12.2.2  Commercial and financial issues

Some issues that may arise as part of the commercial / financial evaluation include:

Certainty of finance.  The certainty of the financing should be assessed as material outstanding issues may cause significant issues to arise as part of the final negotiations phase of the project.  The review should be approached from the financiers' perspective and not just government. In reality, financiers can usually find a basis for withdrawal from the project despite the presence of commitment letters (although their credibility with government subsequently suffers). The evaluation should therefore focus on whether the project cash flows and sponsor support show a proposition likely to meet the requirements of debt providers.

Sponsor (i.e. equity and key subcontractor) support. The financing structure proposed by bidders must indicate some equity contribution and the commercial arrangements with key subcontractors (e.g. builder and FM provider) should include appropriate security arrangements (i.e. bonds and guarantees). A highly debt-funded structure may give a lower bid price, but unless sufficient recourse to the sponsors exists, the project will lack a mechanism to achieve the necessary risk allocation. Contribution of equity funds or security/guarantees from the sponsors means that, if the services are not delivered and service charges are reduced completely or partly, the sponsors have a genuine commercial motivation to overcome the problem. Without this support, the risk allocation proposition is totally dependent on the financiers acting to rectify the problem. These issues need to be reviewed in detail, but generally debt financiers require sponsor support to protect them from the same risks that concern government.

Performance-based charges. The evaluation should particularly consider any proposed changes to the payment mechanisms that would increase the payments due for above-specification outputs (where there is reason to make additional payment for above-specification outputs). A signal may be a bid with a low service charge against the standard requirements but higher hurdles for abatements. The outcome could be a lower price against the base payments, but higher costs to government over the contract term.

Cash flow profile. The profile of payments outlined in bids should be assessed for any solvency issues for the private party. Bidders sometimes desire to back-end payments so that service charges start at a low level and escalate during the term of the contract. This may reflect a value for money financing structure, but assessment is needed of whether sufficient cash flow is available in the early years to support operating costs and debt. Back-ending may also have tax and balance sheet implications.

Residual value/debt amortisation profile. The bid evaluation process should specifically assess the rate at which debt finance is to be amortised. This allows the procurement team to understand the level of debt outstanding at each stage of the contract term. Assumption of residual value risk by the private party may give a lower cost for services to government during the term, but this structure may also result in debt levels giving a higher step-in cost at any stage.

Tax assumptions. The contract is usually drafted to allocate all taxation risks to the private party. The bid evaluation process should focus on the assumptions made about taxable income (i.e. including timing of the recognition of income and timing and availability of tax deductions).  If the project structure assumes incorrect tax assumptions, the private party could face a much larger tax liability than is reflected in its bid, with potential consequences for its viability.

Risks of shared use. Where a bid proposes that the infrastructure be used to service the requirements of both government and third parties, the associated risks need to be considered. Improved usage of the asset is a positive as it should lead to lower service charges to government. However, the third-party activities need to be appropriately partitioned. For example, in a hospital development where part of the facility is to be used to operate a private hospital, government must assess how a possible failure of the private operations could adversely affect services to government. This should include consideration of the financing arrangements and the specific rights of financiers if the private hospital fails.