Joint ventures: advice on types
1 June 2017
Chris Green offers advice on different types of joint venture to help you decide which is appropriate to your circumstances
In the past few years, the construction and infrastructure industries have seen the rise of competitor organisations coming together to form joint ventures (JVs). This is common for contractors, but more recently, consultants have also begun to collaborate.
Major infrastructure opportunities in transport, power, water and natural resources have attracted JVs, and recent prospects such as the refurbishment of the Palace of Westminster have been the catalyst for both construction and consultancy joint ventures. So why are companies that have traditionally been competitors coming together as JVs to pursue major projects and framework appointments?
Capacity is one of the reasons. Major opportunities require extensive financial and technical resources that are often beyond the capacity of a single organisation, so the burden can be shared by JVs. There is also an issue with the breadth of skills and experience required to bid for and fulfil these opportunities. Competitors are effectively forced together to pool their skills and experience to meet all the criteria of a particular opportunity, so JVs offer a depth of resource.
JVs can be formed in 2 ways – incorporated or unincorporated. Incorporated JVs are effectively new companies whose shares are held by the partner organisations. Management teams, staff and operatives can either be drawn from the partners or recruited directly into the new company. The risks and rewards of undertaking projects are borne by the JV company, and the partners distribute dividends in accordance with the shareholding.
Major opportunities require extensive resources, often beyond the capacity of a single organisation, so the burden can be shared by JVs
Unincorporated JVs are formed by contracts known as joint venture agreements (JVAs). Each partner organisation provides management, staff and operatives in the agreed proportions, and shares in the risk and rewards of the project. Unincorporated JVs can be either integrated or non-integrated. In an integrated, unincorporated JV, the work is shared according to the proportions set out in the JVA to create a team comprising a mix of members from the partner organisations. In a non-integrated, unincorporated JV, each partner has a defined work scope and is responsible for fulfilling it from its own resources.
There are no hard and fast rules that dictate which form of JV should be used for particular opportunities; but we can offer some insights from both clients’ and providers’ perspectives.
A client will look to secure the best result on a project by appointing an organisation with the full complement of skills, experience and resources. Where these cannot be provided by a single supplier then the client will benefit by contracting with a JV that can provide them.
Unincorporated JVs are not corporate entities capable of entering into a contract; therefore, the client effectively enters into a contract with each of the partner companies on the basis of joint and several liability. Where the JV is incorporated, the client can contract directly with it, but may require further security from parent companies.
Clients may wish to work on the project themselves. If for instance the client already employs people directly to carry out work of a similar nature but wishes to contract a wider service provision, it could consider participating in a JV. This may be a viable alternative to outsourcing and having to transfer its resources to a contractor; but the arrangement will only work if the JV is incorporated and has the client as a shareholder, because it can then second resources to the JV, with which it contracts to provide the required services.
For a project-specific opportunity, it is usual to form an unincorporated JV. This is a contractual agreement of finite duration between the partners that comes to an end on completion of the contract.
An incorporated JV may be appropriate to address a market-specific opportunity that could span any number of individual projects. This would create a new business entity of indefinite duration. Therefore, incorporated JVs are appropriate when the partners are seeking a durable relationship to exploit a longer-term opportunity. An incorporated JV may also be appropriate where the client wishes to participate in the project, as outlined above.
Each JV balances effort, reward and liability differently, and these all need to be considered when deciding which form to choose. Organisations with similar risk appetites and profit aspirations work well as integrated JV partners, because the risk and reward can be shared equally. It is therefore usual to see 2 such partners enter into JVs on a 50/50 basis.
Problems can arise where one partner provides significantly greater resources for the JV because the profits are still divided equally, unless the JVA contains a mechanism to redistribute reward in proportion to input. In such a case, a JV board should be established to monitor resources and ensure that each partner contributes equally.
Where organisations with different business models wish to enter into a JV, the effort, risk and reward has to be agreed to give each partner organisation the blend of these it is set up to accept. This may be applicable, for instance, when a contractor and a consultant wish to form a JV: the scope of duties is easy to delineate, but the business models of each will require careful consideration when drafting the JVA’s terms.
Where an incorporated JV is formed, the partner organisations – which may include the client – need to consider the shareholding carefully, in particular who has the controlling rights. The effort and liability then become obligations for the JV. Rewards are paid to the partner companies in the form of dividends. This effectively protects the partner companies from the risks that the JV company assumes, unless the client demands security from the parent companies.
Implementation and the JVA
Where JVs are contemplated when bidding for an opportunity, prospective partners need to put in place several agreements ahead of formal appointment and establishment. As the partners may ordinarily be competitors, it is advisable to enter into a confidentiality agreement to protect sensitive information that will be shared during the bidding process.
It is also advisable for the parties to enter into a formal bidding agreement that will include promises of exclusivity and liability. During the bidding process, it is usual for the parties to agree heads of terms in the JVA, or record their intent in a memorandum of understanding. A full JVA may be required by the client as part of the bid submission, so it is helpful to have the document drafted during the bid process.
Incorporated JVs require the establishment of a new company and come with all the costs of stand-alone administration. They will also usually be operated by an executive board in the same manner as any other company, meaning that performance should be reported to the shareholders and dividend payment recommended as appropriate.
An unincorporated JV will usually be run by an operations board that deals with all aspects of service provision, but will also be overseen by a JV board to ensure the agreement is implemented effectively. This oversight will include the balancing of resources, appointing key personnel and recommending payments to the partners.
Clarity on course
As the phrase “joint venture” can refer to several different forms of relationship between prospective partners, it is important from the outset that each partner is clear on the kind being proposed. Proceeding on the wrong course can create insurmountable difficulties for both partners and clients alike, and be detrimental to any hope of collaboration and progress.
Chris Green is Group Commercial Director at J Murphy & Sons Limited