Whether you are a new investor or more seasoned investor, the chances of entering (or being approached to enter) a joint venture relationship are fairly high. As we know with all partnerships, some work out wonderfully and some others are miserable failures. My husband and I have been involved with many different joint ventures over the years, and there have been various “learned lessons” we have picked up along the way.
Let’s begin by defining what a joint venture even is. According to Investopedia.com, “A joint venture (JV) is a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it. However, the venture is its own entity, separate and apart from the participants’ other business interests.”
There are many reasons that two parties enter into a joint venture relationship — all of which often include banking relationships, financial reasons, time, expertise, and the list goes on and on. Joint ventures can be great since the two parties join forces for a common purpose and share in both the risk and reward.
One of the most important ways to set yourself up for success in a joint venture is to have solid agreement in place with the other party BEFORE the project begins. Sometimes it is not necessary to form an entirely new company; however, it is essential to have a strong agreement in place that protects the two parties and also includes all the responsibilities of the parties, money outlay, contingencies, etc.
We are in the midst of finalizing a joint venture agreement for a fix and flip project in Philadelphia, so I figured I would share some critical aspects that you want to consider in your JV agreements. Before I list out 10 key areas to include in your agreement, I need to remind everyone that I am NOT an attorney. I share these ideas and tips with you from our experience as investors, not from a legal perspective! Of course, you want to consult an attorney that is familiar with your local laws before entering into a joint venture agreement.
10 Areas to Include in Your Joint Venture Agreement
Ten areas to consider including in your JV agreement include:
1. Purpose of Joint Venture
Are you buying, fixing, and selling a property together? Are you buying, fixing, and renting a property together? Get really specific on the purpose of this joint venture. That way, both parties are clear and comfortable.
2. Purchaser of the Property
Who is purchasing the property? Sounds a bit obvious — but can be overlooked in some joint ventures. The purchaser of the property is taking on more risk, so this arrangement should be spelled out in the agreement.
3. Term of the Agreement
If you are buying, fixing, and selling a property, you need to put in the agreement how you handle if the property does not sell. You also need to spell out if both partners will be part of the decision-making process of reducing the house price. It is really helpful to include all contingencies and worse case scenarios.
As I shared, we are in the midst of finalizing a joint venture agreement for a fix and flip project with another company. We have specified in the agreement that our partner will determine correct pricing of the finished property and will be in charge of the appropriate timing of reducing the price if need be. Our joint venture partner knows the local market much better than we do, so why would we want to micro-manage these decisions? The key to having a successful joint venture is to be crystal clear on the value each partner is bringing to the table and for the partners to not get involved in areas that are not appropriate for them to get involved with.
4. General Definition Section
Some would say this is just legalese; however, it is helpful to define the key phrases and terms you are using in this agreement. Remember, not everyone defines these common terms the same way.
5. Obligations of the Joint Venture
In my opinion, this is one of the most important aspects of the agreement. You have to spell out in the clearest terms what each partner is responsible for. This includes who will be responsible for obtaining the commercial loan and how much that commercial loan is for (if applicable). This also includes aspects such as:
- Financial: what equity each partner is responsible for
- Operations: who is running the day-to-day operations of the rehab and responsible for bookkeeping and record keeping
- Marketing/sales: who is responsible for marketing and selling the finished product
The key here is to spell out every single detail. Include everything. I have never heard partners complain about too much communication in a partnership.
You might have covered this in another section, but make sure you include the percentage of profits each partner will receive after all liabilities and holding costs, etc. are taken care of. I have seen many joint ventures be 50/50, but sometimes they are 40/60 or 30/70. It completely depends on the value the partners are bringing to the table.
Remember, joint ventures are not meant to be long-term agreements. They are designed to be short-term with a very specific, defined purpose. There is a clear beginning and ending to all joint ventures. These types of details should be spelled out as well in the agreement.
8. Rights and Duties of Parties Included in Joint Venture
This is mostly legalese but helpful to include to protect all parties involved.
9. Payment of Expenses
You need to specify in this section who will be handling funds, who is in charge of the banking relationship (if there is one), who will be paying the contractors and service providers, etc. This should have been covered above in the responsibility section, but if you have not specified how much equity each partner will be putting in, this is another place to add this. Additionally, you should specify in which partner’s business checking account the funds will reside. Money allocation and disbursement is one of the most important areas to cover in these joint venture agreements!
This is an extremely important section. Many times, joint ventures are not newly formed business entities. Therefore, you should be clear on how this project will be protected with insurance and which type of insurances are important to purchase and maintain during the project. In this section, you need to specify who is purchasing and maintaining the various insurances (worker’s compensation, builder’s risk insurance, property insurance, etc.). Again, I am NOT an insurance agent by any means; however, I know the importance of properly protecting the building and all the contractors that will be working in the building.
In summary, I don’t know many real estate investors that have not at some point entered into a joint venture relationship. Therefore, you want to set yourself up for success from the beginning. Even if you are entering the joint venture with a family member or a good friend, you MUST put an agreement in place so the roles, responsibilities, percentage of profit, and money allocations are specified and clear from the very beginning.
For those who have entered joint ventures, please share your experiences. Are there any other areas that I am missing that are essential to include in an agreement?
Thanks for reading!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.