This article does not constitute legal advice. We recommend you seek the counsel of an attorney familiar with your specific situation and market to ensure you make the best decisions within your real estate business.
After the recession of 2009, joint ventures enjoyed a massive surge in popularity. Many real estate investors have taken at least one on in the intervening years—and perhaps you have, too. A lot of the appeal of joint ventures for investors lies in the numbers: It’s common to be able to secure a loan for up to 70% of the value of the desired property.
Investing is not unlike gambling at all. Just as most people don’t want to go to the casino alone, joint ventures rose in popularity in part because they are set up to allow their members to share in both risk and reward.
What is a Joint Venture?
A joint venture is a defined by a contract between two or more investing parties who agree to share both the responsibilities and rewards of the arrangement. All profits, losses, and costs are split per the agreement. Typically, these are one-time arrangements crafted for the purpose of securing a relatively quick profit. These tend to be short-term investments.
Sometimes, however, investors are in joint ventures for the longer haul. This is particularly true if the parties have enjoyed a successful joint venture in the past. In this scenario, the parties will form a new company to operate, own, and manage the investment. This strategy is used to help minimize risk and enforce the original contract.
What Joint Ventures Look Like: A Common Example
To understand how joint ventures and their operating agreements work, let’s take a look at an example case. My pal Johnny loves joint ventures. He can’t get enough of them. We’ve taken to calling him JV Johnny, and he’s had both successes and failures with this type of investment. JV Johnny’s first joint venture involved a property that he purchased with his existing LLC. The plan was to spruce up the downtown Austin house and resell it to some wealthy out-of-state investors. As mentioned before, this was scheduled to happen on a relatively quick timeframe.
Now, JV Johnny couldn’t afford the full value of the property on his own, so he sweet talked our contractor pal Phil into entering the investment. This had the added benefit of bringing in a party who could do some of the necessary renovations, in hopes of minimizing costs. Phil agreed to do the labor for the renovations, and Johnny would reimburse his costs as well as cutting him in on the profits. They drafted an agreement that reflected these promises, signed on the dotted line, and got to work.
What Johnny did isn’t unusual at all. If you’re considering engaging in a joint venture, you absolutely can cut your contractor in by adding him or her to your S-Corp or LLC. However, this isn’t necessarily the smartest move for every situation. Adding a contractor or other party to your existing company is generous—possibly more generous than you intend to be. Yes, it’s an easy way to ensure profits are shared. However, you may not intend to give a chunk of ownership to someone over a simple joint venture. Adding your partner is kind of like getting married, while most joint ventures are short-term deals more akin to splitting the bill of a dinner date or a romantic weekend getaway at most.
A Better Way to Do Joint Ventures: The Venture-Specific LLC
Although nothing bad happened to JV Johnny, it sure could have if Phil had gotten greedy, and the law very well could have sided with Phil. While I’d like to think JV Johnny’s problem was that he didn’t call me, I’m all too aware I’m not the center of the universe, so I’ll instead just criticize his strategy and offer a better method for negotiating joint venture agreements.
The first thing most investors should do when engaging in a joint venture is form a new company solely for the purpose of the particular investment project they’re engaging in. This is known as a venture-specific LLC, and it confers several benefits. First, it’s more true to the spirit of a typical joint venture. It allows for the same profit and cost sharing, but doesn’t bleed over into your other investments. Because of this, the parties also get some liability protection out of the arrangement that you might not have if you use an existing company.
An additional benefit is that it’s easier to just leave the company alone if things don’t go well. While things turned out all right for JV Johnny, he could have landed himself in hot water if he had decided to partner with someone less like the loveable handyman Phil and more like a “Shady Steve.” But you aren’t forced to end your business relationship once the venture is over. To borrow from the earlier analogy, if the date goes well, you can get more serious about the relationship by expanding the terms of the venture-specific company’s agreement.
Venture-specific LLCs have one final benefit: asset protection. Let’s say the venture doesn’t go well, and in fact fails so miserably that you don’t just lose money, you also get sued. If you have used a venture-specific LLC, any liability issues or lawsuits arising out of the JV-owned property can’t bleed into your other assets. Your separate properties (and their profits) stay separate and can’t be touched by a pissed off tenant or disgruntled partner.
How Should You Conduct Your Joint Venture?
What you choose to do with your joint venture really depends on the size of the deal. If you’re commanding armies of contractors to the tune of paper millions, you really might need the protection of a venture-specific LLC. However, the joint venture agreement worked out all right for Johnny and Phil because they were just trying to make a quick few thousand bucks.
The agreement alone is usually ideal for investors who are in the business of rehabbing and flipping properties like single-family homes—or in cases like the one above, where an investor partners with a contractor.
The beauty of joint ventures is that you can harness people from other industries with different types of skills. Done well, diverse backgrounds and skill sets can complement each other in a profitable way. These types of agreements can be wonderful for leveling the investment playing field in situations where partners don’t qualify for quick financing.
While no two partnerships or JV agreements are the same, the most important feature of these deals is working with someone you have reason to trust. That way, even if the project ends up being a one-time deal, you are still growing your business network and building relationships in the industry. There will always be more deals to pursue in the future if you treat your partners well and leave the door open for collaborating again down the line.