If you’ve followed my other articles you would know that proper evaluation and due diligence is essential before making investment decisions. We have covered the process on how to select investment partners (developers), steps to evaluate whether a project *really* stacks up and, to further reduce your risk, how to construct a diversified balanced portfolio of such investments.
Today’s article has been written by my friend and associate Lizzie Frazer (pictured below). Lizzie has worked as a corporate and banking lawyer for Allen & Overy, Cameron McKenna, and other well known firms so she knows her stuff!
I asked Lizzie if she could write about a critical aspect of the DD process that investors often neglect – the Joint Venture Agreement (aka shareholders agreement). This is the agreement an investor signs, with the developer, immediately prior to making the investment. It governs how the investment will be structured and the procedure if anything was to go wrong.
There is no “standard” JV agreement so this is our opportunity to negotiate and shape it to suit our interests as investors.
Property development joint venture agreements: Five top tips from Lizzie Frazer!
When your money is at stake, navigating the complex clauses and indecipherable jargon of legal contracts can feel like an obstacle to investing in property development deals.
Joint venture agreements, which you may be required to enter into with a developer when investing by way of equity, are typical examples of these jargon-filled contracts.
Simply put, a joint venture is an agreement between two or more parties to achieve a common set of objectives. A joint venture agreement is a contract detailing the terms of the joint venture.
In practice, unfortunately, these agreements are not so simple. I remember reviewing my first joint venture agreement as a junior lawyer and wondering whether it was even written in English! But beneath the complexity, such contracts can help you to feel comfortable that you have a secure and transparent agreement with your investment partners. So, here are my top five tips (in English!) to consider when embarking on joint venture agreements:
1. Getting your cash back
As an equity investor, your main concern is getting your capital repaid. You will likely receive your funds after any debt providers who will probably have security over the property or land. So, to minimize your risk, you should always incorporate preferential clauses into the joint venture agreement to state that you will receive your capital before any profits are distributed. You may also want to negotiate to rank above other shareholders providing smaller amounts of funds or the developer’s equity, depending on your bargaining position. This will increase the buffer of cash in the deal for when costs overrun, delays occur, or in the event of an insolvency.
2. Decision making
It is important that you retain some amount of control over the major decisions in the project. Smaller day-to-day decisions can be left to the developer who can act quickly and is usually best placed to make those decisions.
Decisions that could directly affect the profitability of the project and therefore your capital and return should always include your input, or the collective input of the shareholders if there are multiple investors. For example:
- exit strategies (i.e. the sale of the property and for what price)
- debt, guarantees and indemnities incurred by the project company
- main contractor payments
- increased funding and project delays etc.
3. Project spend
There are two main ways that you can retain control over project spend:
a. By being a joint signatory on the project bank account.
b. By appending the budget to the joint venture agreement and adding a clause stating that any cost overruns need shareholder approval.
The advantage of option (a) is that payments cannot be made without your approval. With option (b), if the developer fails to stick to the budget without your approval, your remedy is a claim for breach of contract after the payment has been made.
Option (a) will require a bigger time commitment, so if you want a hands-off investment this might not be for you. Although you can mitigate this by setting certain limits on the bank mandate over which your signature is required – giving the property developer flexibility over smaller payments but maintaining your control over larger payments.
If you are based overseas like me or there are multiple investors, option (a) may cause significant delays as the bank will need to perform ID and money laundering checks to add you and any other investors to the mandate. In this scenario option (b) may be preferable, however, it is even more important that you do your due diligence checks on the developer to ensure they are reputable and trustworthy.
4. Disagreement between the parties
Nobody likes talking about what will happen if things go wrong, but it is important (and usually easier) to discuss these hypothetical events at the outset with a logical and unemotional mindset so there are clear and fair procedures to follow if things start to sour. These procedures are usually referred to as deadlock procedures.
These procedures should start with the parties meeting and amicably trying to remedy or mitigate the situation within prescribed time frames. In the event that this doesn’t work, there should be escalation levels until you reach the point of no return, in which case there is a formula for how the property or land will be sold or how the relationship will come to an end. The more detail the better here as it will ensure that both parties are on the same page from the get-go.
5. Transfer of shares
As an investor you should enter into a joint venture on the basis that you know who your joint venture partner is and that sufficient due diligence has been done to enable you to feel confident that they can bring the project to a successful close. You therefore wouldn’t want the developer to be able to sell their shares to an unknown third party without your consent. Make sure you retain control over who is in the deal. This also includes your approval rights over the issuing of new shares, which is fairly standard.
You should be aware that the term “joint venture agreement” is used loosely to describe a variety of agreements, such as shareholders agreements and LLP agreements, depending on how you structure the deal. Always plan your venture’s structure before drafting the joint venture agreement to ensure effective tax planning and avoid unnecessary legal costs.
At QB Investing, we use our extensive legal expertise within the team to ensure that our joint venture agreements are as watertight as possible to protect our investors’ interests. To find out more about us and what we do, please visit www.qbinvesting.com or contact me directly on firstname.lastname@example.org.
This list is by no means exhaustive and should not be taken in lieu of independent legal advice. There are many other clauses in a joint venture agreement that should be considered from an investor standpoint, such as, warranties to cover the quality of the building design, clauses relating to planning permission and insurance, compensation for major delays etc. A good lawyer will help you understand the risks and incorporate drafting to protect your investment.