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The Benefits and Pitfalls of the Joint VentureBY: SCOTTV. DERCO, CPASAXMACYFROMM& CO., PC

EXECUTIVE SUMMARY

A joint venture is one arrangement contractors can use to compete and grow in a dynamic environ-

ment such as construction.

This article discusses the nature of the joint venture agreement, highlighting the advantages and dis-

advantages of each.

The construction industry may be one ofthe most difficult and unpredictableenvironments in which to operate. For starters,

contractors are constantly exposed to such risks as

labor disputes, work stoppages, and unreliable

subcontractors. They must establish a fixed

contract price based on rough estimates to

complete the project. They must be able to

mobilize their workforce to sometimes remote

unfamiliar locations. Bad weather and poor

economic conditions also affect them. These risk

factors make construction companies more

susceptible to failure than businesses in most other

industries. One way that contractors can better

compete and grow in this dynamic environment is

by forming a joint venture. A joint venture is an

arrangement in which two or more contractors areable to combine their talents and resources to

better compete in a particular market. This alliance

may be formed to complete an individual project

or an indefinite number of projects over time.

Although many benefits are associated with

forming a joint venture, many potential pitfalls

also can make this an unprofitable arrangement for

a contractor. The following sections discuss some

of the advantages and potential pitfalls of the joint

venture, as well as some of the details that should

be considered when preparing a joint ventureagreement.

Advantages of the Joint Venture as a Separate

Entity

Local contacts. When a contractor considers

bidding on work in an unfamiliar area, it may be

advantageous to leverage the knowledge and

resources of a joint venture partner that has an

understanding of this market. The advantages of

local contacts include the following:

1. The partner may have relationships with the

project owner, architect, and engineer.

2. The partner has experience with local

subcontractors, suppliers, and unions.

3. The partner is familiar with local business

rules and practices.

Combined talents and resources. A joint venture

allows two or more contractors to pool their

individual areas of expertise and resources, such

as financial strength, workforce, equipment, and

bonding capacity, while sharing the risks involved

in completing a particular project.

Additional working capital sources. The formation

of a joint venture may allow the combined entityto have a stronger capital base from which to

draw, such as additional cash, financing, and

capital contributions from shareholders of each

company. This can prevent cash shortfalls, which

could hinder the profitable completion of the

project.

Increased bidding power and bonding capacity.

The resources of the combined entity may provide

more bidding power and bonding capacity than the

individual entities could, thus allowing the

combined entity to bid on larger projects.

Better bidding and estimating. If the joint venture

partner is well informed on the business practices

in the local construction market, it may be

advantageous to draw on its insights in preparing

more accurate bids. For example, the partner may

be more familiar with the local labor cost, which

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includes union and other burden expenses. The

partner may also be familiar with the localsuppliers and the pricing of equipment rentals, as

well as local laws and ordinances, which may be

overlooked by a contractor who has not worked in

the local business environment.

Other benefits that could result from the formation

of a joint venture include the possible reduction in

overall insurance costs, as well as a sharing of the

liability and risk among the venture partners.

Pitfalls of the Joint Venture as a Separate

Entity

There is significant risk associated with the

formation of a joint venture. A contractor may

commit resources to a project in which its partner,

as well as the area, may be unfamiliar. This is why

it is imperative that a contractor learns all that ispossible about its potential partners business

practices and financial condition, as well as its

ability to complete the proposed project(s). This

can be done by examining the most recent

financial statements, credit history, and public

records; consulting references from projects

completed by the potential partner within the last

three years; and contacting local trade association.

A surety can also easily access information on a

potential joint venture partner. Many problems can

also be avoided if the joint venture agreement

identifies and addresses these issues in a languagethat is clear and specific, so if a dispute does arise,

the partners may turn to the agreement for

guidance and resolution.

Some potential problems include the following.

Unclear assignment of responsibilities. Many of

the responsibilities of each joint venture partner

are implied at the start of the joint venture.

However, all aspects of contract administration

should be specifically outlined in the joint venture

agreement. These responsibilities may include thefollowing:

1. Who will have responsibility for creating the

new entity?

2. Who will have responsibility for obtaining

bonding and other insurance?

3. Who will have responsibility for monitoring

the day-to-day operations?

4. Who will maintain books and records?

Performance bonds. In bonding a joint venture,

the financial strength of all joint venture partners

is examined by the bonding company. Typically,

the bonding company provides a performance

bond in the name of the joint venture. However, in

a silent joint venture agreement, one of the joint

venture partners may provide the performance

bond in its name for the joint venture. In the event

that the joint venture cannot satisfy its obligations

under the contract, the bonding company looks to

the contractor that supplied the bond to complete

the contract before the bonding company

considers stepping in. In this situation, it would be

beneficial to the stronger contractor if the weaker

partner supplies the performance bond.

Financing and working capital of the jointventure. If the joint venture is formed as an entity

other than a corporation or a limited liability

company (i.e., a partnership), there is a risk that

one partner may be held responsible for the

obligations of the joint venture if the other

partner(s) become insolvent. To avoid this

situation, it may be beneficial for each partner to

borrow the funds and contribute or loan working

capital to the joint venture as they are needed.

Construction costs charged to the joint venture. In

many cases, it is standard practice for the jointventure partners to provide equipment, materials,

and services to the new entity. However, problems

may arise when one partner believes that the other

is charging excessive rates or prices for theseitems, thus draining capital and profits from the

joint venture.

A solution to this problem is to address a standard

billing rate structure for these items in the joint

venture agreement; the structure is agreed to by all

parties to avoid future disputes.

Distributions to joint venture partners. In most

cases, joint venture partners would like to begin

receiving distributions as soon as possible. When

the project is in the early stages and is profitable,

it is very tempting to take out cash distributions.

This practice should be avoided, however, because

if the job encounters problems in later stages, the

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