July 20, 2007
The U.S. Census Bureau of the Department of Commerce reports that construction spending during February 2007 was estimated at a seasonally adjusted annual rate of $1,170.8 billion. Although construction spending is down 2.4 percent from February 2006, demand for larger and more complex projects continues, many of which require a joint venture.
Under a joint venture agreement, companies can share and mitigate construction risk while focusing on their area of expertise. Joint ventures have been popular in Europe and Asia – particularly in the booming Chinese market – for a number of years.
“There has been considerable expansion in the BRIC countries – Brazil, Russia, India and China,” says John Ernst, assurance senior manager with Grant Thornton’s Appleton, Wis., office. “U.S. contractors have been able to tap into these growing markets by forming joint ventures with companies based in these countries.” In international joint ventures, the U.S. company often provides its specialized knowledge or skills and proven practices, while the foreign entity provides market presence and knowledge, as well as on-site labor.
There are also a number of ways construction companies are taking advantage of joint ventures for projects within U.S. borders, according to Marsh USA Inc. Managing Director Drew Brach.
“We’re seeing joint ventures on large, complex and long-term projects. Joint ventures can also fast-track projects and ramp up engineer-procure-construct/design-build projects by using the resources of two specialist companies.”
“Today, there are many projects no one contractor could – or would – be able to bid on,” Ernst points out. “They don’t have the scope, resources or surety capacity. By forming a joint venture, all involved companies not only share resources but also liability.”
Joint ventures can be formed for public and private sector projects, or for public private partnership projects, which are becoming more common. “According to our estimates,” Brach notes, “there will be 25 $1 billion plus PPP projects within the next five to 10 years.”
An example of a PPP is the Port of Miami tunnel, which is designed to transfer the responsibility to design-build-financeoperate- and-maintain the project to the private sector. “In this project, the joint venture (consortium) finances the job based on being paid by the public entities over a 30 to 50 year period,” Brach explains.
“The public entities get the benefit of starting the project now and paying for it in the future.”
Forming, bonding joint ventures
Joint ventures involve two or more distinct companies, each with its own skill set, organizational and financial structure and expectations for the joint venture. The disparate nature of the companies involved in a joint venture makes due diligence an essential part of the selection process.
“Because of the potential risks and rewards involved in a joint venture, contractors should seek out companies with strong financials and similar ethics,” Ernst says.
Prior to entering into a formal joint venture agreement, each contractor involved should consult its attorney, insurance agent/broker and accountant to discuss legal obligations, insurance issues and tax consequences.
“Finding the right company to form a joint venture with is not an easy process,” Brach says. “In addition to all the logistical, technical and financial issues aligning, the chemistry between companies has to be right.”
Once the companies agree to form a joint venture, roles and responsibilities need to be defined. “Attorneys for each joint venture partner will draft the joint venture agreement, which clearly defines what is expected of each company involved,” he says.
The agreement includes the venture’s business objectives and spells out the essential obligations, such as sponsorship percentages, assignment of the joint venture parties’ several responsibilities, insurance coverages, funding and equipment contributions, personnel, procedures, purchases, management authority/controls, dispute and default resolution, profit recognition and distributions, assignment of rights, pricing, bank relationships, records and accounting policies. How the joint venture will be closed out should also be included in the agreement.
“From the surety perspective, joint ventures are an effective way to share and mitigate potential risk,” Brach says.
When reviewing a potential joint venture, surety bond underwriters look at three primary risks: 1) Do you have the right partner(s)? 2) Are all involved parties financially strong? 3) What does each firm bring to the venture?
“Financial performance is of particular importance, since the joint venture team is ‘joint and several’ on the project,” Brach notes. “If one entity becomes insolvent, the other is obligated to complete the project.”
Although not all joint ventures are profitable, there has been only one surety bond loss involving a project performed under a formal joint venture arrangement. “From a risk point of view, the sureties like joint ventures because the risk of default is lower than bonding just one of the partners,” Brach says.
“From finding the right project to selecting the right partner to meeting surety bonding requirements, joint ventures can be almost as complex as the projects they are created for,” he concludes. “It’s as much an art as a science!”