The success of a joint venture will always start from the way it is put together and therefore, the structure of a joint venture in property development is an important element and something we as developers need some understanding around. In part 1 we learnt why a joint venture can be needed and the important of the joint venture agreement.
In this final part we look at the key considerations which need to be taken into account when structuring a joint venture in property development, and the main ways a joint venture can be put together.
We now know that a property development joint venture is an arrangement between two or more parties to co-operate together to achieve a set of common goals, outcomes or objectives. So for this to be successful, we need to consider how it can be structured in order to achieve those common objectives and satisfy the requirements of each party involved.
In this article we are going to start by looking at the factors which need to be taken into account for your structure of a joint venture in property development and then secondly, look at the main options available to you.
Lets get stuck in…
Factors to Consider for the Structure of your Joint Venture:
Lets look at the main factors to consider before selecting the way a joint venture will be structured.
The actual relationship between the parties involved with the joint venture should be considered. If the joint venture is formed of a number of potentially passive investors who have no prior relationship with one another, then a structure which limits liability may be suitable, however, if the joint venture is formed by two long standing friends who both invest an equal amount, then they may be happy to share the liability on debt.
2. The type of Project:
Smaller scale and more straight forward projects will not be suitable for overly complex joint venture structures where the legal costs alone will make the project unviable. However, on the flip side, for larger long term projects or investment projects a complex structure may be needed. The type of project will guide the type of structure required.
How the joint venture will be funded is a key consideration to how it should be structured. Is the project being funded by a number of potential investors or is it funded purely by two companies who are taking a 50/50 equity position, or in reality, the structure may need flexibility to allow for a number of different funding methods. The way in which funding will be found and the security offered to the investors will need to be considered.
4. Limiting Liability:
How important is it to the joint venture partners to have a structure in place which offers limited liability and the ability to ring-fence losses within the joint venture? As we know, property development involves a lot of money and a lot of risk, and there can be serious liabilities on developers or partners along the process.
Does the structure require the flexibility to allow interests of the partners involved to change during the project or the ability to introduce new partners to the structure? This may then point you towards a certain type of joint venture structure.
6. Exit Strategy:
How will the project be finished and ‘exited’? It might benefit, for example, for an office development which is being sold as an investment to be sold as a company rather than a property. Factors like this may rule out certain types of structures within property development.
This is usually a major consideration and often a primary reason for setting up joint venture structures in certain ways. You will want to ensure that the tax implications are considered for all parties involved, as well as, the potential transactions which will happen within the structure. Tax advice is imperative when setting up a joint venture and is something all developers need to consider before agreeing the final structure in property development.
8. Management and Control:
This is an area which can be overlooked in joint ventures, but the structure needs to consider how management of the project and control of the project is envisaged. How hands on will investors be and does a limited company board structure suit all parties?
Certain ways of structuring a joint venture in property development will allow for all parties to remain confidential and information will not be available in the public domain. For some joint ventures, this can be critical, however, for others it will not be a concern.
The Main Structures of a Joint Venture:
Having now looked at the main considerations before choosing a structure, we can now look at the more common ways of putting together a structure for joint ventures in property development. I will also go through some key benefits and disadvantages with each option.
1. Contractual Development Agreements:
A common way to enter into property development joint ventures in the UK, and can certainly be beneficial in many scenarios. A contractual development agreement is simply when two or more parties enter into a contract together for the purpose of carrying out a development.
This is a very quick and flexible option where no time is needed to be spent on forming new companies. Each party is normally only taxed on their share of the profits and is not liable for the debts of the other parties unless there is a shared contract in place with third parties. This structure also allows the joint venture partners to retain ownership of their own assets which can be a major benefit.
There is a risk of creating a partnership, which will give rise to increased liability and it can be difficult to raise finance as there is no legal entity and the contractual development agreement cannot own any assets. Finally, as there is no legal entity, this can result in a lack of focus and structure for the joint venture, which should be considered.
2. Private Limited Company:
This can also be referred to as a JV company or a special purpose vehicle (SPV). Probably the most common way in the UK to structure property development joint ventures and in its simplest form, is the formation of a new private limited company where the partners involved with the joint venture become shareholders.
It is a tried and tested method, and very familiar way to structure joint ventures in the UK, where the company can have a clear objective and have established corporate governance. Liability is usually limited to the amount each party has invested (share capital) and the company can specify the share rights each partner has based on their level of investment and involvement. Additionally, the company can own its own assets and when it comes to the exit strategy, the shares can be sold to a new owner, as well as the asset being sold. This allows for a large amount of flexibility.
There is a greater requirement on the company for its obligations, such as reporting and compliance measures. This puts a greater admin burden (and cost) on the company and the partners involved. The limited liability in theory is great, however, in practice this can be undermined by guarantees being placed on individuals if securing funding or dealing with third parties. Finally, tax needs to be considered as there is a potential for double taxation, both taxed at a company level and then at an individual joint venture partner level.
3. Partnership or Limited Partnership:
This is where the joint venture partners enter into a formal partnership arrangement which is declared to HMRC and is governed by UK law.
This is a flexible setup where the joint venture itself is governed by the partnership agreement drawn up by the partners, and is not restrained by rigid requirements. It provides a level of transparency, so the joint venture parties are taxed directly and the partnership is not taxed on its profits. This structure also allows a significant level of confidentiality, which may be required by some or all of the partners involved.
On the flip side…
For a general or normal partnerships, each joint venture partner has unlimited liability for the all liabilities of the entire structure. For limited partnerships, the managing partner has unlimited liability, whereas the limited partners, who cannot have any part to play in the day-to-day management, have limited liability.
Similar to the contractual development agreement, it can be difficult to raise finance as there is no legal entity and if any of the joint venture partners leave, a whole new partnership is required.
4. Limited Liability Partnership (LLP):
Think of an LLP as a hybrid between a company and a partnership. In many cases this will be the best structure, but lets take a look at the benefits.
An LLP creates a separate legal entity, so benefits from the advantages of this like a company does, but it is treated like a partnership from a tax perspective, so all joint venture parties are taxed directly on its share of the profits. The LLP itself is not taxed on its profits. The LLP also creates limited liability of the joint venture partners, which can be a great benefit.
The disadvantages are…
There is a greater requirement for admin and accounting, similar to (but not has much) as a private company. Additionally, the actual limited liability can be undermined by third party requirements, such as personal guarantees and security to support financing requirements.
Summary and Final Thoughts:
This two part series has provided a basic overview of joint ventures and how to structure a joint venture in property development.
You will have seen that there are huge benefits in forming a joint venture, but there are risks associated with them, and the structure of the joint venture is important and should be aligned with the objectives and requirements of everyone involved.
Joint ventures can be complicated, as it is advised that all developers seek specialist legal and tax advice before entering into any joint venture, as this will save money in the long run and ensure the best and most efficient type of joint venture is being used.
If joint ventures is part of your business plan, then take some more time to understand everything that has been mentioned in these articles, but also understand that there are legal obligations on all joint venture partners including the way joint venture can seek investment. Bodies like the FCA have requirements which need to be considered.
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All the best,