Joint ventures: when two’s better than one

Joint ventures are not only the domain of large firms. As Rupert Rawcliffe describes, even small firms can benefit from pooling their expertise and resources.

Many construction firms are seeking growth overseas by teaming up with local firms, but there is also a trend for more joint ventures in the UK. Larger firms will be familiar with joint ventures (JVs) and consortia, but looking at the mid-market, for some smaller firms there is an opportunity to go for different, and also more, contracts by forming JVs.

Look in the media for JVs in the construction industry and there are many examples, including:

• Capita was recently approved as preferred bidder to create an educational support services joint venture by Staffordshire County Council;
• GTM is a JV set up by partners Galliford Try and Imtech to perform the larger projects under the AMP5 programme for Anglian Water, such as the Hall Water Treatment Works;
• Morgan Sindall, in a JV with engineering consultant Grontmij, was recently awarded a project with Yorkshire Water Services to improve Bridlington’s bathing water quality.

Additionally, following the recent private finance initiative review, Jon Hart, partner at international law firm Pinsent Masons, said: “[PFI replacement] PF2 represents a big step forward in the UK for using a joint venture company for project finance delivery of new infrastructure.”

So it’s clear that if you pool your resources and expertise with others there are some good opportunities out there, so let’s go back to basics.

What is a joint venture?

According to an HM Treasury guidance booklet on JVs, the term joint venture “can describe a range of different commercial arrangements between two or more separate entities. Each party contributes resources to the venture and a new business is created in which the parties collaborate together and share the risks and benefits associated with the venture. A party may provide land, capital, intellectual property, experienced staff, equipment or any other form of asset. Each generally has an expertise or need which is central to the development and success of the new business which they decide to create together. It is also vital that the parties have a ‘shared vision’ about the objectives for the JV.”

JVs can be set up in a number of ways and using different corporate structures, so it’s essential to do your research thoroughly or talk to a professional to find out what options might be best for your business before taking the plunge.

Many JVs fail because information is not being shared effectively, compromises have been made that haven’t been fully thought through and the governance is not in place to deal with any issues before they become a big problem, so it’s important to work out as much of the detail as possible before formalising anything.

Your business should be comfortable with the structure, comfortable with any compromises, and comfortable with who is doing what in the JV. Obviously, everyone involved must bring something to the party, but it’s essential that who is bringing what to the party is defined and agreed upon and that the benefits to the client are obvious and spelt out. Also, who’s in control? Often, there is a specific group that oversees the JV and, as mentioned above, it’s important to ensure good governance is in place to sort out any problems before they become critical.

When should you consider a JV?

In construction, JVs are commonly used to deliver large projects by pooling expertise and resources. So, for example, one party does tunnelling, one builds the roads, one puts in the land, and one builds the houses. Each has a crucial part to play and together they are much better placed to pitch for big projects.

So JVs can be a very effective way of creating and securing new projects by using the combined skills, resources and credentials of the individuals, companies or organisations involved. Since the cost of starting new projects is generally high, a JV can help to mitigate risk by sharing it across the parties as they are all equally invested in the project. They then also share the resulting profits.

JVs are useful for both start-ups and more established enterprises. Traditionally, they have been used for smaller projects, but they are increasingly being used to help larger businesses diversify and cross-sell to their client base. They can also help with managing costs and gaining local knowledge, particularly in overseas markets.

For example, one issue that companies have faced in the downturn is maintaining a healthy balance sheet. Businesses with a wealth of experience and near-perfect credentials can be turned down for work due to a poor balance sheet. Particularly in the construction industry, a client wants to know that if something goes wrong a company can “make good”.

A joint venture for the poor balance sheet company, let’s call it company A, with a larger company with a strong balance sheet, company B, can be one solution to winning the work as it’s then possible for company A to present itself as having a healthier balance sheet. Company B can benefit by diversifying into a new market and offering its clients new services. It can offer a new route to a particular market and each company can retain its own brand.

So in summary, JVs are excellent opportunities for the mid-market to compete on larger projects but it’s vital that the structure and what everyone is contributing is agreed and spelt out up front.

Joint ventures: some structural and tax considerations

A core element in the success of any JV is a well thought through structure. There are four basic options for structuring a JV:

• A limited liability company (Ltd), ie companies A and B get together to create a new company with, for example, a 50/50 shares ownership split between the partners;
• A conventional partnership;
• A limited liability partnership (LLP);
• A contractual agreement.

The structure adopted will obviously reflect the level to which the companies wish to integrate, share costs and pool resources. As well as thinking about the structure of the JV, it’s also important to bear in mind the various tax considerations.

JV structure

The JV structure has to take into account the different tax profiles of the JV partners. Where the JV includes councils or local and central government extra care needs to be taken as these bodies typically benefit from tax exemptions if they carry on activities in their own right. These tax exemptions can also extend to Stamp Duty Land Tax (SDLT) on land purchases. However, private sector bodies pay tax on their taxable profits.

The tax profile of a private sector partner depends on their structure (eg individual, partnership, Ltd).

While a JV company (ie Ltd) is subject to tax, as a distinct legal body in its own right, other types of JV such as conventional partnerships and LLPs are tax-transparent. This means that the JV is not subject to tax itself — instead the JV partners pay tax according to their own circumstances. As a result, tax-transparent entities are often favoured. That said, limited companies offer other commercial advantages and the benefit of tax groupings (subject to ownership percentages).

Funding and cash extraction

The structuring of any funding required, and its tax implications, has to be considered carefully.

Equity funding is straightforward but returns are paid out of post-tax profits of a JV company. Care also needs to be taken as reserves are required in a limited company to pay dividends. The return of equity also needs careful planning.

Debt funding (whether shareholder or bank debt) can be very flexible; the interest should be tax-deductible and can be paid with little consideration to the reserves position of the JV. The loan can then be repaid, as long as there is sufficient cash, or refinanced.

Loans from shareholders may have to satisfy UK transfer pricing conditions. These require the affected loans to be on arm’s length terms, otherwise the company has to make a tax adjustment to reflect the position it would have been in, had a third party lent the money.

VAT

Special conditions often apply to councils and other government bodies in relation to VAT and its recovery. These conditions do not typically extend to JVs with private sector partners; it is therefore vitally important that any VAT impact of the proposed JV is considered up front. Whilst VAT is often recoverable on construction works, there can be a delay between payment and recovery of VAT, which needs to be taken into account.

JVs are excellent opportunities for the mid-market to compete on larger projects. However, it is vital that the structure, and each party’s contribution to the project, is agreed and spelt out from the start.

Rupert Rawcliffe is a director in the corporate finance team at Grant Thornton UK