The Benefits of Joint Ventures

 CIVIL 1By Zach Webber

In a construction environment mired with increasing competition and risk, some firms are using a tool that can both increase margins and mitigate risk. Joint ventures allow firms to “partner” to bid on and complete larger jobs for which a single firm may not have the necessary experience or risk profile. This pooling of assets and resources can create positive synergies by allowing smaller firms to compete in a larger competitive landscape. For a joint venture arrangement to be successful, each firm under the arrangement must realize that trust and communication are key issues, and that playing a “bully” role in the negotiation process could have large negative implications later in the process. Positive synergy cannot be obtained if one of the firms feels like it is not getting the benefits it needs from the venture.

Investing in a joint venture with another contractor can be a very attractive method to take on larger, more profitable jobs while effectively managing risk. A joint venture is organized as a separate entity and can either be created to bid on a singular project or to function with an indefinite life. For the contractor, investing in a joint venture has certain advantages and disadvantages.

 

Advantages:

  • Financing: Joint ventures allow multiple companies to pool their resources to assist with funding a larger project or obtaining more capital from a lender.
  • Risk mitigation: As the number of investors in the joint venture increases, risk is spread evenly across the participants.

Disadvantages:

  • Loss of control: The contractor will have to share decision making responsibilities and financial information with its partners.
  • Increased record-keeping responsibilities: The contractor is required to keep separate records for the joint venture, as it is a separate entity outside of the contractor’s corporate structure. The firm that bears this responsibility will have to devote additional resources to accounting and record keeping.

In its simplest form, a joint venture is really just two firms coming together for a mutually beneficial project. As with any relationship, there are certain key factors that increase the chances of success.

  • Trust: One key factor when developing trust between the firms is the mindset and goals of the negotiators. It is important to remember that a joint venture is not a merger or acquisition, so it may be more important to develop an agreement that benefits both sides, rather than one where one firm takes a dominant position. Each firm needs to feel understood and that they are a valued part of the venture.
  • Strategic compatibility: In terms of management styles, expertise, competencies, the venture must be between firms that create positive synergy. The specific management team of the venture should work to maximize returns for each investor in the entity.
  • Communication: From the start of negotiations, it is imperative that the firms create an open, honest dialogue. Strong communication will help to strengthen trust, which as noted previously, is the number one key aspect to creating a strong relationship.
  • Interaction between colleagues: Whenever two firms are joining together, no matter the scope of the project – whether for a joint venture or a merger or acquisition – a key hurdle is the interplay between the cultures of the respective firms. The corporate culture of construction firms can be very different, so it important to assess these differences for compatibility at the outset of the venture.

In addition to these factors, a firm will need to consider the accounting impact of a joint venture arrangement on its financial statements. The accounting methodology could have a negative or positive impact on the firm’s financial statements, which could impact bonding and banking terms. It is vital that the finance team be involved in the negotiation process to ensure that the venture relationship does not have unintended negative consequences. Depending on the structure and the contractor’s ability to influence the operations of the joint venture, a contractor can have different options for reporting its investment in its own financial statements.

Generally, the following accounting methods are available for reporting in the contractor’s financial statements:

  • Cost method: Normally used when the contractor has less than a 20 percent interest in the venture.
  • Consolidation method: Generally required when the contractor owns greater than 50 percent interest in the venture and can exercise influence over the venture.
  • Equity method: Generally required when the contractor owns between 20 percent and 50 percent of the venture.

Under the cost and equity methods, the joint venture is essentially treated as an investment by the firm in a separate entity. The firm will effectively recognize its proportionate share of the venture on its financial statements. Under the consolidation method, the firm essentially records the full value of all of the joint venture’s balance sheet and profit and loss activity on its own financial statements, and then reports the share of these items that are owned by outside investors.

Zach Webber is a manager at Keiter in its business assurance and advisory services department. He is responsible for performing accounting and auditing related tasks such as planning and preparing audits, recording transactions in journals, reconciling accounts and preparing financial statements. He serves clients in the real estate and construction industries. 

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