A joint venture that cuts both ways

A partnership with its previous employer can provide a beneficial boost for a new spinout, but it also can be a tie that binds.

Last week, PERE reported on the official launch of Miramar Capital, whose founders include two ex-Colony NorthStar executives and a former development partner of the Los Angeles-based real estate and investment management firm.

Spinouts, of course, are nothing new in the private equity real estate firm industry. Indeed, at least seven firms among this year’s PERE 50 were founded by people who came from other private equity real estate platforms.

What is unusual about Miramar’s launch is that it has formed a $100 million joint venture with its former employer. With most spinouts, after all, the founders opt to strike out on their own and become completely independent from their previous employers.

The Santa Monica-based real estate operator and investment firm, however, is starting off with a sizable equity investment from Colony. Despite losing two of its employees, the latter firm stands to be benefit from the new JV because it will be able to access another source of dealflow – critical in this late-stage real estate cycle – as well as opportunities to raise third-party capital around those investments.

The JV, however, has pros and cons for the new spinout. On the one hand, the fact Colony would want to maintain an investment relationship with its former staff is effectively an endorsement of the new firm’s skills in sourcing and executing on deals, particularly with covered land plays, which involve the acquisition of existing properties that would have a higher value if they were converted to a different or more intensive use.

Such an endorsement from an industry giant could potentially raise a new firm’s profile and give it more credibility, thereby enhancing its ability to attract capital from other prospective partners and investors.

On the other hand, while these JVs can be a significant source of initial capital, a spinout needs to consider how the partnership may be perceived by the investor community over the long term, especially if it intends to eventually raise a commingled fund, as in the case of Miramar. Investors evaluating new managers tend to heavily scrutinize the firm’s ownership structure and how it aligns itself with limited partners, according to one such startup. If a new fund manager has an existing investment partnership, alignment may be a bigger concern for investors than with firms that do not have such a joint venture in place.

Moreover, investors may assess the partnership in other ways. For example, they may want to know if the manager’s partner has a stake in the business or will be an investor in the manager’s fund, and, if so, what type of control they consequently may have over the firm and its investments. They also may want to know how long the partnership – and potential conflicts with other investors – will last.

Given the potential alignment and conflict issues, it is paramount a spinout involved in such a JV put a lot of careful thought into how the partnership is structured and what long-term repercussions there may be for its business. After all, in many cases, a partnership between a spinout and its former employers represents what one investor calls “a partial divorce.” It is not the clean separation that is attractive to most capital providers and ultimately allows a new firm to stand on its own.