A Joint Venture (JV) is an agreement between two or more parties who contractually agree to co-operate in order to achieve common goals or objectives for a period of time.
Most joint venture agreements involve a party contributing capital and an operating member. The capital member contributes land or finances while the operating member, usually an expert in real estate, provides the necessary skills and is responsible for daily operations and management.
The structure of a joint venture should address the following issues; distribution of profits, capital contribution, liability, taxation, flexibility, Non-Disclosure Agreement, and the exit mechanism.
There are four major categories of joint ventures;
A contractual development agreement provides a quick and flexible option to launch a joint venture without having to form a company. It is formed when two or more companies get into a contract for the purpose of carrying out a development project.
Distribution of profits is defined and each party is taxed separately on their share of profits from the venture and is not liable for the debts of the other parties unless there’s a contract in place with third parties. A contractual development agreement allows the parties to retain ownership of their assets which is a major advantage.
The disadvantage of a contractual development agreement is that there is a risk of forming a partnership which will lead to increased liability and difficulty raising finances since there is no separate legal entity formed. Additionally, a contractual development agreement cannot own any assets.
This structure occurs when the joint venture is created in the form of a corporation. The corporation is owned by shareholders and is managed by a board of directors. A separate business entity is thus formed which enables it to own assets and makes it easier to raise finances. The liability of each contributing partner is limited to the amount invested. The demerit of this structure is that corporations suffer double taxation as both the corporation’s profits and shareholders’ dividends are taxed separately.
This kind of venture can also be referred to as a JV company or a Special Purpose Vehicle (SPV). In this structure, the parties involved become shareholders of a private limited company which is a separate entity. Liability is limited to the amount each company has contributed. Share rights and revenues are distributed based on the level of investment and involvement. The company can own assets and the structure is flexible enough to allow for an exit strategy where a partner can sell assets or sell their shares to a new investor.
The downside of a private limited company is that although it is ideal in theory, its practicality can be undermined by administration costs and company obligations such as reporting and compliance measures. There’s also double taxation both at the company level, 25% corporation tax, and at an individual joint partner level, an additional 25%.
Partnerships can be divided into limited liability partnerships and unlimited liability partnerships. An Unlimited Liability partnership is a flexible setup where the joint venture is governed by the partnership agreement drawn up by the partners and is not restrained by rigid requirements. The joint venture partners are taxed directly and it has the advantage that the profits are not taxable. This structure also allows for a significant level of confidentiality which may be a requirement for the parties involved. A confidentiality agreement or a non-disclosure agreement could be signed at the commencement of the joint venture. This helps protect insider information shared during the venture from being used against the parties. On the flip side, each party has unlimited liability. This means that in case the venture fails to meet its financial obligations, the partners’ personal assets could be claimed to settle outstanding debts. Another drawback is that similar to a contractual development agreement, there could be difficulty raising finances since there is no legal entity formed. Additionally, if any of the joint venture partners leave, a whole new partnership is required.
A Limited Liability Partnership (LLP) can be thought of as a hybrid between a partnership and a company. An LLP leads to the creation of a separate entity with limited liability and the benefit of ease of accessing finance. From a tax perspective, however, it is treated as a partnership, meaning the partners are taxed directly on their share of profits which is a major benefit. The caveat of this structure is that it has a greater bureaucracy requirement for administration and accounting, which can lead to increased costs.
In conclusion, when getting into a joint venture, it is critical to understand what kind of venture you’re getting into and your level of liability. There’s no perfect structure for all situations since each structure is designed for specific purposes. A contractual development agreement could be favorable for a short-term venture while a corporation could be the best structure for a long-term project. The cost also differs with each structure, so that should also be put into consideration.