on actual costs or negotiated fixed rates for each item.
Very importantly, a joint venture agreement should outline the way cash distributions from JV profits are made to partners. It’s prudent not to permit cash distributions until the project is more than halfway complete to ensure you have the cash flow for job costs.
Unforeseen conditions can create extra costs, so there should be a provision requiring partners to fund the JV in the absence of sufficient revenues. If one partner can’t contribute to the funding, the other partner(s) may be required to step in and cover that portion. Thus, the financial stability of potential partners should be disclosed before an agreement is signed.
Who Can Help?
A well-planned JV can be a big step forward for some construction companies. A poorly planned or structured one, however, will likely wind up as a major stumble. Consult with trusted legal and financial advisors with expertise in JV agreements before signing on the dotted line.