Governments have employed up-front payments in PPPs in the form of capital contributions in number of instances in the past. Their most common use is on revenue based projects, to improve the financeability of the private portion. On availability based projects, up-front payments clearly reduce the overall private financing requirements but, at the same time bring forward the public sector payments. At best (depending on the discount rate used), this may have a positive impact on Vfm calculations by reducing the quantum of private financing costs. It may also allow different public entities to adjust their respective contributions (e.g. up-front payment to Government and a reduced unitary charge to a local authority).
There is an important distinction to be drawn between public sector capital contributions which (i) act to reduce the scope of the project to be financed by the private sector, and (ii) the situation when the public sector provides a contribution to the financing required for the PPP project. An example of the former case is where the public sector commits to provide access roads in a motorway project. This is generally the simplest model - although in the specific example given where the private sector is taking motorway traffic risk, it will wish to be assured that access infrastructure is, indeed, in place.
The situation is more complex where the public sector makes a contribution to the funding requirement of an otherwise privately financed project. Firstly, there will be issues of how and when the contribution is paid (presumably, as a minimum, after equity and pro rata to senior debt). Secondly, lenders will need contractual assurance that the funds will, indeed, be paid - otherwise, the project could run out of liquidity and go into default. Lenders will also be concerned about the seniority of public contributions in the case of project failure, and the implications for lenders' compensation on termination2.
PROS: It is probably the simplest way for the public sector to bring financial support to a project (assuming funds are readily available). Other practical benefits are mentioned above.
CONS: However, as a response to the credit shortage, up-front payments do not appear to have any significant advantages compared to the other forms of public support described below: obvious drawbacks are their permanent nature and the lack of compensation to the public party for its investment.
When they represent a significant part of the total financing, they also distort the balance of risks, as all projects risks have to be born by a smaller private element. Some of the financial benefit of the "free" public contribution can then be offset by increased private funding costs.
Finally, they raise potentially difficult inter-creditor issues and unwanted risk transfers, notably in case of default, where the public sector requires a repayment of some, or all, of its contribution.
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2 A useful discussion of these issues is given in Moody's Special Report "Impact of Grant funding on Senior Debt Ratings" of December 2008.