Joint Venture Risks – A Marriage of a Different Kind (Part I)
Vice President, Regional Practice Leader – Risk Management (Ontario)
Joint ventures have been around for some time. However their popularity as a business structure seems to be increasing. I frequently get asked questions from my clients about the risks involved in joint ventures and thought it was time that I summarized many of the answers I give to these questions.
Joint ventures are increasing in popularity in some industries for many reasons, but some of the main ones are:
- The desire of customers to simplify their lives by dealing with fewer entities, thereby forcing their vendors to enter into joint ventures so a “one stop” solution can be delivered.
- It is a great way for companies to expand their customer base into new industries and geographical areas by leveraging the brands, relationships, knowledge, local presence and expertise of others.
- It is a way to spread risk across other parties.
- It enables you to take on larger projects than what you could do on your own.
- It may be required to meet certain regulatory and compliance requirements in a jurisdiction.
- It allows you to limit the liability of participants to a specific project.
- It is sometimes an opportunity to “test drive” a company before buying it.
There are three basic types of joint venture arrangements. Here is a general overview:
- Silent Joint Venture: one party holds the contract with the owner and likely provides the surety, project financing and/or expertise in return for a certain share of the profits and losses.
- True Joint Venture: a separate legal entity has been created to govern the parties. It will hold the contract and acts as the employer for all the employees involved in the project. A limited partnership is the most common legal formation used.
- Line Item Joint Venture: the joint venture holds the contract, but has no employees. The joint venture entity sub-contracts the work to the venture partners, who may in turn sub-contract to non-joint venture parties.
Here are some of the basic considerations when looking at entering into a joint venture arrangement of any form:
- Do you share common values with all the other joint venture partners? This is probably one of the most underappreciated criteria. In essence, you are entering into a “marriage” with these other companies. Throughout that project you will be jointly representing each other, each of the partners will be making decisions on a daily basis that can impact the others, and there can be issues arising that will require the partners to come to an agreement on how to respond. If you do not share common values with respect to how you do business, these situations can evolve into major problems and fractures within the partnership.
- Do all the partners have the needed level of knowledge and experience to successfully complete this project? You are only as strong as your weakest link. Sometimes a party is brought into the joint venture due to a relationship they have that can help win the project, or they have the local requirements needed. However, if they cannot deliver, they put everyone at risk. This needs to be identified and mitigated early on.
- Does everyone have the financial capacity to take on this project? Private companies in particular can be very secretive with their financials. However, big projects can require large investments in capital and all the players need to know that each partner is capable to make the needed capital investments and cash flow their operations during the thin periods.
If you have determined that everyone meets these criteria the next step is creating a Teaming or Joint Venture agreement. The timing for creating this can vary. Many like to wait until they actually win the project, others will try and get it in principle before they bid on the project. In my opinion, being proactive on the agreement is better, especially if all the partners need to put in capital without knowing if the project has been won. Things can get very complicated if you win the deal and then one of the partners is opposed to terms in the agreement that are considered “non-negotiable” by the other partners. Trying to start the project and hammer out disagreements with the partners at the same time can become very complicated.
Stay tuned for my next blog post in which I provide additional advice on joint ventures’ written agreements and risk management.