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San Diego Joint Ventures: Limiting Risk and Capital Exposure
With many types of business efforts and potential market exploitations, joint ventures offer many advantages such as:
- Cost sharing, which can be particularly useful if none of the joint venturers can independently fund the enterprise
- Sharing of divergent talents, skills, experience, learning, and technological capabilities — a division of labor in a manner of speaking
- Sharing of real, personal, and intangible assets, often on a temporary basis with lower risk
- Opportunities for limited and often temporary involvement in new market to “test the waters” with lower risk
Moreover, if legally constructed in the proper manner, a joint venture can limit capital exposure so that, if the venture goes “sour,” the joint venturers have only lost their investments. This involves a well-drafted joint venture agreement with limits and caps, the use of corporations or limited liability companies (“LLCs”) as the joint venturers and strategically timed capital infusions into the joint ventures. A good San Diego corporate attorney can help.
San Diego Joints Ventures: Capital/Asset Infusions
In general, joint venturers fund the joint venture enterprise with contributions of cash or other assets. In turn, the ownership percentages are a function of the percentage of the total cash/assets contributed. (As a side note, if the parties to the enterprise want to de-link the percentage contribution from the percentage of ownership/profit, then an LLC might be a better vehicle of the deal.)
To limit risks, a well-drafted joint venture agreement (“JV Agreement”) is needed. The JV Agreement will, at minimum, plainly and clearly set out the initial capital/asset infusion, and specify ownership and expected distribution of profits. Sometimes, the initial infusion is sufficient and those are the only infusions that are expected. Often, however, the enterprise expects further infusions as it proceeds. With respect to later infusions, a well-drafted JV Agreement will plainly and clearly set out schedule of capital/asset infusions. Clear and plain statements of expectations help reduce risk. California courts interpret contracts based on the words used and the intent expressed. Limiting ambiguity limits the courts’ ability to go beyond and outside of the words used in the agreement.
In general, to limit risks, the JV Agreement should contain caps and specific and clear limits on how much capital must be contributed. This must be done even if the JV Agreement allows for unscheduled or unexpected additional capital/asset infusions. Depending on what the parties have agreed, the JV Agreement can specify the mechanisms and triggering events for such later mandatory capital infusions. Such are not inconsistent with the idea of limiting risks.
If the joint venturers agree to allow discretionary infusions, such should be treated with caution. The JV Agreement should clearly state that a discretionary infusion by one joint venturer does not and cannot affect or waive the cap/limit with respect to other venturers. In general, the JV Agreement should then provide for adjustments to ownership and profits rights as a consequence of non-equal discretionary capital/asset infusions.
San Diego Joints Ventures: Limiting Risk by Limiting Mandatory Capital/Asset Infusions
As noted, to limit capital risks, the JV Agreement should clearly and plainly limit and cap the amount that any joint venturer is required to contribute. These limits/caps should not be arbitrary, but should be reasonably linked to the capital that was initially projected as necessary for success. Thus, if $1 million in startup capital was originally projected as the amount needed for the joint venture to succeed, then the limits/caps should be related to that original projection. Remember that among the potential “audience” for your well-drafted JV Agreement are creditors who — in the future after failure — are reading the JV Agreement and trying to pierce the various corporate shields to get at non-JV assets. Other members of the future “audience” are judges and members of a jury. You do not want to give a judge or jury an excuse to claim the joint venture was some sort of scam or deception on creditors.
San Diego Joints Ventures: Limiting Risk by Using Corporate Entities
The second mechanism for limiting risk is to use corporate entities as the joint venturers. This limits capital/asset risk because corporate entities shield non-corporate assets from creditors. Often the corporate entities are specifically created to become members of the joint venture.
As example, let’s say that you own ABC Corporation. To participate in the joint venture, you cause ABC Corporation to create ABC JV, LLC to become one of the joint venturers. In this manner, the assets and revenues of ABC Corporation are not at risk if the joint venture fails. To be a successful shield, your LLC must be set up properly, should have an Operating Agreement, must pay its annual franchise taxes and otherwise comply with corporate formalities. Again, a good San Diego corporate attorney can help maintain your corporate shield.
San Diego Joints Ventures: Limiting Risk by Using Strategically Timed Capital/Asset Infusions
The final key to limiting capital risk with a joint venture is the use of strategically timed capital/asset infusions into the joint venturer, as distinct from infusions into the joint venture.
Continuing our example from above: Let’s say that ABC JV, LLC was required to make an initial $120,000 capital contribution into the joint venture. That $120,000 very likely came from ABC Corporation, its owner. In general, that is not a problem; that is normal. Let’s further imagine that ABC JV, LLC is expected to contribute another $120,000 during the first year of the joint venture enterprise, if needed and as needed. It is BEST for ABC Corporation to deposit money into ABC JV, LLC on a regularly scheduled basis — say $10,000 a month. Then, if there is a “capital call” from the joint venture, the money is already in the bank account for ABC JV, LLC. That looks “good” and looks like ABC JV, LLC is a legitimate entity.
Without these strategically timed monthly infusions into ABC JV, LLC, these are the “optics:” capital call on day one, cash paid on day two — probably in the same amount as the capital call — by ABC Corporation into ABC JV, LLC, cash forwarded on day three by ABC JV, LLC. That looks “bad” from an “optics” standpoint. That looks like ABC JV, LLC is just a shell entity and that the “real” joint venturer is ABC Corporation. As such, potential creditors have an argument for trying to go after the assets of ABC Corporation. Strategically timed capital infusions into the joint venturer helps prevent any argument that the joint venturer was/is a sham. This, in turn, limits risk.
Contact San Diego Corporate Law Today
If you would like more information about joint ventures and drafting joint venture agreements, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard can be reached at (858) 483-9200 or via email. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters. Mr. Leonard proudly provides legal services to business owners in San Diego and the surrounding communities.
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