In commercial real estate, investors love their lingo. But with so many different types of partnerships, it can be overwhelming figuring out the legal protections — and risks — of each type. Two of the most commonly confused are joint venture vs strategic alliance.
If you think the term strategic alliance (or strategic partnership as they’re more commonly referred to in the CRE world) seems to be broad and vague, that’s because it is. A strategic alliance is an arrangement between two companies to undertake a mutually beneficial project while each retains its independence.
If you know anything about types of joint ventures, a strategic alliance seems to be the same thing.
Many people classify a joint venture as a type of strategic alliance between business entities — and in the literal sense, they would be correct. However, when it comes to most things in commercial real estate finance, it’s a little more complicated than that.
Joint Venture vs Strategic Alliance: What’s the Difference?
The most significant difference between a strategic alliance and a joint venture is how they’re formed. A joint venture is structured by teams of lawyers that set it up under a separate business entity entirely.
The terms of strategic alliance are set up in a variety of ways that are much less stringent.
What Is a Joint Venture?
Joint ventures are where two or more companies join forces to accomplish a specific task. A joint venture is a binding agreement, solidified by a formal joint venture agreement, that the parties set up as a business entity (typically an LLC but can take any form).
The joint venture is only concerned with the particular goal that the members set out to achieve and is not affected by any other company’s business activities.
As defined by the Corporate Finance Institute, a joint venture is one of three types of strategic alliances. They paint a picture of a joint venture in a way that’s easy to understand by calling the companies signing into the JV as the “parent” companies and the JV itself as the “child” company.
The “child” company operates outside of the “parent” companies; therefore, the joint venture cannot drag in the parent companies if any legal complications arise or if the investment fails. By forming JVs in this manner, the investing companies can hedge risk. Learn more about joint liability.
What Is a Strategic Alliance?
The best way to think about a strategic alliance is to picture a scenario where two complementary companies strike a deal to do business in a manner that mutually benefits both parties.
Examples of a Strategic Alliance:
- A local gym that offers membership discounts to employees of nearby companies.
- A professional baseball team that only sells a particular brand of a hot dog at their games.
- A music app that offers a one-year free membership with the purchase of a specific brand of smartphone.
The common theme that sticks out is that the companies involved in each alliance don’t need to change any of their everyday business practices. They’ve just partnered in a way that mutually benefits both of them.
Memorandum of Understanding (MOU)
A strategic alliance deal can range from a handshake agreement where no contract is signed, to more binding arrangements. However, in commercial real estate, strategic alliances (partnerships) almost always involve a memorandum of understanding (MOU).
An MOU is an expression of agreement to proceed and indicates that both parties intend to move in a particular direction. MOUs are not legally binding but are serious agreements that are typically followed by some form of contractual agreement.
Now, let’s examine two of the most common strategic alliances: equity and non-equity alliances.
A joint venture is the most common form of strategic alliance, yet there is one other example. In some cases, one of the companies involved in the alliance buys a portion of the other company’s JV equity to operate in more of an ownership manner.
The previous hot dog/baseball team example could be an instance of an equity alliance. The baseball team owner could offer to buy a percentage of the hotdog company’s equity to purchase their hot dogs at cost.
A non-equity strategic alliance is where two companies agree to combine their resources or assets to help one another. The above example of the local gym offering discounts to nearby companies could be an example of this.
The gym’s assets are the fitness equipment and classes. The employees themselves are the assets of the companies. The gym benefits because they gain more members (though at lower margins) who may bring in friends or family members, further increasing the gym’s members.
The local companies see a benefit because their employees are getting an additional benefit for working for them and are healthier and happier.
4 Key Differences Between Joint Ventures vs Strategic Alliances
Above, we mentioned some distinct differences in how joint ventures and strategic alliances are structured. But, there are many other differences between the two that are worth mentioning.
One significant difference between joint ventures and strategic alliances is who calls the shots. In a joint venture, the parties who form the venture closely manage every aspect of the investment.
Since strategic alliances tend to operate congruently to the regular day-to-day of each business involved, those who ally often delegate their management to other team members to focus on different aspects of the company.
The length of time that a strategic alliance or joint venture exists can vary for each. However, with joint ventures, the expiration date is clearly defined, whether it be three or ten years.
Strategic alliances can be set to end at a specific time but typically last as long as it’s benefiting both businesses. Because of this, strategic partnerships are often set up with looser exit strategies between the parties.
3. Levels of Risk
There can be high levels of risk and return with both strategic alliances and joint ventures. However, what is at stake is different between joint ventures vs strategic alliances.
With joint ventures, it’s usually high levels of equity that are at risk if the venture fails (this is especially true in commercial real estate). Since strategic alliances can be more loosely formed, if one member decides to back out, the other can experience unexpected losses in revenue, in addition to the loss of time and resources.
It’s important to reiterate that a joint venture is a company in and of itself, while strategic alliances are contracts or agreements. Although contracts are legally binding, they get broken all the time, and one side pays for the damages.
Yet, it takes many legal hurdles to dissolve a company if one of the partners wants to back out. Joint ventures typically cannot be terminated until the JV has reached a specific maturation date or the investment is no longer profitable; therein, both parties can decide to end the agreement.
When Should You Use a Joint Venture vs Strategic Alliance in Commercial Real Estate?
Now that you understand what joint ventures and strategic alliances are and how they differ, let’s look at instances involving commercial real estate where it would be better to use one or the other.
When Joint Ventures Make Sense
Joint ventures in commercial real estate serve one primary function: to see significant returns on the investment of an asset. Whether the goal is a new development or the acquisition of property to refinance, forming a joint venture makes sense in the following instances.
To Scale Your Portfolio
In terms of commercial real estate, joint ventures usually involve investing vast amounts of capital across one or many different deals. Joint ventures allow commercial real estate developers and investors to take their investment portfolios to the next level.
To Leverage Capital
Suppose you’re a general partner looking to develop property but only have a small amount of capital to invest. In that case, joining forces with a capital partner in a joint venture can cover large cash gaps in the deal while still providing significant returns for both parties.
To Get Big Returns
In commercial real estate, establishing a joint venture can result in unlimited earnings potential for the parties involved. There is some risk to overcome, but once all debt is repaid, the JV members are left with a highly valuable asset poised to provide limitless returns.
When Strategic Alliances Make Sense
When Developers Need Assistance
Sometimes developers in a particular region will form strategic partnerships with property management groups to staff and manage the operations of certain properties.
These alliances typically begin with an MOU then become more formalized over time after the management groups show they are capable.
When Breaking Into New Markets
Breaking into and understanding a foreign commercial real estate market has many challenges. Many times, overseas investors will form a less binding strategic alliance with local investors so that they can get their feet wet in a new market.
Strategic alliances like these can exist at the local/national level as well. When it comes to understanding zoning codes and other regulations, developers can team up with law groups and construction companies to expedite the development process.
When Trying to Gain/Curate Tenants
Developers aren’t creating mixed-use buildings just because they’re popular; there’s a strategy behind it. Creating residential or commercial properties with pre-designated retail space provides opportunities for strategic alliances that benefit both the retailers and the property owners.
When You’re a Commercial Real Estate Broker Trying to Expand Your Network
In areas where the market might be saturated with commercial real estate brokers, firms will often join forces to broaden the range of their expertise and expand their network. An example of this is the Caton Commercial Real Estate Group partnering with Dolan & Murphy, Inc in the Chicago area.
5 Considerations Before You Start Any Alliance in Commercial Real Estate
Sometimes, a strategic alliance presents itself, which seems to be too good to pass up. Before you strike a deal, make sure it fits your specific commercial real estate situation. MIT Sloan Management Review goes into detail about the many factors to consider when selecting and managing a strategic alliance. When it comes to commercial real estate, there are five crucial things to consider.
1. How Does the Joint Venture vs Strategic Alliance Fit Into The Overall Strategy of the Real Estate?
What may seem like an excellent partnership now may not always be best for your business later. Many market factors can affect an alliance. Both parties must be flexible to these considerations.
It’s vital not to become pigeon-holed in an agreement that will be detrimental down the road. On the other hand, perhaps there is a positive strategy angle presented by the deal that emerged, and there could be additional benefits of a prolonged alliance.
2. Can Your Company Capture All of the Value of the Collaboration?
In many strategic alliances, one party is poised to gain more than the other. If you’re the partner with less to gain, get creative with the deal so the deal is structured fairly and both parties benefit equally.
3. Is There a Process for Assessing the Effectiveness of the Alliance?
It’s crucial to have mechanisms in place to ensure that the strategic alliance is performing as planned. It’s a good idea to dedicate a team to assess the validity of the partnership frequently.
4. Are Both Parties Protected in the Agreement?
Although you can form a strategic alliance on as little as a handshake, we don’t recommend it, especially in commercial real estate. Hire the proper representation to draw up contracts to ensure both parties clearly understand all aspects of the alliance.
5. What Is Your Exit Strategy?
Within the contract, specify terms and conditions in which either party may terminate the alliance. Also, include an expiration date of the partnership and revisit and re-enter it later.
Joint Venture vs Strategic Alliance: The Bottom Line
Strategic alliances (partnerships) are another creative way companies can work together to achieve a goal. The major difference between a joint venture vs strategic alliance is that the purpose of a joint venture is always the same: returns on investment. While with a strategic alliance, the parties’ goals may be different depending on the arrangement.