An investor entering an unfamiliar European market almost always needs a local partner, and the joint venture with a local operator is the standard answer. It is also the structure that generates the most disputes, for a reason that is structural rather than personal: the two parties contribute different things, are exposed to different risks, and measure success differently, and unless the documentation reconciles that, time will not.
What each side is actually contributing
The investor contributes capital and, usually, bears most of the downside. The operator contributes market access, execution capability, relationships and time, and typically far less capital. That asymmetry is the whole design problem: the operator earns most of its return from the promote at the end, which means its incentive is weighted toward upside, while the investor’s exposure is weighted toward loss. A structure that does not address this is a structure where the parties will want different things at the moment it matters.
Alignment is bought, not assumed
The most effective alignment mechanism is real money: the operator invests a sum that matters to it, not a token. Beyond that, the promote should be earned above a genuine preferred return, so that the operator is paid for outperformance rather than for the passage of time, and it should be subject to a mechanism that prevents the operator being paid early on gains that later reverse.
A partner who has money in the deal reads the downside case with different eyes. That is not cynicism, it is the entire purpose of co-investment.
Control: the two lists
A working joint venture has two written lists. What the operator can do alone, which should be broad enough that the asset can actually be managed. And what requires investor consent, which should include sale, refinancing, capital expenditure above a threshold, material changes to the business plan, related-party contracts and anything affecting the tax structure. The second list should be short and specific. A consent list so long that everything requires approval produces paralysis and an operator who works around it.
Information rights are the early warning system
The investor’s protection between board meetings is information: monthly operating reporting, quarterly financials, immediate notification of defined events such as a tenant default, a licence problem or a budget overrun above a threshold. The reporting standard we describe in our note on reporting and governance for investors in a managed asset applies directly. An investor who first learns of a problem from the annual accounts has lost the year in which it could have been fixed.
Related-party dealing has to be regulated
Local operators frequently have affiliated businesses, property management, construction, agency, and using them is often sensible because they are competent and available. What is not acceptable is using them at prices nobody tested. The joint venture agreement should require related-party contracts to be on market terms, disclosed, and above a threshold approved by the investor. The tension between managing an asset and financing or servicing it is one we address in our note on financing and managing the same asset.
Planning the ending at the beginning
Every joint venture ends, and the documents should say how. An agreed sale window, a buy-sell mechanism, rights on default or on the departure of the key individuals the investor was actually backing. That last point is often overlooked: an investor backing a local operator is usually backing two or three specific people, and the agreement should say what happens if those people leave.
Montclare manages and structures European real assets for institutional and private investors, from acquisition through to exit. Our services are set out on our services page.
This article is informational and does not constitute investment, tax or legal advice. Asset management and investment advice are regulated activities and the treatment of any transaction depends on its facts. Each engagement is subject to scope and applicable regulation.