Joint Ventures Unpacked: Navigating Partnerships in Government Contracting

MICHAEL SIPPLE: Welcome to Cherry Bekaert’s GovCon podcast, where we discuss current government contracting trends, compliance matters, and best practices to guide federal contractors forward.

Today we are discussing joint ventures. We will start by defining joint ventures, discussing the various aspects of these agreements, and reviewing the accounting for joint ventures.

I am Michael Sipple, Managing Director in the Advisory Group with Cherry Bekaert. With me today is Sarah Tucker, Senior Manager on the Audit team. Let's jump right into this. Sarah, let’s talk about what a joint venture is.

SARAH TUCKER: Great to join you, Michael. Starting from the basics, a joint venture is where two or more companies combine certain aspects to work towards achieving a business objective.

They are formally created as a business entity, such as a separate corporation or partnership. Usually, there is a limited or defined duration for the arrangement.

The companies involved in a joint venture maintain their own separate business operations and continue to exist as they did before the joint venture. The formal agreement is the core of that venture.

Participants set forth the extent to which they will exercise control over the venture's activities and profits. The agreement also outlines who provides services, equipment, and support, as well as terms regarding termination and splitting profits.

There are various reasons to form a joint venture. Joint ventures are advantageous because businesses pool resources and share risk, experience, and expenses to make a project successful and profitable for all parties involved.

It is a common business strategy among businesses seeking to achieve a common goal or reach a specific consumer market. When a joint venture is successful, participating companies share in the profit agreed upon in the contract.

Likewise, a failure in a joint venture results in all participating companies realizing a portion of the losses. More often than not, a company enters into a joint venture because it lacks the required knowledge, human capital, technology, or access to a market necessary to pursue the project on its own.

Coming together with another business affords each party access to the resources of the other participating company without having to spend excess capital to obtain them. For example, let's say Company A owns facilities and manufacturing production technology that Company B needs to create and distribute a new product.

A joint venture between the two companies gives Company B access to the equipment without purchasing or leasing it, and Company A is able to participate in the production of a product it did not incur the cost to develop. Each company benefits when the joint venture is successful, and neither is left to complete the project on their own.

Michael, what are some different types of joint ventures?

MICHAEL SIPPLE: That is a good question. There are four different types of joint ventures people primarily talk about.

While this is not intended to be an all-inclusive list, the types we normally see are project joint ventures, where two companies come together to accomplish one specific project. It is not expected to exist beyond the project itself. Once the project is over, they go their separate ways.

You can also have a vertical joint venture, which is usually associated with the supply chain. It involves companies at different stages of the supply chain. For example, a manufacturer might partner with a supplier to realize savings.

A functional joint venture is done with the notion of gaining mutual benefit through synergies, where parties join to improve functions such as marketing or research and development. What we call a horizontal joint venture is normally between two companies in the same or similar line of business that share a client base.

Two companies in the same industry collaborate to combine their strengths and gain a competitive advantage. If you are wondering about the difference between a joint venture and a teaming agreement, a teaming agreement does not create a separate legal entity.

It is a contractual relationship between the parties. A joint venture involves a shared legal entity and the risks associated with that entity. In a teaming agreement, each participant remains its own entity.

If it does not generate revenue, the real loss is simply the initial payment to be involved in the product. There are pros and cons to each approach.

Regarding teaming agreements, the pros are that they are typically smaller in scale, perhaps for one specific contract or task. Past performance can be highlighted between the two parties, partners are not considered affiliated, and it is relatively easy to dissolve.

The cons are that they only apply to one project or group of tasks. If you get another project, you have to set up another teaming agreement and renegotiate terms and conditions each time. It can also be difficult to litigate if things are not clearly specified.

In a joint venture, the agreement specifically states what each party is responsible for. The pros include a greater collaboration of resources as two or more parties bring all their resources to the table.

You can rebrand a joint venture because the entity is separate from the other entities. Another key benefit for government contractors is the ability to use shared performance experience.

This allows you to put together a company that is doing work directly with the government, and the performance experience and metrics of each company come together to make a stronger proposal. It is a separate legal entity and, in some cases, can test cultural compatibility.

The cons of a joint venture include the fact that members can be considered affiliated, which may impact small business status. The impact on small business status is a complex topic with many layers that could be a separate presentation.

Additionally, the complex accounting structure requires more work because you are treating the new entity as its own business with its own accounting setup. Potential problems include partners not working well together, leading to the trouble of dissolving the venture.

There can be disagreements or conflicting goals. It may require the sharing of intellectual property, and one partner may not be as committed as the other. If both are not fully invested, one party may feel they are picking up the lion's share of the work.

SARAH TUCKER: You mentioned a benefit related to government contractors. Michael, you and I work a lot with government contractors, and there are particular benefits to forming a joint venture in that field.

The Mentor-Protégé Program is a federal program that pairs new businesses with more experienced businesses to compete for government contracts. This program is designed to be mutually beneficial and provides an educational opportunity for the protégés.

The Mentor-Protégé Program allows joint ventures to compete on the qualifications of the protégé. A Mentor-Protégé joint venture can compete as a small business for any small business contracts, provided the protégé individually qualifies as small.

Furthermore, joint ventures may pursue any type of set-aside contracts for which the protégé qualifies, including contracts set aside for 8(a), Service-Disabled Veteran-Owned, Women-Owned, and HUBZone businesses. The Mentor-Protégé Program is a nuanced topic we could dive into in another podcast.

Let’s move on to the accounting for the joint venture, Michael.

MICHAEL SIPPLE: Accounting is near and dear to our hearts. Because a joint venture is a unique entity separate from the partners, it is set up as its own company.

The joint venture agreement defines key aspects, including the legal entity, the owners' responsibilities, and the profit sharing allocation. As a unique entity, the joint venture should be set up with its own bank account, balance sheet, income statement, and EIN.

It is not a part of the other companies. The managing partner named in the agreement is normally responsible for the overall accounting setup and management.

Joint venture partners need to think through where the entity's accounting will be maintained. In some instances, it is set up as a separate accounting platform.

In others, it is housed within the managing partner's accounting system as a separate entity, tracking it outside of the other partners' financials. Within the joint venture, the balance sheet and income statement reflect all venture expenses and recognize all revenue as the work is performed.

The profit or loss of the joint venture is then transferred to the co-venturers or partners in accordance with the allocation outlined in the agreement. Sarah, let's talk about the partners in the joint venture.

SARAH TUCKER: As you mentioned, the joint venture is its own entity, and we have to consider the partners separately. Partners participating in a joint venture typically account for it under the equity method of accounting outlined in ASC 323.

ASC 323 covers equity methods and joint venture accounting and is applicable if a company has significant influence. Significant influence is defined within that standard as control of the entity or over 50% ownership.

Joint ventures are typically structured so that each member has a share in management and no partner has significant influence or control under that equity method. Partners reflect their initial investment in the joint venture as an asset on the balance sheet at cost.

The investment is adjusted each reporting period for the allocation of the joint venture's profit or loss through the income statement. You will see fluctuations based on the net income flowing through.

Typically, it is easier for the partners to consider the work done on contracts for a joint venture to be a subcontract relationship. Labor costs are expensed and billed to the joint venture.

Within the accounting system, the work on that joint venture project is commonly tracked as a separate project. I want to highlight a few ways Cherry Bekaert can help, as we encounter many joint ventures.

We can assist with corporate setup and tax structure. We can also assist with setting up the books of accounts, including the balance sheet and project reporting.

Additionally, we provide accounting solutions and tax support for managing the joint venture. Michael, I will hand it over to you for some takeaways.

MICHAEL SIPPLE: Here are some key takeaways. A joint venture is a temporary partnership between companies that dissolves at a specific future date or when a project is completed.

A joint venture affords each party access to the resources of the other participants, reducing the possibility of incurring additional expenses. Each company can maintain its identity and easily return to normal business operations once the venture is complete.

The balance sheet and income statement of joint ventures are separately maintained, and the partners share in their portion of the profit or loss. Joint ventures also provide the benefit of shared risk.

That concludes our podcast on joint ventures. It was a pleasure talking to you. If there is anything Cherry Bekaert can do, please reach out to Michael Sipple or Sarah Tucker.

We would be happy to help you through this.

SARAH TUCKER: Thank you.