They say that two heads are better than one – when it comes to landing bigger construction contracts, that’s often the case. In an industry as competitive as construction, two smaller companies will stand a better chance of winning a contract if they pool their skills and resources such as land, equipment or access to capital. Together, they can set up a joint venture to benefit from the credibility of a larger company, enabling them to meet the specific demands of a large construction project.
Creating a commercial alliance between two entities will enable both companies to share the risk and reward involved with the project – what’s more, it can also open the door to overseas expansion help them to achieve large project goals with ease.
That said, by their very nature, joint ventures are high risk, and you don’t need to look too hard to find examples of when they go wrong. For that reason, entering into a joint venture (JV) is not something that should be done without serious consideration and legal advice. We’ve gathered together the following legal considerations when entering into a joint venture to help you make the right decision:
1. Defining the right partner
When scouting for prospective partners, contractors should take care to perform extensive due diligence to lower the risk of the joint venture. A specialist legal team will be able to assist in assessing your potential partner, focusing on the following areas in particular:
Does the company possess the relevant skills and resources to make the joint venture worthwhile? Due diligence should confirm that the company meets standards in regard to performance and quality.
· Financial strength
What is the company’s working capital? How is their ability to manage cash flow, and what is their projected revenue? Gaining clarity on this in advance will provide assurance that the partnership is a viable venture.
· Track record
If your prospective partner has had prior experience in setting up and running a joint venture, it may be wise to reach out to past JV partners to get an overview of their strengths, weaknesses and whether they would consider a venture with the company again – if not, for what reason?
· Legal history
Disputes are a fact of business life, but if your potential JV partner has regularly been involved in lawsuits in the last 7 years, such a pattern could alert you to their ability to work cooperatively and ethically. A lawyer can help to identify patterns in their legal claims history and draw attention to any potential red flags.
2. Forming the joint venture
If the joint venture is being set up for the purpose of taking on multiple projects, it may be worth setting up the JV as a new entity such as an LLC or partnership agreement. Setting up as a legal entity is not essential, particularly if you only plan to pursue one construction project together. If this is the case, you can simply form the JV through means of a contractual agreement. In either case, your lawyer will be able to support and advise on the best vehicle for formation of your joint venture taking into account future ambitions and tax considerations.
If the joint venture is established by a contract rather than a legal entity, then the members of the joint venture are personally exposed to liabilities incurred pursuant to the venture. In a construction project, shared liability can cause issues – for example, when one member is bonded and the other is not. Should a supplier seek to take action against the payment bond and demand compensation, the unnamed JV member will be equally liable. As well as future ambitions and scope of work, it is for this reason that some owners may choose to set up as a corporation or limited liability company (LLC) – this way, each member will only be liable to the extent of their investment in the corporation’s stock or their interest in the LLC.
3. Deciding ownership, profit share and governance
No matter the set-up of the JV, the agreement must clarify the exact ownership share of each member as well as their share of profits and losses generated from the project. This could be the same as each member’s ownership percentage.
Remember, “profit” can mean different things to different people – so make sure your agreement is clear in its definition of profit, loss and any terms relating to the distribution of cash from the venture. Further, it’s imperative that the agreement specifies the level of control that either party exercises over the joint venture’s operations – this should mirror the relative capital contributions, although other factors may play into the decision – for example, if one party provided more capital but the other brought local contacts, resources such as equipment or valuable knowledge that was required for the project.
4. Setting out expectations for capital
Working capital is the fundamental building block to any construction project, so it figures that your JV agreement should set out plainly the expectations for capital requirements throughout the life of the project. Should the project overrun or last longer than expected, the contract should precisely state the process for capital calls to fund the rest of the project, including the details of who will be responsible for identifying such circumstances and the steps to take if a member does not meet a capital call. When the venture comes to a close and the project is complete, the agreement should provide a roadmap for determining how profits, losses and return of capital will be distributed.
5. Determining the dispute resolution process
When it comes to disputes, prevention is better than cure. A comprehensive JV agreement is the foundation of a good business relationship – by setting in stone each member’s rights and responsibilities from day one, you minimise the risk of disputes from arising. Of course, no matter how promising the joint venture may be, disagreements do happen. Setting out a clear process for dispute resolution as part of your agreement including potential mediation or arbitration at least provides both parties with a framework for resolution should the worst happen.
While a joint venture can prove profitable for all involved, rushing into an agreement is not recommended. Due to the risk involved, setting up a JV demands the expertise of a well-experienced lawyer who understands the nuances of the industry enough to provide reliable advice and support throughout the process. Our construction lawyers regularly assist clients in the industry to ensure the joint venture will be a beneficial vehicle for growth and their commercial interests won’t be at stake. To find out more or to speak to a member of our expert team, fill in the footer form below or drop us a message on our live chat.