Strategies for Successful Public Private Projects

The third primary source of US P3 project debt in addition to TIFIA (Transportation, Infrastructure, Finance and Innovation Act) and PABs (Private Activity Bonds) is bank debt. Outside the U.S. bank debt is generally the primary – and sometimes only – form of project debt. And while 2008’s financial downturn and subsequent increased focus on bank balance sheet strength led to tighter controls and more rigid borrowing terms, bank debt remains a valuable source for P3 project financing.

Without the lengthy application or allocation process associated with TIFIA and PABs, securing bank debt takes much less time. In addition, many private developers and construction firms have existing relationships with lenders which can make for an easier and faster process to finalize loan details. These existing relationships also allow the lender to better understand the borrower’s business structure and to be more familiar with the type of projects they tend to work on. 

Bank debt is particularly valuable on smaller scale projects. TIFIA requires a $50 million minimum project cost to be loan eligible. And bond issuance costs for small projects are proportionately much higher than they are for larger bond deals. While there have not been many small scale P3s, bank debt offers an effective financing source for those projects. 

For the larger projects, banks are also still important. With TIFIA covering only 33% of project costs, remaining financing comes from PABs, bank debt, or a combination of the two. Up until financial close, most P3 transactions will keep both bank debt and PABs available as options to see which will offer the best overall rate. During the period up to financial close, should the private borrower want to modify the terms of either instrument the bank debt is typically easier to adjust.

The most significant limitation concerning bank debt has been the maximum term length. TIFIA and PABs provide terms up to 30 years and beyond with rate certainty. Banks will not lend out for that long a period. Long term projects will have future refinancing risk, which can still be hedged but can often make the bank option less competitive.  

On the other hand, bank debt provides very competitive rates in the shorter term. Depending on the nature of the project (construction period, commencement of revenue streams, etc.), and with take-out financing coming from another source, banks can still be a valuable element of a long term financing. 

With P3s being applied to a growing variety of projects, it is increasingly important to find financing structures best suited to each. In assessing the merits of different structures, some fundamental considerations should be:  1) how much public funding to provide, 2) the desired amount of private equity, and 3) the level of complexity in the mix of financing sources.

P3s can involve various methods of public sector contributions to the project. Sometimes the project involves a defined public component, such as a series of approach roads, which would be entirely funded by the public party. In other cases, the public sector will fund a percentage of the overall P3 project cost. These public funds could come from federal/state/local grants or other sources available to the public entity – including their own financing through tax-exempt debt.

The amount of public funding for the project can depend on several factors. These include how the P3 project relates to the public entity’s capital planning priorities and how much debt capacity is available for the project under associated debt issuance limitations. Depending on the nature of the project and form of the public entity, a certain amount of public investment might be legally required. There are also non-financial considerations for the public party in terms of how they want to show their commitment to the project. Larger contributions often grab larger headlines. There are no set rules with regard to the public party’s financial participation in a P3 project; each project is its own unique situation.

Most public agencies advancing a P3 projects want to make sure that the private developer has a stake in the project’s long-term success. They want the developer to have some “skin in the game” by contributing equity. But there is a flip-side to having more developer equity. The developer’s equity rate of return will be higher than the rates associated with the rest of the financing package they bring to the table. The more developer “skin in the game,” the higher the cost of the overall project financing.

The public entity, as the procuring party, needs to determine what minimum developer equity contribution is needed (generally between 8 – 10%). Prior successful similar P3 transactions can often serve as a guide. Of course, developers can elect to exceed this minimum. Typically, however, they do not in order to submit the least costly financing plan. Occasionally the public side gets the best of both worlds. One developer team provides the highest equity amount and their total cost to design, build, finance, operate and maintain the project is still the lowest.

The primary funding source for the private developer will come in the form of debt. This debt mix should be based on characteristics of the project such as:  the length and spending profile of the design and construction phase; the time until commencement of facility revenue operations or payments to the developer; and the projected operation and maintenance costs post-construction. Typically bank debt will offer the most attractive short-term rates, while bonds and private placements will fill in the longer financing troughs and be used to refinance expiring short-term bank loans. Depending on the types of debt instruments, a tiered debt structure can evolve where some debt has higher priority than others. This is common when a TIFIA loan is one of the financing sources.

With a myriad of available instruments and varying maturities, the financing structure should not be unnecessarily complicated. The more parties involved, the more inter-creditor agreements and legal costs. There will also be more time required for all aspects of advancing the project. While a large mix of financing sources might yield the lowest effective rate, a P3 is ultimately a project delivery model with associated financing benefits, not merely a financing solution.  

Public entities, when confronting challenges to fund and deliver large infrastructure projects, turn to public-private partnerships (P3s) as the best solution. While the use of a public-private partnership structure for the procurement, financing, and delivery of a project often results in time savings, financing efficiencies, and other project benefits, it is very important for public sector entities to understand that a P3 structure by itself does not guarantee a project’s success.

Delivering infrastructure projects is often complex and time consuming.   Land acquisition, environmental matters, coordination among project stakeholders, design, and construction all involve certain degrees of risk and uncertainty. P3 projects are most successful and benefit both parties when project elements can be clearly and cleanly assigned to each side based on who can perform those elements best and assume the corresponding risk.  

In a P3, the private partner would likely be more familiar with cutting-edge technology, design and engineering approaches to construct a new facility and take on the associated risks. The public partner, on the other hand, would be better able to navigate through an environmental review process involving federal, state, and local officials on the location of the project. Depending on the nature and degree of project risks, a P3 will not necessarily enhance project delivery or save costs and time. 

Facility demand can also impact a project’s success – especially when its revenues directly support the financing. P3 structures can transfer revenue risk to the private party or the public side can opt to maintain it – most common when those revenues also support (either directly or indirectly) the public entity’s existing debt. When the public side retains the revenue risk with very questionable demand, the use of a P3 will not solve the problem.

In times of constrained public budgets, P3s can seem to be very appealing. P3 project payments from the public entity to the private developer generally escalate over time. This makes state/local budgets look good in the short term, but can mask the long term financial impacts. In effect, this just kicks the problem further down the road.

Public entities nearing their statutory debt issuance limits could also look to using P3s. Rather than using state or local debt, a P3 will use a variety of other financing sources. However, the project will still require revenues to pay for these P3 financing sources. The simple truth is that no matter how it is funded – be it a pay-as-you-go, state/local debt, federal funds, or with a P3 – a viable infrastructure project requires a secure and ongoing revenue source.

In the end, the fundamentals of the infrastructure project will determine its success. The P3 structure should be seen as an enhancement to the project allowing the private sector to add value beyond what is typically available from the public side. P3s also benefit projects by providing a risk-sharing framework and a basket of financing tools that can be tailored to specific project needs. Each of these will be discussed in future segments of this series.

One observation that has continually struck me over my twenty-five year career advising businesspeople is how often financial management, let alone mastery, is overlooked and avoided.

Successful business leaders embrace financial management as much as they do engineering, marketing, and sales. Yet many otherwise excellent business managers leave finance to others without retaining their own leadership and creativity in the matter. Business powerhouses are built on firm financial management and proactive relations with capital providers, so that fleeting opportunities can be seized in the moment.

The approach outlined in this series has delivered significantly greater access to capital for 95% of the clients that have engaged us over the last twenty-five years. Given the critical importance of finance in capital-intensive industries, there is much to be gained by setting your sights on business financial mastery.

When we say business financial mastery we mean knowing every aspect of your company’s revenues, expenses, assets, and liabilities, and how they show up in your bookkeeping, financial statements, and presentations. This knowledge becomes the basis for efficiently evaluating and responding to urgent opportunities.

It is one thing to trust your passive investment funds to the capable oversight of a stockbroker or mutual fund manager. It is a wholly different matter to defer to staff, accountants, or bankers when it comes to your business financial life.

Our intention at Strategic Rail Finance is to illuminate business financial mastery as an executive management skill that pays big dividends when attained.

We work with many businesspeople who fervently attend to management responsibilities such as sales and project management while deferring to others when it comes to bookkeeping, financial statements, company presentations, bank relations, and ultimately to their access to capital for growth. Instead of investing ongoing attention to capital access, they focus on finance at the 11th hour when their back is against the wall or they need capital for a pregnant opportunity. This management style forfeits control to lenders and usually results in less than ideal structure, terms, and overall access to capital.

An important question for business leaders is; what do we want to master ourselves and what do we want to trust others to do for us. Delegating to others is fine if you have the executive insight to know the role of finance in reaching your business goals and can then interact powerfully with those to whom you have delegated.

Like any skill, there are methods and approaches to attainment. Our 10-step “Financial Management for Growing Your Business” Series is a roadmap of the path for attaining this mastery. Each week we will follow this initial communication with the next step on the path.

Before we continue, you can ask and answer for yourself: Is business financial mastery something you want to develop?

In our clients’ tightest financial times we build a month-by-month and sometimes week-by-week cash flow spreadsheet of every dollar coming in and out of their business. This “Company Management Tool” provides the missing rudder for stabilizing relations with vendors, lenders, customers, and employees.

On the other hand, when your company is on an even keel, not in stress mode, financial control makes for smart decision-making and lots more profit.

This control is rare among businesspeople for no good reason except that it hasn’t been taught in business schools or by our mentors. This is why the first three steps of our series, “Financial Mastery for Business Growth” are Step 1) Financial Mastery, Step 2) Financial Control, and Step 3) Financial Integrity. These three steps will take you and your business to new heights of success, profitability, and ease.

Too many business people needlessly fret over the uncertainty of not being in control of their finances when control, no matter in growth or turnaround mode, could be at their fingertips. 

We invented our Strategic Rail Finance “Company Management Tool” because QuickBooks-type bookkeeping systems and financial statements are inadequate for proactively managing a business. They provide historical and comparative data in hindsight only. Even otherwise useful business projections typically built around an annual, long-range planning framework do not allow adjustments as actual results occur, so they are relatively useless as a management tool.

You can create your own “company management tool” by building an excel spreadsheet with columns for each month (or weeks in tight times) with rows that capture each and every cash outlay and all income. The starting point is your current checking account balance. What matters in running a company effectively is how much cash is in the checking account now and at any point in the future as bills are paid and revenues are collected. Then you clearly know how much will be available for catching up on payables, investing in business growth, or distributing to shareholders.

Banks, lenders, and investors fawn over our clients because they don’t see this level of business control elsewhere. They can see where the repayment will come from. They trust us, and trust attracts capital. See our Case Studies.   

Having your own “company management tool” is as valuable as the dashboard on your vehicle. Once you have this spreadsheet in hand, you will have every activity and relationship displayed in one document. It becomes the discussion outline for conducting strategic conversations with your team and for orchestrating the day-to-day operational decisions that mostly all circle around money. With the hands on the steering wheel of your company, you can plan, negotiate, and commit with certainty that you can meet your goals and your obligations.

Our next edition will cover Financial Integrity—the power of making promises you know you can keep, keeping the promises you make, and communicating when you can’t.

Let us know if you would like to discuss your opportunities and how we can help you attract all the capital you want.