30.2.1 The majority of PFI/PF2 projects have been based on a project-finance structure. This is due principally to the following factors:
• the amount of finance required to meet the investment needs of many PF2 projects is beyond the balance-sheet capacity of many of the individual companies bidding for these projects. Typically therefore consortia of financial and industry investors bid for PF2 projects through SPVs (whose financing will normally be off the investors' balance sheets);
• low average cost of capital with project finance, as a high proportion of the funding is derived from debt rather than higher-cost equity;1
• the project finance markets have provided long-term finance to match the long-term service delivery requirements of many Contracts, whereas few individual companies bidding for PF2 projects can support such long-term finance; and
• PF2 payment mechanisms are based on Unitary Charges which are payable over the full period of service delivery and are linked to standards of service performance. Such long-term predictable revenues are a common characteristic of project finance transactions and the project finance market is thus familiar with and able to fund such arrangements.
30.2.2 However transactions are also financed using the balance-sheet resources of the contractors, i.e. using corporate finance, which is not project-specific but relies on the overall financial strength of the contractor.
30.2.3 Corporate finance may be used by a bidder:
• where there is a single bidder instead of a bidding consortium;
• where the bidder has a strong balance sheet, and uses corporate finance for new projects as part of its normal business model;
• where it is cost-effective, such as for smaller transactions where the reduced transaction costs make it more cost-effective than project finance (which has relatively high fixed transaction costs); or
• where it gives greater flexibility for the investor or the Authority compared to project finance.
30.2.4 Although used in the past mainly for smaller (below £10 million) transactions, corporate finance has also been used in some sectors for large transactions. It should be noted however that transactions below £50 million capital value should not be pursued through a PF2 route.
30.2.5 Defining characteristics of corporate finance are:
• the entity with which the Authority signs the Contract is a prime contractor with credible financial standing or is supported by equivalent guarantees from a member of its group which impart financial strength to the entity;
• no references to third-party finance, or associated features such as interest-rate hedging (whether equity, debt or other forms of finance), appear within the Contract or other documents or letters entered into by the Authority;
• there is no third-party creditor due-diligence process;
• no assignments, acknowledgements or other documentation are given by the Authority in favour of or for the benefit of the Contractor's funders;
• there is no direct agreement between the Authority and the Contractor's funders; and
• there is no movement in the bid price once the bid has been submitted because of changes in market rates.
30.2.6 Where all the characteristics set out in Section 30.2.5 are present the funding can qualify as Corporate Finance, and the Contract amendments set out in Section 30.5, and the procurement changes set out in Section 30.3 should be applied. Where some but not all such characteristics are present, the Project has a "variant" structure (see Section 30.7) and amendments and procurement changes should be applied as appropriate to deal with corporate finance aspects of the funding. Authorities should seek advice in this regard.
30.2.7 Corporate finance, if chosen by bidders, may provide equally good performance incentives and value-for-money drivers as project finance, so long as the principles underlying this guidance are followed. The key principle is that private-sector capital must be at risk during the long-term delivery of outputs specified by the public sector in the Contract. The form of private-sector capital is, in this sense, secondary so long as risks are transferred cost-effectively.
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1 Notwithstanding that there is a theoretical position that gearing might not affect the overall cost of funding.