Public-private partnership financing structures

A public-private partnership (PPP) involves collaboration between a private entity and a government (or government entity) in a joint venture, each party applying their respective strengths in developing a project more efficiently than the government would achieve alone. PPP arrangements may take difference forms - for example, a situation where the private entity brings in the funding to finance government infrastructure project and assumes some form of ownership subject to oversight role and approval by the government. The structures may differ in the way the government entity and private entity share responsibilities, risks, and rewards related to the infrastructure project (Winch, Onishi, & Schmidt, 2012; Rosnani, Suhaiza, & Julia, 2018).

Finnerty (2013) identifies some PPP financing models available for the financing of typical infrastructural projects. The main financing models include the build-operate-transfer (ВОТ) model, build-transfer-operate (BTO) model, buy-build-operate (BBO) model, lease-develop-operate (LDO) model, perpetual franchise model, wraparound addition, temporary privatisation, speculative development, value capture, and use-reimbursement model. Each financing model differs in the contributions from, responsibilities for, and rewards for each partner (public or private venture). Finnerty (2013) suggests that determining the most appropriate financing model requires addressing the following key issues:

  • • Whose role is to design and construct the project?
  • • Whose role is to provide funding?
  • • Whose role is to arrange financing?
  • • Who has legal ownership of the projects and its assets and to what extent?
  • • Who bears all risks and liabilities?
  • • Whose role is to operate the facility?
  • • Who is responsible for generating revenue from the project?

The choice of PPP financing model would be based on the extent to which each party does what in the project. Next, we discuss each of the PPP financing models.

BUILD-OPERATE-TRANSFER (ВОТ) MODEL

The ВОТ model is the commonest form of PPP financing structure. It entails the private sector entity's committing to construct and build a commercial structure or infrastructure and run or operate it for a stipulated number of years, after which its ownership reverts to the local government. With this type of agreement, ownership rests in the hands of the private operations from the time the project is started and finished, and some years it is operated by the private entity. After a stipulated future date, ownership reverts to the government or elected governmental bodies. This arrangement allows for ample time for the private entity to recoup its capital investments, after which ownership transfers to the government or public entity. The private entity fully finances the project only for ownership transfer to occur at a later date. This model is quite common in developing economies because of governments' fiscal constraints. It may be difficult for such projects to come to fruition if the government is left to do it alone. On the part of the private investors, it is a win-win situation, because they are also able to make satisfactory returns on their investment. A typical example is a construction of highways by private entities, after which the private entity collects tolls for some years and then transfers ownership to the government entity (Laishram & Saty- anarayana, 2009). Box 14.1 provides details of a healthcare project that used а ВОТ model.

BOX 14.1 Lesotho public-private investment partnership

The government of Lesotho and Tsepong (Pty) Ltd (a private consortium) in 2008 entered into a healthcare PPP to rebuild the national referral hospital and associated clinics in the capital city of Maseru in Lesotho. The duration of the contract is 18 years (2008 until 2026), and the government and Tsepong established the project structure on the 1 October 2008 over the 18-year period for USD256.8 million. The construction is jointly financed by 37.7% of public funds and 62.3% of private funds. The project aims to design, build, and construct a 425-bed hospital (made up of 390 public and 35 private beds) and refurbish and re-equip three urban clinics. The hospital was to be operated and managed by Tsepong for the 18-year period. The hospital and the clinic constructed a health district for supporting the application of integrated care to ensure improvements in efficiency and expand healthcare access for the people of Maseru and all of Lesotho. The funding structure of the project is shown in Table 14.1.

TABLE 14.1 Financing structure

Source of capital

Public capital investment (USD)

Private capital investment (USD)

Total

(USD)

Funding %

Debt

94.9m*

47.5m

142.4m

93.01%

Equity

0.47m

10.2m

10.7m

6.99%

Total

95.4m

57.7m

153.1m

Source-. Downs, Montagu, da Rita, Brashers, and Feachem (2013) Note-, m = million

BUILD-TRANSFER-OPERATE (BTO) MODEL

The BTO model involves the private entity's initiating and building a project only to transfer it to the government entity upon completion. The government entity then operates the facility or can lease it back to the private entity for a fixed term. If the infrastructure is leased back to the private entity, it is at liberty to make financial gains from it, and this is normally the case. If the government entity operates the structure, it still has the option to hire the private entity to manage the project on its behalf. Under this model, the chunk of the financial commitment falls on the private entities; the government makes little financial commitment. An example of a PPP project that could employ this model is private-public collaboration to build a government hospital for a district.

BUY-BUILD-OPERATE (BBO) MODEL

Under the BBO model, the private entity acquires an existing government structure or building, modernises it, and then operates it. In this arrangement, the title or ownership of the property transfers to the private entity after purchase. The private entity after purchasing the property can repair, expand, or improve the property and can monetise it. This model is often applied in government privatisation schemes. Usually, the government cannot turn things around concerning these properties so giving them to private management is the best option for it. This model of financing is also quite popular in developing economies. An example of partnerships where this model could be used isthe privatisation of government buses for private usage and management.

LEASE-DEVELOP-OPERATE (LDO) MODEL

In the LDO model, the government leases a public property with the accompanying land to a private institution to use and manage for an agreed term. In the model arrangement, ownership of the property is retained by the government entity while the right to use and manage the property is given to the private entity. This arrangement works well in a situation where the private entity is not able to make a full payment for the acquisition of the property, unlike they can in the case of a BBO model. It means the cost of the lease is much lower than an outright purchase of the property. Also, the risk from the project is not borne by the private entity alone but shared between the two parties. This could be an advantage to both parties. Also, the LDO model gives the government right to some of the profits from the project after it has been leased. An example of a project that could be financed using the LBO model is the lease of government land to be used as a transport yard.

PERPETUAL FRANCHISE MODEL

Concerning perpetual finance model, the private entity obtains a 'perpetual franchise' to operate the project or structure for the foreseeable future. This 'perpetual franchise' is obtained from the local government. Funding is provided by the entity, and the ownership and title of the project's assets reside with the private owners. The way that governments come in is by regulating the project. The government has the right to regulate the quality of the project's output, pricing, profits, safety, level of output, and more. The government or public institution does not retain any of the profits that accrue from such infrastructural investment. A good example where this model may apply is a government's providing land for a private investor to construct a compost plant. The government offers the land while the private entity provides the necessary accoutrements to build the plant. Further, the government can regulate the pricing of the compost and influence whom it should or should not be sold to.

WRAPAROUND ADDITION

In this financial model, the government gives the private entity the right to expand and use up a property. The private entity undertakes to upgrade and use the government property. In this case, the title of the core property remains in the hands of the government entity. The private entity retains ownership of the extra upgrade or additions it brings. This model has a risk and profit-sharing mechanism just like the LDO. In most cases, the private entity would be the one running the operations of the whole structure. An example of a project that could use this financial model is a government warehouse converted and developed into a factory by a private entity. A real example where this financing model is used is the Azura Power West Africa Ltd in Edo Nigeria, where for a 2.5% minority stake in the project, the government provided 100 hectares of land (see https://azuraedo.com/about/).

TEMPORARY PRIVATISATION

The temporary privatisation model is similar in some respects to ВОТ model in that the private entity operates the property for only a stipulated amount of time. Here the private entity obtains the right to use the property from the government. The private entity then develops or repairs it, then operates it for a predetermined period. In this case, the ownership of the property does not transfer to the private entity. The government signs some lease agreements with the private entity. Normally the property will need some form of upgrading, and the private entity then commits to upgrade it and operate it for a period to recoup its investments. Here all the risk is transferred to the private entity in the period of operation. The term given to the private entity is usually long enough for it to recoup all its investments and make sufficient returns. The private sector entity is also not required to share profits with the government entity. After the time allotted has elapsed, the right of operation is then reverted to the government. An example, in this case, would be the repairs and operation of a bridge or railway by a private entity for an agreed period.

SPECULATIVE DEVELOPMENT

This model is speculative in the sense that a private entity identifies a public need that has not been met. It ascertains whether it could monetise it and then performs all the necessary groundwork with the knowledge of government after obtaining the necessary permission. When the private entity can make measurable progress, the government comes to provide financial and nonfinancial support. In this model, ownership usually remains in private hands, although it could be joint ownership in some cases. The main risk from the project inception rests with the private entity until the government comes in to offer some assistance. Due to the speculative nature of the project, it could also easily go bust. However, in cases where the project becomes successful, the private entity can rake in more profits. An example of a project that would use this financing model is the setting up of an amusement park on government property.

VALUE CAPTURE

This model is sometimes referred to as the involuntary partnership model. In this model, the value created by the existence of a project is taxed to generate revenue to complete the project. An infrastructural project like the building of a railway or highway will generate externalities to those affected, which could be monetised. When a railway passes through a town, there are many externalities created; property values appreciate, ease of transport improves demand for housing close to the rail, and commercial enterprises have access to a bigger market, among others. These externalities enhance revenue generation to the entities involved. Because of these positive externalities, the value created could be captured and monetised to generate revenue for the project. Value capture imposes special taxes on those the project would affect, to generate revenue to run the project. Revenue collection agencies would be set up to collect these taxes and channel them directly to the project. In cases where the revenue flows are regular and predictable, bonds could be issued on them to generate additional finance to complete the project quickly. As alluded to earlier, a typical project that could use the value capture method is railway construction.

USE-REIMBURSEMENT MODEL

In this model, the project company enters a utilisation contract with the public or private entity. This contract requires the public or private entity to make periodic payments to the project company to cover all debt accrued to the establishment of the structure. This method works particularly well in a situation where the funds for the project were borrowed from an external source and repayment has to be made after the project has been completed and is in operation. So revenue generated from the structure is used to defray the debt. The loan is usually guaranteed by the government, thus exposing the government to credit risk. After completion and subsequent operation, the loan has to be repaid whether the structure generates profit or loss. Again, the loan repayment structure is usually standardised and regular. An example of a project that could fall under this category is the construction of a cluster of schools by private contractors for the government.

 
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