Back to Basics | Funds vs JVs
Joint ventures (JVs) and funds are two frequently used structures which allow parties to pool capital and expertise in a way that shares both the risk and the potential upside of investments. A common question we often get asked is “what are some of the key differences that will determine whether a structure is JV or a fund?”.
A key difference between JVs and funds is the applicability of the Alternative Investment Fund Managers Directive (AIFMD), which introduced a common regulatory framework for EU-based managers of alternative investment funds (AIFs). The UK has maintained AIFMD in UK law post-Brexit and therefore AIFMD will need to be considered whether the structure in question is European or UK based.
Whilst a fund will nearly always be within the scope of AIFMD, the AIFMD recitals state that JVs are not intended to be caught. This is a key reason why parties may opt for a JV over a fund – being outside the scope of AIFMD greatly reduces the compliance and reporting burden and avoids the need to appoint an authorised alternative fund manager (AIFM) to manage the structure.
It should be noted that funds and JVs will often be structured using the same legal vehicle (commonly a limited partnership) and therefore it will not be possible to determine whether an undertaking is a fund or a JV simply by looking at the legal vehicle used. Rather, it is differences in characteristics and operations which will be decisive.
What is a JV?
AIFMD does not define a JV, or explicitly exclude them from its scope – mainly because “joint venture” does not have a precise legal meaning. Therefore, whether or not an undertaking is a “JV” which is not caught by AIFMD ultimately turns on whether or not it falls within the definition of AIF.
What is an AIF?
In order to be an AIF, the undertaking in question must:
- have more than one investor;
- be a collective investment undertaking – i.e. an undertaking which pools together capital raised from investors for the purpose of investment with a view to generating a pooled return for those investors;
- raise capital from a number of investors;
- invest that capital in line with a defined investment policy; and
- not be a retail fund regulated by the UCITs Directive.
An undertaking will only be an AIF where all of the criteria are met, which will be a question of fact. Accordingly, if an undertaking meets the definition of an AIF it will be an AIF even if it is referred to as, or intended to be, a JV.
The remainder of this article looks at the two main arguments used to categorise a structure as a JV that is not an AIF.
Control
The clearest example of a JV that is not an AIF is when all parties have day-to-day control (in the ordinary sense) over its activities. However, provided that the strategic financial and operating decisions are under the control of all parties, and they have a continuous involvement in the overall strategic management, it is possible to have a JV in which not all of the parties have day-to-day control. This may be desirable where the parties have come together in a marriage of expertise and equity.
In this situation, the JV will typically be structured so that the party with the expertise has delegated authority to carry out the day-to day-management of the JV in accordance with a pre-agreed business plan (subject to certain tolerances) with certain key strategic decisions (known as ‘Reserved Matters’) requiring the approval of all parties.
Whilst for the most part, the list of ‘Reserved Matters’ is up for commercial discussion, in order to show that all parties have a sufficient degree of control to avoid being an AIF the matters must extend beyond usual shareholder controls e.g. voting on mergers, appointment of directors etc.. At a minimum all parties will typically have approval rights over the business plan and any deviations from it (subject to pre-agreed tolerances), and, depending on the nature of the investments, over decisions regarding the acquisition and disposal of investments as well.
The requirement that all take part in strategic management means that the number of parties should be sufficiently low for joint management to be practical – in our experience once you get above 5/6 investors, it is simply not possible to resolve the legal and commercial tension. For example, obtaining unanimous approval for ‘Reserved Matters’ can prove challenging with multiple investors.
Control vs Number of Investors
Where a JV is structured as a limited partnership (as is common), in addition to being limited partners we would also expect all parties to be able to exercise control over the general partner either by virtue of them being shareholders of it or by having the right to appoint directors to its board. In contrast, in a fund using a limited partnership as the main fund vehicle, we would expect the general partner to be wholly owned by the manager (or its affiliates) with investors being limited partners only. In both cases, care needs to be taken not to give limited partners too much control such that their limited liability status is jeopardised and is a further reason why in a JV it is often therefore preferable for the parties to predominantly exercise control through the general partner.
Common JV Structure
Raising Capital
An alternative argument for classifying an undertaking as a JV that is not an AIF is that it does not meet the criterion of “raising capital”.
The definition of an AIF envisages a distinction between the undertaking that “raises capital” and the parties that invest capital. For example, in a fund context, the manager will often go out on a roadshow to market the fund, taking steps to procure the commitment of capital from third party investors, some of whom may not previously be known to the manager. In this case, there is a clear distinction between the manager as the entity that raises capital and the third parties who invest capital.
However, in a JV context, there is often no such distinction – instead the parties are coming together on their joint initiative. Where the parties come together in the proposed project before the structure of the venture is determined and capital raised and/or the parties have existing relationships there will no external capital being raised – the persons raising and investing the capital will be the same.
Other indicators
The level of granularity of the investment policy can also be an indicator as to whether an undertaking is a fund or a JV. If an undertaking has a defined investment policy (for example, prescribing the type, value and geographical location of property which can be invested in) this leans towards it being an AIF. JVs are more likely to have a ‘big picture’ policy or objective focused on commercial goals (for example, the investment in and construction of mid-to-high end build to rent apartments in a particular location).
Conclusion - Fund or JV?
In many circumstances whether or not a particular project can be structured as a JV will be dictated by the facts at hand (for example, where there is a large number of parties (5+) it will nearly always be a fund). However, where there are between 2 – 5 parties, it may be possible to make an active choice to structure the project as a JV with a view to falling outside the scope of AIFMD. In making this choice, the parties need to weigh up the benefits of being outside the scope of AIFMD with the practical implications of being a JV.
In particular, the manager will need to consider whether it is willing to relinquish control over key strategic decisions to investors to the degree required in order to be a JV. If not, and if the preference is for investors to remain passive, the manager may ultimately decide that a fund structure is more suitable especially if it (or its affiliate) is already authorised as an AIFM. Even if a JV is not an AIF it may be subject to other regulatory requirements which will still need to be considered.
If you want advice on how to set up a JV to ensure it falls outside the scope of the AIMFD or advice as to whether a JV or fund structure would be more suitable to a particular project, please contact us.
