* NOTE: GFOA has an Advisory on Public-Private Partnerships alerting governments to the risks involved with these agreements.
Use of a Public-Private Partnership (P3) for economic development or redevelopment purposes involves the use of public resources or financing capabilities to promote local economic development. Generally, governments participate in projects of high importance to the community; and, in some cases, public resources are required to make the project feasible. In these P3 agreements, the public entity will provide some combination of tax incentives, public land or other assets, infrastructure investments or financing assistance. The private entity will contribute capital investments, commit to provide jobs, contribute development expertise and should assume most of the financial risk for the ultimate project outcomes. These “partnerships” can either have short life spans covering only the construction period for the project, or longer life spans covering debt repayment or long-term operating agreements.
Depending on the project and the proposed terms of the agreement, the amount of risk facing the public and private entity can vary considerably. For some projects, the public entity may be serving only as an issuer of conduit debt, enabling the private borrower to gain access to tax-exempt financing but with no promise to commit any other public funding. However, the other end of the spectrum the public entity may be required to guarantee the private party’s debt or otherwise place public funds directly at risk.
For a P3 project to be successful the agreement must be mutually beneficial to both the public and private entity. For the public entity, the outcomes of the project need to be realized while the financial risk is minimized – the public benefit should justify the public cost. For the private entity, the project must provide an appropriate return for the level of capital and/or risk involved.
If governments pursue a P3 agreement, it should consider the following processes, tools, and practices in performing due diligence on P3 agreements.
- Conduct an Initial Review of Project Feasibility. Public entities should complete a feasibility study to determine if the project(s) have short-term and long term financial viability. This initial review must be a realistic evaluation that looks at demand, project risks, expected revenues and cash flows, and the ability to achieve the project goals. All economic development and redevelopment projects are subject to overall market fluctuations and involve risk that the project will not deliver expected outcomes.
- Evaluate the Project for Consistency with Community Priorities and Long-Term Strategic Plans. All P3 Agreements should be consistent with the overall strategic, master plans, and financial policies of the organization. In addition, the organization should evaluate the objectives for the project and determine if participation in the project is consistent with the mission of the government.
- Identify any Unmet Competencies on the Government Staff. Complex projects will require specialized resources, but with many other P3 agreements, internal staff will be able to lead the analysis. For all P3 Agreements, the organization will need to gather a team that contains analysts, legal counsel, resources with industry related expertise, potentially a financial advisor/municipal advisor with economic development expertise, and/or bond counsel. Public entities should determine early on in their analysis whether outside resources are needed to complement staff resources in executing the recommended processes of this best practice.
- Determine the Fiscal and Economic Impact of the Project. The public entity should determine the likely fiscal and economic impacts of the proposed project taking into account any project risks or uncertainty in the calculation. Factors to consider when identifying potential costs and benefits include:
- Initial Costs of Incentives
- Long-Term Costs of Incentives
- Expected Return to both the Community and to the Private Entity
- Operations Costs (salary, benefits, equipment, supplies, indirect costs
- Taxpayers Risk – Assigning explicit costs to risk and risk-like consequences
- Infrastructure Impacts, including the long-term costs of maintaining infrastructure.
- Opportunity Costs – Do the public benefits of a project reflect the best use of the public investment (best use of funding, effort, and land
Economic development projects should be reviewed using multiple tools and methods of analysis to provide a complete picture of the financial sustainability of the project. GFOA recommends that finance offers use the following methods in reviewing the likely fiscal and economic impact from potential P3 opportunities.
- Cash Flow Analysis / Fiscal Impact. A fiscal impact analysis or cash flow analysis can be used to determine how much incentive is required and at what point the government must be involved. Private entities are motivated to request as much as possible in incentives so governments should be very cautious about providing funding above what is necessary.
- Net Present Value Analysis. Economic development projects with returns far into the future should have those returns discounted and judged based upon the present value of the options. The discount rate or rate of return should be the rate the public entity can expect from alternative uses of the upfront investment.
- Sensitivity Analysis. All calculations of fiscal impact and net present value will be dependent on certain assumptions used in the calculation. A proper analysis should determine the impact of changing those assumptions.
- Risk Modeling. When multiple uncertain factors are involved, risk modeling will determine the likely impact after many simulations of multiple factors together.
- Benchmarking Analysis. The finance officer should compare this proposed project to other historical examples within other communities.
For complex projects, the advisor should be able to assist finance officer to assess risk factors and understand risks thoroughly.
- Identify Appropriate Financing. Governments should determine the most appropriate financing, if any, for the proposed project considering the likely financial and economic impacts, the overall risks, and the following:
- Exportability. Who is baring the burden of the project cost?
- Length of Debt and Ability to Service the Debt. What is public entity’s ability to service the debt in the future?
- Relationship of the Project to the Revenue Stream. How reliable are the expected project revenues and is it appropriate to consider the project revenues as being available to pay any deb service.
- Public Preferences and Existing Policies. Should the public borrow to help private development projects; how will it benefit the public interests?
- External Factors. How are revenues available to pay debt service impacted by changes in customer demand, overall economic conditions, or competition from other projects in the region.
- Assess Any Impact on Service Levels or Demand for Public Services. Large economic develop projects will likely have an impact on the provision of existing services. Any direct and indirect impacts on existing services should be carefully considered.
- Negotiation Protections for Implementation. See GFOA’s best practice on Performance Criteria as Part of Development Agreements.