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P3 Toolkit

Guidance Documents

Establishing A Public-Private Partnership Program: A Primer

November 2012

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Chapter 5 - Identifying, Evaluating and Structuring P3 Projects

Identifying projects that have the potential to be delivered as P3s early in the planning process allows agencies to more carefully consider how P3s fit into their long term performance objectives and fiscal constraints. Early identification can help to position P3 projects for success by ensuring that the P3 delivery model is considered in the scoping, preliminary design and environmental review of the project.

Public agencies have to make important and complicated decisions to develop effective P3 programs and projects, often under intense public scrutiny. Key issues that policymakers must consider, which are discussed further below, are:

  1. Whether to set up a P3 program or develop P3 projects on a project-by-project basis, and whether a P3 program should be housed in the State DOT, be a separate entity or housed in some other agency; and
  2. Criteria and a process for the selection of projects as potential P3s.

To evaluate and structure P3 projects, public agency staff will also need to be conversant with various evaluation tools, risk allocation considerations and financial considerations. These are also discussed in this section.

Program vs. Project-by-Project Approach

Once P3 authorizing legislation is in place, public agencies can take different approaches to identifying and evaluating potential P3 projects, conducting procurements and managing contracts. An important initial decision is whether to pursue P3 opportunities on a project-by-project basis or to establish a P3 program.

If a steady stream of projects is expected, a permanent P3 program can improve identification of P3 opportunities, reduce transaction costs, and educate stakeholders. An established P3 program could potentially instill private sector confidence. If the private sector sees public agencies investing in a P3 program, potential bidders may have added confidence that the agency is serious about carrying P3s from inception to deal-close and beyond. This can improve the number, quality and competitiveness of interested bidders on a proposed project. In addition, a permanent P3 program may allow staff to accumulate institutional knowledge and proactively identify future opportunities where P3s may be beneficial. However, setting up a program office is a significant undertaking that may not be worthwhile unless there is an expectation of a significant pipeline of P3 deals to evaluate and manage.

If the decision is made to set up a P3 program, a related issue is whether a P3 program should be housed in the State DOT, be a separate entity or housed in some other agency such as the Treasury. The advantage of having a P3 program outside the State DOT is that both transportation and other social infrastructure projects can be handled by the P3 unit, ensuring a large enough "deal flow" to make it viable to support full-time in-house experts in the various professional fields that are needed to successfully identify, evaluate, develop, negotiate, and oversee P3 projects.

Project Selection Process

States with ongoing P3 programs typically establish goals, policies, and standard processes that guide and facilitate the development and implementation of P3 projects. Clear program goals can guide agencies in establishing policies and making decisions related to identifying projects, structuring agreements, and selecting partners. Specific program goals may include:

  • Promote economic growth;
  • Encourage competition and innovation;
  • Realize long-term cost savings;
  • Transfer cost and schedule risks;
  • Accelerate major projects;
  • Coordinate agency processes and build public capacity to undertake P3s; and
  • Communicate the benefits and risks of P3s to stakeholders.

Not all projects are suited to P3 project delivery, so agencies need a way to identify which projects have the best potential to succeed as P3s. Agencies may identify projects with the help of the private sector through unsolicited proposals or a call for nominations, or projects may be selected through programmatic project screening.

Evaluation Tools

Once public agencies have identified a project as having the potential to be a P3 through a qualitative screening process, they typically conduct a series of progressively more rigorous evaluations to determine the best approach to deliver the project. These evaluations help decisionmakers choose how best to structure and procure a potential P3 project. Several types of analytical studies may be commissioned by public agencies to conduct these evaluations:

  • Traffic and revenue (T&R) studies;
  • Preliminary design and cost estimates;
  • Risk assessment;
  • Financial feasibility assessment using cash flow and valuation models; and
  • Value for Money (VfM) analyses.
Traffic and Revenue (T&R) Studies

T&R studies are used to forecast traffic and revenue on toll roads under various toll rate structures and macroeconomic scenarios. Agencies typically hire consultants to prepare T&R studies, which help the agency determine how to structure toll rates, decide whether to transfer, retain or share revenue risk, and understand what to expect from private sector bids.

Risk Assessment

Agencies use risk assessment4 to identify project risks, risk mitigation strategies, and the appropriate allocation of risk (discussed further below). While many risk assessments include only qualitative information, agencies can take the risk assessment a step further by quantifying the probability of risks and assessing the potential consequences in monetary terms. Agencies can then use the risk assessment to assign an equivalent monetary value to each risk. A risk assessment can help a public agency decide which risks to transfer to the private sector, which to retain and which to share.

Financial Assessment

Agencies use financial models5 to understand potential project value and cash flow requirements under different agreement structures and macroeconomic scenarios. Financial models include assumptions about revenue, project costs, financing costs, tax and inflation rates, and discount rates to estimate potential concession fees and/or project subsidies and to estimate appropriate toll rates if the facility will be tolled. Public agencies can also use these models to better understand the private sector's perspectives and incentives.

Value for Money (VfM) Analysis

A VfM analysis6 compares the projected risk-adjusted life-cycle costs of a project delivered through a P3 to a public sector comparator (PSC). A PSC is an independent, objective assessment of project costs if delivered solely by the public sector, against which potential and actual private sector contract bids and evaluations may be judged.

VfM analysis is used to guide decisions regarding potential P3 projects, including which procurement approach to use, which risks to allocate to the private sector, and which private sector bid to accept. Agencies employ VfM to compare the costs of different project delivery options by assessing the value of transferring risks to the private sector, as well as the value of any efficiency gains that may be obtained through P3s. Due to the tax-exempt nature of public debt, financing costs may be lower for the PSC. However, some tax benefits available to private investors (e.g., interest deductions and accelerated depreciation) can help level the playing field. Additionally, finance tools such as Private Activity Bonds (which are tax exempt) and low-cost Transportation Infrastructure Finance and Innovation Act (TIFIA) loans may substantially reduce the difference in financing costs between the PSC and the P3 option.

Inaccurate or erroneous estimates of cost and/or risk may seriously affect the estimate of the PSC. Further, the PSC is estimated using numerous assumptions and projections into the future, adding a high degree of uncertainty7. There are highly contentious arguments over the discount rate to be used - should they be the same for both public and private options? A recent study for the Pennsylvania Turnpike monetization used different discount rates for each option - lower for the public option, based on the government's borrowing rate, and higher for the private option, based on the private sector's weighted average cost of capital.8

Risk Allocation Considerations

Risks may be categorized in one of three ways:

  • Transferrable risks, i.e., risks fully transferrable to the private sector.
  • Retained risks, i.e., risks for which the government bears the costs, e.g., the risk of delay in gaining project approvals required from various Federal, State and local governmental agencies.
  • Shared risks, i.e., risks that are shared due to the nature of the risk, e.g., earthquake risk. (If the facility were to be damaged by an earthquake, the private sector may be only partially responsible for repairing the asset, depending on the extent of damage.)

To determine the optimal allocation of risk, an agency compares the public sector's ability and willingness to manage each risk to the ability and willingness of a potential private partner to do the same. Risks that the private sector is more capable of managing are transferred; risks that the public agency is more capable of managing are retained.

Financial Structuring for P3s

P3 projects are partly financed by debt that leverages revenue streams dedicated to the project. Structuring effective partnerships requires an understanding of the advantages, disadvantages, interests and capabilities of various sources of financing such as public agency bond issuances, Private Activity Bonds (PABs), special governmental credit issuers (such as the Federal TIFIA Program), private equity investors, and commercial loans.

Figure 5-1 shows a typical P3 financing structure under a P3 arrangement. The critical private investor is the concessionaire, the partner who bids for the project and is responsible for delivering it. To facilitate financing, the concessionaire typically establishes a special purpose vehicle (SPV), a legal entity organized to limit the liability of investors while at the same time protecting the project from the outside liabilities of the private consortium. Typically, the SPV has no assets or liabilities other than those related to the project. Investors in an SPV are sheltered from claims on their revenues or assets outside of those directly related to the project.

Figure 5-1 Simple P3 Financing Structure

Figure 5-1 Simple P3 Financing Structure.

Revenue from the transportation project is channeled through the SPV. The cash flow is structured so that accounts for project costs and reserve funds, as well as accounts to repay lenders and investors are sequentially funded. This is commonly referred to as a cash flow waterfall (see Figure 5-2). The cash flow waterfall defines the order of priority for project cash flows as established under the loan and financing documents. In a typical cash flow waterfall, dedicated revenues are used to pay for project costs and debt repayments before surplus revenues are used to pay back investors or shared with the public sector.

Figure 5-2 Typical Cash Flow Waterfall

Figure 5-2 Typical Cash Flow Waterfall.

Compensation Mechanisms

P3s are commonly classified by their compensation mechanism. The three most common compensation arrangements in P3 concessions are:

  • Toll concessions, where concessionaire receives compensation by obtaining the right to collect the tolls on a facility;
  • Shadow toll concessions, where the concessionaire receives a set payment from the public agency called a "shadow toll" for each vehicle that uses the facility; and
  • Availability payment concessions, where the concessionaire receives a periodic "availability" payment from the public agency based on the availability of the facility at the specified performance level.

Concession Term

The concession term (i.e., period of the agreement) may vary widely depending on the economics of the project and requirements of the contract. A typical length for a P3 contract is 35 to 40 years, but some contracts have terms of as long as 99 years. In the United States, private firms tend to prefer terms of 50 years or more because they can then capture the potential tax benefits of asset depreciation in an accelerated manner over a period of 15 years instead of over the entire term of the contract9. This "benefit" will be reflected in the bid price.

Concessions of less than 50 years are more likely to correspond to the design-life of a transportation facility, the term of financial instruments, and the time over which an agency can reasonably assess risk. There are always provisions to modify the contract over time as needs change, but these modifications may come at a cost.

One study for the Organization for Economic Co-operation and Development (OECD) and European Commission10 concluded that the optimal concession length is between 30 and 35 years, and a concession may be sub-optimal for taxpayers beyond that range. European countries have restricted the length of P3 contracts to 21 to 35 years.11

Pricing Financial Risk

Whether revenues are derived from tolls or other sources, public agencies seek to structure a P3 agreement in a way that achieves public benefits and can attract private financial resources. Potential private project sponsors determine whether and how much to invest or lend to a project based on an evaluation of projected project cash flows and associated risks. Both equity investors and lenders assess the extent and likelihood of project risks and price those risks. To the extent that they perceive risks to projected net revenues, investors will demand a higher rate of return and lenders will demand a higher interest rate or reduce the amount they are willing to lend.

Investors will make a bid if they decide that there is a good chance that they can meet a defined internal rate of return (IRR) or "hurdle rate." The IRR calculation is a measure of how well an investment pays off over time, and allows investors to compare different types of investments to decide where to invest their capital. Different investors have different hurdle rates.

Lenders are primarily concerned with the projected debt service coverage ratio or the amount of annual cash flow available to meet debt service payments in a given year, and the quality of the analysis that led to the project. Lenders generally expect a debt service coverage ratio of 1.2 or higher, depending on the source of revenue and other factors. Equity investors often anticipate refinancing a project on more favorable terms when the project has been fully operational for several years and the uncertainties associated with the project are significantly less.

Availability Payments

A Different Risk Transfer Approach: Rather than ask the private sector to rely on tolls for project revenues, public agencies have offered fixed availability payments to the private partner based on performance of the facility to standards. In the availability payment structure, payments to the private partner are not dependent on tolls. The public partner commits an annual payment to the private partner for maintaining and operating the facility to a specified standard. If the project is a tolled facility, the public partner would retain the revenues from the tolls. To determine the amount of the availability payment, private sector bidders submit bids based on the annual payment they would require.

There are a number of reasons why a public agency may choose to use availability payments instead of toll-based payments. The availability payment structure may allow the public sector to attract more bids that are competitive. It may be used in cases where tolling is infeasible, or on a toll facility when the public sector wishes to retain traffic risk because the private sector demands too high of a risk premium. An agency may also choose to use availability payments for a managed lanes project to retain the ability to dynamically manage toll rates to optimize mobility along the entire corridor in both managed and general purpose lanes. Finally, tolling may be more palatable to the public when the public agency controls toll rates and collects and retains toll revenues.

Other Ways to Share Demand and Revenue Risks

If the public agency is uncomfortable retaining all of the demand risk on a toll facility, there are alternative contract mechanisms that can allow it to transfer some portion of the demand risk. Innovative contract arrangements have been used to enable sharing between the public and private partner of the risks associated with uncertain future toll revenues. They include "dynamic concession terms" and "revenue bands." With dynamic concession terms, the term of the concession ends when a specified net present value (NPV) of the toll revenue stream is reached. With the revenue band approach, upper and lower bounds of the expected toll revenue stream are set contractually. If toll revenue is below the lower bound, the public agency provides a subsidy to make up some of or the entire shortfall. Revenues in excess of the upper bound are shared with or turned over entirely to the public agency. Both approaches reduce the exposure of the concessionaire to revenue risk.



4. FHWA, Risk Assessment for Public-Private Partnerships: A Primer. Available at:

5. FHWA, Financial Structuring and Assessment for Public-Private Partnerships: A Primer. Available at:

6. FHWA, Value for Money Analysis for Public-Private Partnerships: A Primer. Available at:

7. U.S. Government Accountability Office. Highway Public-Private Partnerships: More Rigorous Up-front Analysis Could Better Secure Potential Benefits and Protect the Public Interest. GAO 08-44, U.S. GAO, Washington, DC, February 2008.

8. Foote, J., G. J. Gray, and P. J. Cusatis. For Whom the Road Tolls: Corporate Asset or Public Good; An Analysis of Financial Strategic Alternatives for the Pennsylvania Turnpike. Commissioned by the Democratic Caucus of the Pennsylvania House of Representatives, February 2008.

9. Subcommittee on Highways and Transit, House Transportation and Infrastructure Committee. Public-Private Partnerships: Financing and Protecting the Public Interest. U.S. House of Representatives, February 13, 2007.

10. Stambrook, D. Final Report: Successful Examples of Public-Private Partnerships and Private Sector Involvement in Transport Infrastructure Development. Produced by Virtuosity Consulting for OECD/EMT Transport Research Centre, Paris, France, May 28, 2005.

11. Jeffers, J.P. et al. Audit Stewardship and Oversight of Large and Innovatively Funded Projects in Europe. FHWA-PL-07-001. Federal Highway Administration, Washington, DC, 2006.


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