A joint venture is a separate business interest in which two or more parties are involved. A joint venture has its own assets, resources and management control. Entering into a joint venture enables contractors to combine their knowledge, skill and finances with other companies to take on larger projects. Larger projects usually have less bidders so the opportunity for success is increased. Risk mitigation, along with the potential for obtaining new contracts, makes joint venture arrangements especially appealing.
The maximum amount of credit a surety company will provide a contractor for a specific contract is referred to as single job bonding capacity. This amount is heavily influenced by the financial strength, or lack thereof, or the contractor. One of the best ways for the contractor to increase its bonding capacity is to partner with another contractor who is financially stronger.
Since a joint venture is its own entity, complete with its own assets, resources, and management control, each joint venture shares in the risk associated with the projects. The proportionate level of risk each joint venture partner is subject to is often in line with their ownership interest. Partnering with contractors that possess complementary skills allow construction companies to successfully win contracts that are normally out of their range.
Due to the long term nature of large construction projects, a compatible working relationship between joint venture partners is paramount to help reduce legal risk and work through any potential disagreements. Performing due diligence on potential partners is essential prior to entering into a comprehensive agreement.
Due diligence procedures may include the following:
Reviewing the financial statements of the prospective partner
Talking with sureties, bankers, and other referral sources in the potential joint venture partners region
Executing a joint venture operating agreement that includes effective governance and dispute resolution provisions
Equity method of accounting - when a company has the ability to significantly influence, but not control a joint venture, it should account for its investment in the joint venture using the equity method of accounting. This method results in a single line item on a company’s income statement. The net income generated from the joint venture partnership is allocated in proportion to the percentage of ownership the company has in the joint venture. Under the equity method of accounting, a company generally records its initial investment at cost as a single line on its balance sheet, after which the investment is adjusted for dividends or distributions – as well as the company’s proportionate share of the joint ventures earnings or losses.
Many smaller construction joint ventures are formed as partnerships. A partnership is an agreement between two or more entities to share the profit or losses.
The most common joint venture tax structure is a limited liability company (LLC), which is similar to an S corporation in that it generally protects the partners of the joint venture from being liable for its debts and liabilities. It also separates the assets of the joint venture from the partners assets. By receiving pass-through taxation treatment, an LLC structure also helps joint venture partners avoid double taxation.