Joint Ventures 101
This post is written as a mini tutorial on how property joint ventures are structured and the types of questions that need to be agreed beforehand.
Joint ventures are great way to increase productivity and profits. We are all stronger together.
Its important that the JV roles , responsibilities and objectives are clearly defined and agreed from the onset.
Generally, what we do is have a draft JV agreement completed and then go through the process of legalising the agreement through lawyers and the creating of a limited company.
The agreement will need to list:
- Responsibilities of each party
- Exit strategy: when will the JV end, if ever?
- Buffers and back up strategies that the JV will have in place (for example, will we hold a set amount as a buffer)
- How profits and equity will be split
- How and when the profits will be paid out
- Who is responsible for making decisions if there is a disagreement
- Sale of assets: how will this be handled?
- How to deal with death, divorce or illness
- What if the property makes a loss? Who will fund that?
- How tax will be dealt with
- Accounting: what entity will the JV be structured in?
A TYPICAL ARRANGEMENT
The following example revolves around a short term (12 months) buy and sell joint venture. However the principles remain the same for purchasing to hold for long term capital growth and interim profits the investment will provide.
One investor (let’s call them “the first investor” / you ) is able to contribute substantial funds and cash flow towards a small project to purchase a house, renovate it and then on-sell it for a profit. (or in our case generally keep it long term)
The second investor (me) will contribute their skills to acquire the right property, renovate it appropriately, manage that process and then effect a sale of the property for a profit.
HOW DOES IT WORK?
The second investor (me) will identify a property suitable for the project and obtain approval for its purchase by the first investor.
The first investor will fund the acquisition of the property (usually in a company structure ) by directors loan to the new company.
The second investor will offer suggestions and submit a proposal to the first investor for the renovation of the property and its eventual sale for a profit to be shared equally between the two (i.e. the overall scheme of things with a simple joint venture).
Let’s look more carefully at the specific contributions of each of the investors.
FIRST INVESTOR’S CONTRIBUTIONS
The property will generally be purchased through SPV (special purpose vehicle which is essentially a brand new limited company setup for this purpose) and the first investor will provide all of the funds necessary to do so together with funds necessary for its renovation or development including:
- The deposit and purchase price;
- All Funding costs;
- All legal fees and stamp duty including any building and building reports, survey reports, town planning searches and the costs of any other enquiries;
- Payment of all rates, taxes and levies on the purchase of the property; (or until the property can pay these itself when keeping long term)
- All insurances for the property. (or until the property can pay these itself when keeping long term)
This contribution by the first investor will be typically called the “Initial Contribution”.
All other continuing costs (called the “Continuing Contribution) during the ownership, development and sale of the property including payment of interest and loan expenses, renovation works and sale costs will typically be met by this first investor. (or until the property can pay these itself when keeping long term) –
In short, all purchase costs and expenses, development costs and sale costs are met by the first investor and are commonly called “Join Venture Expenses”.
These expenses are tallied up and recorded to the directors loan account. We use an online accounting system called xero which you will have live access to the bank account and all transactions.
THE SECOND INVESTOR’S CONTRIBUTION
The contribution of the second investor to the project will usually be as follows:
- Identification of an appropriate property to buy for the development project, including negotiating the terms of the purchase, arranging for appointment of lawyers and engagement of any others to carry out due diligence enquiries before settlement of the purchase.
- Selection of builders required, preparation of plans, obtaining approvals and quotes for renovation and development work.
- Assistance with sourcing appropriate finance to fund the development.
- Payment of all project expenses incurred in relation to the property’s development and sale.
Typically, there’ll be no charge by the second investor for providing their contribution to the project, as it’s understood that they are to be remunerated from their share of the net profits on the eventual sale of the property. (and ongoing rental profits when keeping long term)
So, what if there’s some disagreement or dispute between the two investors about whether the property should be sold after it’s developed and if so, at what price?
As this issue falls within the province of the contribution of the second investor, they will usually determine these issues after consultation with the first investor.
That is, the second investor will decide the matter but in making such a determination, the Joint Venture Agreement between the parties will usually provide that the second investor must act reasonably and with a view to achieving a net profit for both parties.
THE NET PROFIT
When the property is sold the sale proceeds are usually paid as follows:
- repayment to the first investor of their Initial Contribution;
- repayment to the first investor of their Continuing Contribution (i.e. investment project expenses); So basically paying down the directors loan accounts first and
- sharing of the balance (i.e. any rental received from the property during its ownership and renovation equally between the parties as “net profits”).
- And sharing of the equity equally.
TERM OF THE JOIN VENTURE
The typical term for a joint venture of the style outlined above is a maximum of 12 months unless a property is sourced, purchased, renovated and sold earlier, in which case the term comes to an end on the settlement of the sale of the property, the repayment of the first investor’s contributions and division of the net profits between the parties.
In a long term buy to hold we would usually agree that either investor can sell out and any time so long as there is a net profit to be realised. Usual holding terms would be 5/10/15/20 years or longer.
SHARING OF THE RISK
Although it’s expected at the time of entry into the agreement that a profit will be made, the reality is that sometimes there’s a loss.
The Joint Venture Agreement will provide that the losses are shared equally between the parties in the same way they share between the parties.
REGULAR MEETINGS
Schedule regular meetings even if there appears to be little to discuss.
This is especially important when there are more than two parties to the joint venture.
These meetings ensure that everyone is kept up to speed and communication channels are open.
Record in writing everything that’s discussed and agreed upon in the meeting and, as soon as possible after the meeting, circulate a copy of the minutes to all parties of that meeting.
If there’s some misunderstanding about an issue on the agenda as recorded in the minutes, it will very quickly be flushed out and can be dealt with sooner rather than later.