Buddy, Can You Spare a Dime? John Kuhl and Amy Wells
Coz Castle & Nicholson LLP
During challenging economic times, investors in real estate joint ventures need to be creative and flexible when considering strategies to preserve the viability of the venture and its projects. This is especially true when it comes to deciding if and how additional capital should be raised, if that becomes necessary to see the venture through difficulty.
Typically, a real estate joint venture raises capital through equity contributions by the venture members, debt financing provided by third-party lenders, or some combination of equity and debt. In a capital-constrained environment, obtaining additional third-party financing for a struggling real estate joint venture may be difficult, if not impossible. As a result, the joint venture members themselves may be the only feasible source of additional capital. However, the ability or willingness of the venture members to place additional capital at risk may vary. For example, it is not uncommon for the members to agree that additional capital is both necessary and desirable but for one of the members to be unable to contribute its share. In those instances, to induce the financially capable member to provide all of the needed capital, the members must agree upon the manner by which that member is sufficiently compensated to induce it to take on the entirety of the economic risk associated with the new investment.
There are any number of possible approaches, depending on the particular circumstances of the joint venture and its members. These approaches tend to fall into several broad categories, including preferred equity, where the financially capable member provides a new class of equity to the joint venture that enjoys a priority return over the existing equity or adjustments to the members' relative interests based on the amount of the new capital in comparison to the existing capital. Note that some joint venture agreements describe 'company loans' or 'member loans,' which can be made by the contributing member to cover both its capital contribution and that of its non-contributing partner. Commonly, attributes of traditional third-party loans are not attributed to these 'loans' because they typically do not include collateral and often are not separately documented using loan documents. Such 'loans' have the attributes of preferred equity and are not the subject of this article.