March 23, 2006

Joint ventures are like marriages — know your partner

  • The more partners know and understand each other, the more successfully they will be able to work together.
    Benson & McLaughlin

    Contractors are naturally competitive, but there may be times when it makes sense to share the wealth with other construction companies. By combining resources through a joint venture, you and one or more other companies may be able to position yourselves to do even better than you could on your own.

    Two become one

    A joint venture is a business entity owned and operated by two or more organizations. Pooling resources may allow you to:

    • Take on projects that are larger than you would normally bid on, with a view toward spreading the risk.

    • Tap another company's unique skills.

    • Enter new markets.

    • Increase your ability to raise capital.

    • Take advantage of local knowledge.

    • Increase bidding power and bonding capacity.

    While most joint ventures are limited in scope to a single project, they can be left open indefinitely.

    Will you marry me?

    Just like with a marriage, take the time to find a partner that's a good match. Look for a company with a genuine interest in joint ventures and a similar corporate culture. The more partners know and understand each other, the more successfully they will be able to work together. National and local industry trade associations are a good place to begin your search. Other respected construction firms may also be able to recommend a suitable partner.

    During the screening process, ask the potential partner's current and former clients to share their thoughts about the company. Also check whether the firm faces any legal actions. Finally, assess the company's resources, strengths and weaknesses, philosophy, manpower, bonding capacity and workload. Before signing on the dotted line, make sure your and your prospective partner's organizations are capable of shouldering any problems that may occur on a project.

    Drafting a prenup

    A well-defined written agreement is a must for any joint venture. The best agreements clearly establish the basic rights and obligations of the partners, along with business objectives, funding, equipment contributions, personnel, procedure, purchases, management authority and controls, profit recognition and distributions, assignment of rights, pricing, and records and accounting policies.

    Working out the finances

    A joint venture is generally considered a separate entity, maintaining its own accounting records and producing financial statements that are independent of the partners' financial records but also reflected in the partners' records. Your percentage of ownership and level of control in the joint venture dictate the accounting method used to report joint venture activity: cost, equity or full consolidation.

    1. Cost. With this method, you record your initial investment and any subsequent financial contributions in the joint venture. You record earnings only when the joint venture receives or declares distributions in excess of the amount invested. If you own less than 21 percent of the joint venture and have no influence or control over it, you should typically use the cost method; if your share is 21 percent or larger, you generally can't use cost accounting.

    2. Equity. When your interest in the joint venture is at least 21 percent and no more than 50 percent, and you have some degree of influence or control, you should probably use the equity method of accounting. With this method, you record your initial capital investment in the joint venture at book value and adjust it to recognize your proportional share of joint venture earnings, losses or distributions. As the venture makes or loses money, you record your share of the income or loss on your income statement.

    3. Full consolidation. Typically, if you're the majority owner, you will use the full consolidation method. This means you consolidate the joint venture's financial statements with your own financial statements for assets, liabilities, revenue and expense items. Then you subtract the minority partner's joint venture interest from your balance sheet and income statement.

    Financial statement disclosures are a key component of joint venture accounting. Required information includes the name of the joint venture and percentage of ownership, liabilities and key contract provisions. And, depending on the accounting method you use, supplemental disclosures may be required.

    Till project end do us part

    The real work starts after the partners sign the agreement. Each partner should make sure its own scope of work is coordinated internally. While interdisciplinary coordination is everyone's concern, each partner needs to hold up its end of the bargain. Joint venture partners must rely on one another to make sure there are no last-minute surprises.

    Just like a marriage, a good alliance is built on mutual communication, trust and understanding. Joint venture partners have little to lose and everything to gain in sharing the risks and the rewards.

    Mark Hanson is an audit shareholder with Benson & McLaughlin, a CPA and consulting firm. He heads the firm's construction industry practice.

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