Joint ventures are common in the construction industry, especially with large long-term projects. These collaborative arrangements allow construction firms to work together, for a limited time period, on one or more construction projects.
The upsides include pooling of expertise and resources, broader geographic reach, reduced risk, and enhanced financing and bonding capacity. But joint ventures also have potential pitfalls, so they need to be set up and managed with care.
It’s important to understand how joint ventures work, because you never know when you’ll be presented with the opportunity to form or join one. For example, your firm might possess the requisite experience and ties with local contractors that a client is looking for, but you might lack the manpower, licensing or financial reserves to complete the project alone. As an experienced local contractor, you could secure the job and then form a joint venture with a bigger firm that will supply extra manpower, cash reserves, licensing and bonding capacity to see the project through completion.
Before jumping headfirst into a joint venture, however, conduct due diligence to verify a potential partner’s financial strength and capabilities, as well as its bonding and financing capacity. Request copies of the company’s financial statements and tax returns. Also inquire about any outstanding legal claims and talk to past joint venture partners, if possible. If one of the parties to a joint venture fails, the others may be responsible for completing the project.
Once you’ve selected a joint venture partner, work closely with your attorney to set up a formal written joint venture agreement. Proactive planning in the early stages of your relationship can have a direct, material impact upon your tax and cash flow consequences as the venture progresses.
Your agreement spells out the details of your business relationship, including:
- Business structure. Most joint ventures are set up as separate legal entities, such as partnerships, corporations or limited liability companies, in which each member has a proportionate interest. Entity choice has important tax and liability implications that you can discuss with your tax and legal advisors before choosing.
- Capital contributions. Each joint venture member will contribute cash, equipment or other “capital” to get the project started. Additional contributions may be required throughout the duration of the joint venture. The agreement defines the conditions that require capital calls and what will happen if any partners fail to contribute additional funds.
- Ownership percentages. Often ownership is assigned according to the value of each member’s capital contributions. But some contributions — such as knowledge or bonding capacity — are harder to put a price tag on than cash. It’s important that the parties agree on ownership allocations, because it can affect the degree of control each member has over the joint venture’s operations, as well as reporting methods and future distributions of profits, losses and capital.
- Roles and responsibilities. Define who will manage key aspects of the project, including materials procurement, billings and payroll, subcontractors, safety and insurance, legal issues, permits and licenses, and information technology. If you fail to assign responsibilities, important tasks may fall through the cracks, leading to misunderstandings and disputes.
- Dispute resolution and termination. Joint venture members don’t always see eye-to-eye, so it’s important to establish agreed-upon procedures for handling disagreements, such as mediation or arbitration. This can minimize delays and costly litigation.
It’s also important to discuss how the accounting for the joint venture will be done — and by whom. Someone’s got to create and maintain the books for the joint venture. It’s not enough to have each member account for its own involvement. Your joint venture will need its own set of books and bank account.
Designate a bookkeeper from one of the joint venture entities to maintain the accounting records. He or she will set up a chart of accounts and job cost ledger, as well as track each member’s capital contributions.
Typically, each member will bill the joint venture for the work it does on the project. Establish standard billing and lease rates upfront to simplify recordkeeping and minimize disputes. Billings and third-party job costs will also be recorded directly to the joint venture’s accounting records.
Consult with us to properly set up a joint venture’s books. It will save the trouble of backtracking to produce the records you’ll need later for tax and financial reporting purposes. CPA oversight also adds perceived credibility and objectivity to the joint venture’s accounting records, which can become a point of contention if the project doesn’t live up to everyone’s expectations.
Joint ventures can open up doors to new opportunities, but working through the fine details of these arrangements can be complicated. Contact your legal professionals and us if you’re thinking about joint venturing with another construction firm. These advisors can help navigate the process, from setting up to winding down a joint venture.
Joint Venture Accounting Methods
Typically, tax law requires that a joint venture’s year-end be the same as its majority partner. This simplifies matters because your construction firm will need to account for its investment in the joint venture on its financial statements and tax returns. You may account for a joint venture using one of these three methods:
- Consolidation method. If you own more than a 50% interest, you might need to consolidate the joint venture’s records with your company’s books. The consolidation method is more complicated than other accounting treatments. It requires the controlling owner to allocate the joint venture’s assets and liabilities, as well as revenues and expenses, to its financial statements proportionately. Eliminating entries are made for inter-company transactions.
- Equity method. Here your initial capital contribution is recorded as a long-term investment (asset) account on your firm’s balance sheet, similar to purchasing a non-controlling interest in another construction firm. The investment’s carrying cost is adjusted each period for its pro rata share of the joint venture’s profits and losses, as well as any distributions and additional capital contributions. This method is generally used by companies that own 20 to 50% interests in joint ventures.
- Cost method. If your interest in the joint venture is less than 20%, you may be able to use the cost method. This is similar to the equity method. However, no adjustments are made to the investment account, except to record contributions and distributions, until the joint venture terminates.
Ask us about the appropriate accounting treatment for your joint venture. The method will affect the appearance of your financial statements, which may have unexpected tax and financing consequences that you’ll want to know upfront.