IllinoisCRE Six factors for a successful public-private partnership Guy Smith August 3, 2018 Share on Facebook Share on Twitter Share on LinkedIn Share via email In June, the Chicago Infrastructure Trust announced a high-profile partner had come aboard one of the city’s most anticipated projects, an express rail line connecting downtown and O’Hare International Airport. The Boring Company—headed by the decidedly not-boring Elon Musk, of Tesla and SpaceX fame—was selected from a group of four firms to design, build, finance and operate the train. While no official price tag has yet been declared, the Chicago Tribune reports that Boring has estimated the cost would not exceed $1 billion. Large-scale infrastructure projects of this sort are increasingly financed by a public-private partnership (P3). This model was first proposed in the late 1990s as an approach to enhance flexibility for public entities in the procurement, construction and management of public facilities. Since then, much debate has arisen regarding the conditions that must exist for the P3 approach to be successful. While P3 arrangements can be used to deliver a wide range of economic infrastructure (roads, bridges, dams, electrical transmission lines, etc.) and social infrastructure (schools, hospitals, courthouses, museums, etc.), the delivery method should not be considered a cure-all for every public infrastructure development opportunity. Although each public-private partnership project is unique, there are common criteria that should be considered prior to a jurisdiction moving forward with the complex and challenging processes of a P3 procurement. Here are six key areas of consideration for communities considering projects using the P3 structure. 1. Political and legislative support The political leadership for the area of the proposed P3 development must be prepared to provide the team responsible for procurement, development and delivery with support at all stages of the project. Examples of support include developing enabling legislation, bridge financing for the procurement phase and communications support. In addition, financial guarantees must be made, demonstrating the jurisdiction is prepared to make payments to the successful P3 project “special purpose” corporation (“ProjectCo”) for the duration of the project agreement, which could be 30 to 40 years. In some cases, enabling legislation may not be in place to allow a jurisdiction to grant a license to the ProjectCo to operate or maintain the facilities over the term of the P3 agreement. In other cases, the jurisdiction may lack the capacity to enter into a long-term agreement with the ProjectCo, or to raise sufficient capital through bond issues to support the project from initiation through execution. These are key criteria that must be thoroughly analyzed prior to the jurisdiction moving too far forward along the road to procurement. 2. Value for money compared to traditional procurement A key component of a jurisdiction’s readiness to move forward with a P3 is developing a business case outlining the potential benefits and risks of proceeding with the project as a P3, compared to the benefits and risks of a traditional design-bid-build approach. The value in a P3 arrangement is often derived from the economies of scale of the P3 contractor assuming operations and/or maintenance of the proposed facility. As a result, the party preparing the business case must include the cost of operations and/or maintenance of the proposed facility under a traditional procurement approach for direct comparison. Once the business case has been completed with a risk-adjusted cost comparison of the traditional approach to a P3 approach, the decision-makers are able to make a reasonable assessment of the value of a P3 approach and determine whether the risks deemed inherent in the P3 arrangement are mitigated by cost savings over the term of the agreement. 3. Measurement of private partner performance The success of a P3 arrangement often depends on the ability of the private partner, or ProjectCo, to manage the risks it assumes when agreeing to perform work on the project over the term of the agreement. This risk management approach takes the form of economies of scale during the design and construction process, or efficiencies during the operations and maintenance stage. The key success factor for the jurisdiction lies in its ability to measure objectively the work of the ProjectCo throughout all stages of the project. If the ProjectCo does not meet its obligations, the jurisdiction may be enabled by the agreement to make adjustments to the ProjectCo’s payments reflecting the failure to meet contractual obligations. Therefore, a key component of a successful P3 arrangement is the presence of a clearly articulated payment (and payment adjustment) mechanism throughout the agreement term. 4. Separation of private partner performance from other activities related to the project When deciding whether to proceed with a P3 arrangement, the complexity of the proposed project is a fundamental consideration. The jurisdiction must determine in the early stages whether the proposed project includes a significant amount of renovation or rehabilitation work, or whether the project is on a greenfield or brownfield site. There should also be a determination of whether the work of a P3 ProjectCo can be separated from other work that may not be the responsibility of the ProjectCo. We strongly recommend that the P3 project be developed with minimum complexity; complexity introduces risk into the relationship, which can significantly erode the potential value for money of the proposed project. 5. Sufficient market interest and capacity The level of interest in the proposed project from the private partner community is a key success factor; the public-sector entity does not want to be placed in the position of throwing a party nobody wants to attend. Therefore, we strongly recommend that the jurisdiction engages in a robust market-sounding process prior to announcing the project publicly. This market sounding will allow the jurisdiction to determine not only the level of interest of potential private-sector partners, but also their capacity to engage in and complete the project in the manner and to the schedule specified by the jurisdiction. Market sounding is an important component of the communications strategy adopted by the jurisdiction to ensure it receives sufficient coverage and interest from the right potential private-sector partners. This exercise will also give the jurisdiction certainty on whether or not the proposed project is large enough (or small enough) to attract the appropriate private-sector partners to pursue the project. Pursuit costs for P3 projects can often be quite high; as a result, private-sector companies tend to be selective about potential public-sector partners to achieve optimum yield on their pursuit efforts. 6. Sufficient operations and/or maintenance component The ability of the public sector to benefit from efficiencies of the private-sector partner from the operations and/or maintenance component of the proposed project directly affects the success of the project. The public-sector jurisdiction must have a clear understanding of what elements of the maintenance and operations it is prepared to transfer to the private-sector partner, or ProjectCo. In addition, the jurisdiction must clearly articulate in the agreement its expectations of the ProjectCo and the prescribed payment adjustments that will be imposed if those expectations are not met. The operations and maintenance component of the project must be sufficient to allow the ProjectCo to leverage the efficiencies that can be passed along to the public sector. About the author Guy Smith has over 40 years of experience in the property development and institutional construction industry, starting out with one of the largest construction corporations in Europe before moving to Canada in 1977. He has experience in quantity surveying, cost management, statistical analysis, development economics, cost modeling and process management and strategic planning. He currently conducts P3 Advisory Services at Rider Levett Bucknall.