How would you answer this JV interview question?

Question: What terms would you want to include in a JV agreement if you were concerned about your partner's experience or financial situation?

 

What's your answer? Thanks!

Comments (16)

 
Feb 23, 2021 - 9:35am

Everything to do with rights or control of the venture to protect your interests. Different kick-out clauses and/or cause events allowing you protection to take over the venture completely, or gain more control. Could be for additional capital provided if the partners financial situation is bad or if their inexperience causes some situation down the road that jeopardizes performance.

In the real world I'd want to know why you're moving forward with a thinly capitalized, or inexperienced partner, but realize that's not the question at hand per say. 

 

 

 
Most Helpful
Feb 23, 2021 - 7:08pm

We made the mistake in the GFC of arranging a more preferable waterfall for ourselves and allowing our partners to have much smaller coinvests. If your partner has made more back in fees than they invested they're going to hand you back the keys and say "have fun". In order to protect yourself you need to make sure that when things go south the managers have the proper incentives to continue operating the project well because let's face it, as an LP sitting in NY/SF/LA, you're not going to have the expertise to take over a single family rental portfolio in Georgia. That takeover clause is nice, but unless you're vertically integrated it doesn't help much. That said, we've had other situations where we have kicked out our GP because we were prepared and they weren't doing a good job.

TLDR: make sure that the partner has a BIG coinvest/financial stake in making sure the project succeeds (or at least doesn't tank in a downturn).

 

 
Feb 24, 2021 - 3:10pm

can you explain the "give them the keys and walk away" scenario. Does the operator really have the ability to walk away if they've made back their investment in fees? I understand they have the incentive if they realize they can never reach the promote, but how is this allowable in a JV? Is there any provisions that would disallow this scenario?

 
Feb 24, 2021 - 3:45pm

This is where the legal contract and reality differ. You may have provisions in the deal saying that they have to stay on, but how are you going to stop them from walking away? You can put whatever conditions you want in the agreement, you could sue the manager, but if they're giving the keys back on a project, there may not be much assets to sue for, and you're looking at at least a million+ in legal fees to go through the process with no guarantee you'll win, and it'll take months/years to get them to do anything, during which your project is just sitting there. And, let's say you sue them for specific performance and win, do you really want someone who is literally only there because they are legally required to be running your project? 

The only acceptable answers I've seen are 1 - they have to have significant money in the deal up front and 2 - the LP has to be ok with kicking out the partner and comfortable that they could run the business plan internally. 

 
Feb 23, 2021 - 11:26pm

Is this a programmatic thing or a one-time deal? Putting aside the "why would you do that" aspect, the future of the relationship tweaks the focus a touch.

 
  • Works at Citigroup
Feb 23, 2021 - 11:30pm

Just an interview question so limited context around programmatic vs one-time

 
Feb 24, 2021 - 2:01am

It's a question around risk and mitigation at its heart. Not knowing asset class or continuation of the relationship, what are your pitfalls? Sponsor side, if they're weak then don't think about how they might fail your JV, think about how they make up for it on other spots to keep afloat too: sponsor focus (time standard), guarantor liquidity, execution, profit alignment of fees, promote clawback, fee clawback, coinvestment requirements and/or lack of GP funds, pref and waterfall, cannibalism of asset class or tenancy or services like PM (competitive radius), control provisions, business plan approval, step in rights (goes to debt too, permitted transfers), reporting and performance defaults, etc. The name of the game is papering it right. In your case, weak cash and operations, high level, means you make them put more skin in the game on coinvestment, limit control on business plans for fee income with a set schedule, cross against promote for clawback on fee income, and the rest is regular business. Promote and fee income is your bargaining chip, align them there.

 
Feb 24, 2021 - 8:35am

I'll get a bit more specific but the above comments cover it broadly. Biggest areas to focus on are around control and how the managing member can be removed. Keep in mind for all of these they are whatever you can negotiate and there is a limit to what you'll get even with desperate operators.

Some ways to mitigate this in the partnership agreement would be:

  • Low performance thresholds for removal of Managing Member

In an ideal world you would be able to remove for any reason but no one will agree to this so your goal would be to tie GP to low threshold cost, operating data and schedule goals based on an aggressive business plan. This way if they don't meet any you have a trigger available for removal to keep them honest.

  • Protective and thorough Major Decision descriptions

Insist on a more thorough and longer list of what are considered to be Major Decisions. Typically these benefit the LP more as they are determined by voting rights within the agreement so you would include decisions more on the fringe like changes in project design, pricing and specials changes, modification or change or any key team members, etc. This way the GP keeps coming back to you and maintains open communication.

  • Reporting requirements

Expand the frequency and depth of information in reporting. Have them provide as much access to primary data as possible including accounting and project management software access, leasing calls/updates/reports, etc. This way there's a constant information flow and you can see how they run their deals to get comfortable.

  • Additional capital contributions and stake in the game

This one should have been higher but make sure additional capital contributions are "painful" but not totally dilutive to the GP. You want them to have real stakes and cash in the deal at all times and when/if you go over budget they need to feel that pain. An example would be even though at initial capitalization we are 90-10 split for any future additional capital calls we contribute 80-20. Admittedly this will be a tough get since most operators are cash poor.

I'm burying the lede here because I wanted to address your question first but the reality is experience and execution of your GP is the #1 biggest factor in a deal's success. Yes it's all well in good to take over a great property/piece of land but the reality is real estate is an execution business and most equity shops don't want to not have the capacity or capability to step into an Operator's shoes.

 

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