As construction season heats up nationwide, contractors could encounter opportunities to engage in joint ventures with other construction companies. These opportunities can be fruitful, but they pose risks and complications as well. Let’s review some of the finer points of joint ventures, so you can be prepared should your business get the chance to participate in one.
Various advantages
Why do contractors choose to participate in joint ventures? As you might know from experience, there are various reasons. For starters, some projects, though potentially lucrative, are beyond the financial capabilities — in terms of both bonding and working capital — of a single construction company. A joint venture can reduce the amount of each participant’s investment to a manageable level.
There’s also a risk management benefit. A joint venture provides an opportunity for two or more contractors to participate in larger or more complex projects than they usually would. The financial and other risks of such jobs are shared by participants so, if things go awry, one business won’t have to absorb all the negative repercussions.
A construction company might be able to broaden its horizons through a joint venture — literally. Contractors can move into other geographic markets by forming joint ventures with construction businesses in those areas.
Joint ventures sometimes play a role in diversity initiatives, too. It’s not unusual for bigger construction businesses to partner with smaller, minority-owned companies to enhance diversity and bolster the reputation of the industry.
The hard part
The primary disadvantage faced by participants in a joint venture is loss of control. Most contractors are accustomed to managing project operations without input from another leadership team. However, when you become a partner in a joint venture, you must consider the interests of the other partners and sometimes change how you do things.
In fact, important decisions on joint ventures are often the result of compromise, after much discussion, among the partners. Therefore, as one might expect, an unwillingness to compromise is a major reason why some joint ventures fail.
Joint venture agreements
To avoid failure, which can lead to considerable financial losses and reputational damage for everyone involved, the parties should draft and sign a well-written and comprehensive joint venture agreement.
Although the specific provisions of joint venture agreements tend to differ depending on the project and participants, the following items are commonly addressed:
- A statement of the venture’s purpose,
- The capital contributions to be made by each participant (such as cash, equipment and other project elements),
- The rights and responsibilities of each participant,
- The bonding responsibility, if any, of each participant,
- How profits and losses will be shared,
- How decisions will be made,
- What, if any, dispute resolution measures will be used,
- Under what circumstances the joint venture can be terminated, and
- Default provisions and remedies.
Be sure any prospective joint venture allows time for you to have your attorney review the agreement, as well as for some negotiation among the parties.
A careful decision
Some joint ventures are designed and created for bidding, negotiating and performing one specific project. Others, however, are created to be permanent. The purpose of permanent joint ventures is usually to pool resources and bid on all contracts of a specific type for an indefinite period.
No matter why a joint venture is formed, it’s critical that you and your leadership team thoroughly discuss the potential advantages and risks of the arrangement. You should also undertake a thorough due diligence process to vet your partners and the project owner. Your CPA can be of invaluable assistance in helping you crunch the numbers and decide whether to move forward.
Accounting for investments in joint ventures
Contractors that agree to participate in a joint venture should be prepared for complex accounting ramifications. There are three typical methods of presenting a construction company’s interest in a joint venture on its financial statements:
1. Consolidation. Consolidated financial statements present the financial position, operational results and cash flows of a construction business and the majority-owned joint venture as if the two were a single economic entity. Note that, in some cases, using consolidation can lead to a joint venture being considered a variable interest entity, which can lead to particularly intense accounting challenges.
2. The equity method. Under this method, a joint venture participant recognizes its share of the earnings or losses reported by the venture through adjustments in the carrying amount of the participant’s investment, as well as adjustments to the participant’s earnings.
In relatively seldom cases, a contractor might use the expanded equity method to account for a joint venture. Under this method, the contractor presents its proportionate share of the venture’s assets, liabilities, revenues and expenses in capsule form on its financial statements.
3. Proportionate consolidation. Investments in unincorporated joint ventures are sometimes structured such that each participant receives an undivided interest in the joint venture’s assets and liabilities. So, the proportionate consolidation method enables a participant to report its pro rata share of the individual assets, liabilities, revenues and expenses of the joint venture.
Note: If a voting equity interest in a joint entity doesn’t give the holder a controlling financial interest, or the ability to exercise significant influence over the operating and financial policies of the entity, the investment doesn’t qualify for consolidation or the equity method.
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