The state simply sells a publicly owned asset to the private sector in anticipation of achieving some or all of three key benefits:

• An immediate infusion of cash into the state treasury as a result of the sale.
• Long-term increases in state revenues as a result of the creation of a taxable asset, operation, or entity.
• Increased efficiency or quality as a result of turning the asset over to private sector management.

Example: A municipality which owns and operates an airport needs to increase revenues and reduce expenditures in order to avoid an increase in taxes. The governing body votes to sell the airport to the private sector in order to raise money and reduce costs by obtaining cash from the sale, making the airport and its operations taxable, and eliminating the cost of its management and upkeep.

A build-lease-transfer transaction is a variation of a lease-purchase financing arrangement involving the construction of a capital improvement by a private developer who leases the facility to the public or private user after the completion of construction and ultimately transfers title to the user. This arrangement allows the public body to finance the purchase of the facility without having to go through the procedures associated with bond financing.

Example: The state engages a private developer to build a warehouse and maintenance facility. According to the terms of the agreement, the state rents the facility for several years before legal title is transferred.

In a BOT project, the involvement of the private sector entity that builds the capital improvement does not end with the completion of construction and the making of final payment as it would in a conventional arrangement for public construction. Instead, the private sector builder is given a franchise which permits it to operate the new facility for a specified period. Transfer of legal title may occur at any time during the operations period, but ordinarily will remain with the private sector builder during the period of the franchise. During that time, the builder-operator is responsible for maintenance of the facility and is entitled to a financial return such as user fees. The opportunity for this additional return above and beyond what profit might be earned through the completion of the contract is a financial incentive which can make the project attractive enough for the private sector to provide all or part of the financing, allowing the state to avoid the need to raise funds.

Example: The Commonwealth of Virginia solicits bids on a BOT basis to build a new combined road and tunnel in the Hampton Roads area. A consortium of companies forms a new company which is awarded the project which includes a 30-year franchise agreement covering design, financing, construction, operations and maintenance of the facility. The local transit authority commits to lease the facility for the entire franchise period. Companies participating as shareholders in the franchisee are awarded contracts for major portions of the construction work. With the exception of the administrative costs associated with soliciting the bids and negotiating the contract, no public financing is required.

The state engages a private developer to build a warehouse and maintenance facility. According to the terms of the agreement, the state rents the facility for several years before legal title is transferred.

In a BOO transaction, the contractor is engaged to construct and operate a facility without transferring ownership to the public sector. Legal title to the facility remains in the private sector, and there is no obligation for the private sector to purchase the facility or take title.

Example: A Social Services Department engages a private developer to finance, build, own, and operate a day-care facility in an area where private facilities are not available. Dependents of state employees are guaranteed preference in filling available openings at guaranteed rates, but the owner-operator may use excess capacity to care for dependents of the local population at market rates.

In a BTO project, the private sector entity builds the facility and transfers ownership to the state at the outset of the operations phase, immediately after the completion of construction, taking back a lease and a long-term contract to operate the facility.

Operating revenue provides the required return on investment. Its advantages are similar to those offered by a build-operate-transfer (BOT) project, but the point of transfer of ownership occurs at the end of construction rather than at the end of the franchise period.

Example: The state hires a company formed by a group of private sector investors to develop and construct a toll bridge.

After construction is complete, the state receives title, leases the bridge back to the bridge development company, and hires the company to operate the bridge and collect tolls for a specified period of time.

Change in use rules are IRS rules which govern the possible loss of tax-exempt status for debt issued to finance construction of a publicly owned facility if the facility is acquired by or operated by the private sector. As such, they will affect the financial feasibility of private sector acquisition or operation of the asset. In February 1997, the IRS published Revenue Procedure 97-13 (Rev. Proc. 97-13) to set forth the latest rules which create a "safe harbor" so that a service contract will not result in a private use of a bond-financed facility. Rev. Proc. 97-13 supersedes all prior regulations in this area and is effective for contracts entered into, modified or extended after May 16, 1997.

The new rules provide a degree of certainty and specificity which has been missing from the public financial markets. The increase in the maximum permissible term for management contracts and the expansion of the number of projects able to access the change in rules will simplify the structuring process for many public-private partnerships and will make tax-exempt financing available for a greater number of projects.

Regulations and related revenue procedures regarding change in use rules are complex and legal counsel should be consulted regarding the procedures.

Corporatization is one form of privatization. It is a method whereby a state agency or function is turned into a privately owned corporation through an employee stock ownership plan (ESOP) or other financial transaction such as an asset sale or a sale of stock which leads to private ownership of the "business" involved. Refer to employee stock ownership plan (ESOP) in this document for further definition.

Example: A Department of Highways wishes to interject competition into its system for the maintenance of local roads. Instead of terminating all its road maintenance managers and crews and contracting out for all its road maintenance work, the department works with them to organize their own corporation which will compete with private firms for the work. Alternatively, the department may work with existing private firms to sell the maintenance system to the private sector and enter into an initial contract which will be recompeted by the department in later years.

Customerizing is a term referring to actions taken to help an organization provide better service to its customers. It is similar to the term performance measures.

Example: A police dispatch unit center works toward goals calling for a reduction in the amount of time required to respond to 911 calls.

By selling development rights as part of a total project package, the state can raise funds from the private sector that can be used to develop capital improvements which can enhance the value of areas surrounding the project.

Example: The state intends to rehabilitate an intercity railroad station. In order to help finance the project, the state sells rights to develop property surrounding the location of the new station which will be built.

Devolution is not a form of privatization, although it could lead to privatization. It is the transfer of a function from a higher level of government to a lower level of government, usually from federal to state, although it could be from state to local.

Example: If the federal government were to stop managing job training programs and provide funds to the states through block grants intended to be used for the same purposes, some states might choose to privatize this new function by contracting out the block grants or to provide vouchers to trainees.

An ESOP is a qualified employee benefit plan primarily used for retirement purposes. An ESOP is governed by the federal Employee Retirement Income Security Act (ERISA), which gave ESOPs statutory framework in 1974. ESOPs are a form of a stock bonus plan designed to make a broad spectrum of employees stockholders in the sponsoring company. An ESOP may be used whether the organization is already in the private sector or in the public sector, and is in the process of making the transition to private sector ownership. When the ESOP technique is applied in the public sector, it is a form of privatization. ESOPs have been used as a means of privatizing government agencies in foreign countries. In the United States, ESOPs have been primarily used in restructuring private corporations, but have a role in providing government services. ESOPs are advocated as a means of improving performance of an organization by giving its employees a stake in the operation. Senate Document No. 12 (1998), is the ESOP study conducted by the Council. The study embraces ESOPs as a privatization/competition opportunity for performing government services.

Example: This is an actual example. When the U.S. Office of Personnel Management decided it was necessary to reduce the cost of its division performing background investigations, an implementation plan was developed to form a new private organization to serve the needs of its customers while providing financial stability and opportunity for its employees. This vision was converted to reality with the creation of US Investigations Services, Inc. (USIS), which commenced operations in July 1996. The 700 former federal employees now own the largest private investigations company in North America. In its new corporate form, the company is profitable, has significantly reduced the cost of investigations to its customers, and the value of employee stock increased over 10 fold in less than two years. The USIS website is: www.USIS1.com.

Franchising is the granting of a special privilege to conduct business operations in a particular market. In the context of privatization, it would involve a government grant to a private entity of a right to provide services or to build or operate a facility with a public purpose. Some degree of exclusivity must be conferred with the franchise in order for the private party to reasonably evaluate the potential levels of return offered by the project. This technique is also referred to as granting concession benefits.

Example: A Department of Public Works uses a build-operate-transfer (BOT) approach in the development of a highway intended to be operated as a toll road. The state grants the developer the exclusive right to collect tolls. As part of the franchising agreement, the state agrees not to open competing routes for a certain period of time.

The fully allocated cost of performing a service or providing goods is the cost that includes all direct full-time and part-time personnel costs; materials; supplies; equipment purchases; capital and equipment depreciation cost; rent; maintenance and repairs; utilities; insurance; travel; operations overhead; and general and administrative overhead, all of which are defined in the Council's Cost Comparison Program ("COMPETE") user's manual. This cost is sometimes referred to as the true cost.

The development of the fully allocated cost is a necessary step in the competition process. Since governmental budgeting is developed on a cash basis and not an accrual basis, the budget cost does not reflect the full costs of performing government services. This full cost is required for informed comparison decisions with private sector costs to perform the service. The "COMPETE" software is not released outside of Virginia government.

These type of corporations have a mix of private and public characteristics. Possible forms of corporate organization include government ownership of all or part of the equity, and government sponsorship through some form of financial backing. They differ from ordinary agencies in their budgeting methods, their rights to operate as an independent entity, and their forms of governance.

Example: The Virginia Port Authority is a corporation owned entirely by the state, run by a Board of Commissioners appointed by the Governor, financed by user fees, and included in the Appropriation Act.

In contrast to a typical public sector facility which is owned and operated by the government, a GOCO facility is owned by the government but run by a private sector firm pursuant to a management and operations contract.

Example: Many sport coliseums are built with public funds and then managed and operated by private firms that specialize in securing both sport and other events for the facility.

An inherently governmental activity is one that is so intimately related to the public interest as to mandate performance by government employees. Activities that meet this criteria are not in competition with a commercial source.

Example: State police patrols are inherently governmental activities.

In a LDO transaction, the state would lease a facility and surrounding land to a private developer. The state enters into a long-term agreement to expand and develop the facility under a contract which calls for revenue sharing between the developer and the state.

Example: The state with a run-down facility enters into a long-term lease with a private developer of property surrounding the facility which allows the developer to develop and operate a retail complex near the facility. The project improves the facility, creates a tourist attraction, and generates tax revenues for the state.

Lease-purchase financing is, in effect, the private securitizing of government installment purchase obligations. As lessee, the state makes scheduled payments, and equity in the equipment or facility being purchased accrues to the state with each payment. Typically, the state will own the equipment or facility at the end of the lease term when all payments have been made, however, title can transfer at an earlier time as the parties mutually agree.

Private investors purchase the state debt in the form of certificates of lease participation which offer returns that are exempt from federal taxation. This method of financing is used as a means of shifting responsibility for financing major equipment or facilities from the state to the private sector in situations where the essential nature of the purchase gives the lenders confidence that the state will make the necessary lease payments. This type of transaction does not require voter approval as in a general obligation bond issue, but usually requires a non-appropriation clause in the transaction documents since the state cannot guarantee payments beyond the Appropriation Act in effect at the time of the transaction. Lease-purchase financing is also know as tax-exempt lease-purchase financing.

Example: A Department of Public Works enters into a lease-purchase agreement for the procurement of electronic toll facilities, thereby shifting the responsibility for the financing and maintenance of the system to the private sector.

In a leveraged leasing arrangement, the owner of a capital facility obtains the tax benefits of ownership of an asset by arranging debt financing and leasing the facility to a party who pays rent from revenues generated by the facility.

Example: A group of private investors borrows money to rehabilitate a highway and convert it to a toll road, leasing the road to a separate toll road development firm. The lessee uses toll receipts to pay the rent, which the owner/investors use to service the debt, and the owner/investors take advantage of any available tax deductions and credits associated with ownership and debt repayment.

A "make or buy" analysis is undertaken by a state agency to determine how much it costs to perform a function with state personnel as compared to contracting with an independent contractor from the private sector. The Cost Comparison Program ("COMPETE") is used to develop the fully allocated cost of a government function to compare the cost with a independent contractor. It is a step in the Council's competition process.

A "make or buy" analysis is recommended for many commercial activities that are put out to bid or for which a RFP is requested. They may also be required from an unsolicited proposal pursuant to §§ 9-346 and 9-347 of the Code of Virginia. An important purpose of a "make or buy" analysis is to introduce managed competition into performance of the function and to generate tax savings.
See DPS manual

Example: A state agency develops the current fully allocated cost for the maintenance and operations of a major state facility and issues an RFP with a performance work statement (PWS) for private sector proposals. After scrutiny of its fully allocated cost, the agency also responds to the PWS in the RFP with its most efficient organization (MEO) proposal which may differ from its current approach to the task in question. The cost of the MEO is compared against private sector proposals and the most cost-effective alternative is chosen.

Managed competition allows a state agency to compete with private sector providers for the right to perform public services which may or may not lead to contracting out for services. Based on a performance work statement (PWS) developed for private sector proposals, the state agency submits its most efficient organization (MEO) and corresponding cost estimate which will compete directly with the private sector proposals.

Example: This is an actual example. In 1978, the Department of Public Works in Phoenix, Arizona began to compete with private companies for the city's refuse collection business. After losing the first five bids for various refuse districts to private companies, the Department and its employees developed new most efficient organizations (MEOs) to its work which included better equipment, smaller crew sizes, redesigned routes, and performance incentives. As a result, it won back all five districts, the quality of services and worker morale improved, and costs to the city declined.

This is a term related to managed competition. It means the reengineered or reorganized organization that is proposed by a state agency to compete with the private sector to perform a commercial activity. It is based on the performance work statement in a RFP.

Example: The example described above in Phoenix, Arizona represents the approach to developing the most efficient organization.

It is a term used to describe various methods of improving the financial status of public or private sector organizations through transactions designed to extract untapped value existing in their assets.

Example: Examples of this approach as it applies to improving a government's financial picture include asset sales, sale-leaseback arrangements and wraparound additions.

A natural monopoly is thought to exist because it offers the most efficient market structure and because a competitive market would create inefficiencies that would be detrimental to the public welfare. As a substitute for the discipline of the marketplace, and as a means of preventing predatory practices, natural monopolies are sometimes owned by the government and highly regulated in terms of operations, pricing, and profits.

Example: For years, child support enforcement was considered the province of government only. In recent years, however, competition has been introduced into the marketplace and now private companies compete for contracts with the states to run successful private child support enforcement offices meeting the regulatory requirements at attractive prices.

Overhead includes the indirect costs that are not directly attributable with performing a state service or producing goods. These indirect costs include depreciation, operations overhead, and general and administrative overhead which includes a number of supporting functions.

In comparing state costs with private sector costs, it is necessary to compute state overhead costs to ensure a level playing field with the private sector.

Details and the method of calculating overhead costs are found in the Cost Comparison Program ("COMPETE") User's Manual.

The "COMPETE" program is not released outside of Virginia government.

Performance-based contracting employs specifications and a statement of work which focus on the purpose of the work to be performed and allow the contractor latitude in the manner of performing it. Performance-based incentives are contract provisions calling for the imposition of positive consequences for good performance and negative consequences for poor performance by the contractor.

Example: An agency engages a private sector firm to provide custodial services using a contract which specifies the required tasks in broad performance terms and provides for payment based on cost-reimbursement plus an award fee that increases the contractor's compensation depending on the quality of the contractor's performance. Performance quality is judged by criteria including quality of work, responsiveness and productivity.

Performance measures provide a series of indicators, expressed in qualitative, quantitative or other tangible terms, that indicate whether current performance is reasonable and cost effective. Performance measures can include workload and output-to-cost ratios, transaction ratios, cost per service unit of output, error rates, consumption rates, timeliness measures, and completion and back order rates. Performance measurement in the field of providing public services represents an effort to improve the system by focusing on measurable results or outcomes rather than inputs. It can be used purely by state agencies or by private sector entities working for or in partnership with state agencies.

Example: Instead of deciding how much money it wants to spend on road maintenance and appropriating that amount of money to the Department of Public Works, the City Council sets measurable goals for various specific levels of road maintenance. The Department managers respond with a statement of what it will cost to achieve the specific goals, and the General Assembly decides what will be required. Performance measures can also be applied to private contractors working for state agencies in cases of contracting out.

The Council's Cost Comparison Program ("COMPETE") is a tool to determine the performance measure of the cost of a per unit of output. "COMPETE" is not released outside of Virginia government.

Yes. A performance standard reflects the minimum, sector-specific, requirement for the performance of a commercial activity. It incorporates both quality measures and cost measures. Cost measures reflect the cost comparability procedures in the Cost Comparison Program "COMPETE" to assure equity in the comparison of state performance standards with private sector standards.

Example: In developing the fully allocated cost of its payroll operations, a state agency determines that it costs an average of $9.03 to issue a payroll check. The American Payroll Association indicates that its standard to issue a payroll check is $7.65. This is an indication that the state agency should take appropriate action to provide this service at the lower per unit payroll cost.

The Virginia Government Competition Act of 1995 (Title 9, Chapter 45, Code of Virginia) describes "privatization" as a variety of techniques and activities which promote more involvement of the private sector in providing services that have traditionally been provided by government. It also includes methods of providing a portion or all of select government-provided or government-produced programs and services through the private sector. Also see definition of managed competition.

Example: Examples of activities occurring in Virginia state government include: the private construction, management and operations of select state prisons; private operations of select child support enforcement offices; and the asset sale of the Virginia Education Loan Authority to a private servicing firm.

Public purpose debt is traditional debt used to finance a project intended to be of value to the general public. It can include ordinary government securities such as general obligation bonds or revenue bonds as well as qualified private activity bonds (PABs). Numerous non-traditional examples used to finance public projects are included in the previous examples.

Example: A general obligation bond is the traditional finance method to build public schools. Another effective non-traditional method to finance the schools would be a lease-purchase financing transaction.

A public-local government partnership occurs when several organizations in the public sector share a common interest with the state in the success of the venture. It is a joint venture in which state and local government resources are pooled in a joint effort.

Example: The Department of Health develops a community-based health education program with local governments in which the state and local governments share the cost of the program.

A public-private partnership is a partnership in which government and the private sector share a common interest in the success of the venture. It is a joint venture in which state and private sources are pooled in a joint effort.

Example: The public-private partnership between Virginia Correctional Enterprises and private firms yields benefits for all involved parties. State agencies are receiving more and better products and the prison inmates are receiving valuable training. The private firms are providing additional sales techniques and customers for the products and they are now able to compete in what previously was a state monopoly. At the Department of Motor Vehicles, private auto dealerships are working directly with the Department to provide car sales information via computer, saving time and money for customers.

Qualified PABs are instruments of indebtedness which are exempt from federal taxation when they satisfy certain requirements of the Internal Revenue Code (IRC). They include bonds issued to finance the construction of certain public purpose facilities and infrastructure projects. The private activity bond regulations issued on January 10, 1997 by the IRS facilitate more utilization of public-private partnerships for projects with tax-exempt bonds.

The new IRS regulations on management contracts and change in use rules create new safe harbors providing assurance that private operation or ownership of a facility will not cause the bonds financing the facility to become taxable. The new rules create expansion of opportunities for the private sector to enter into long-term contracts to operate and manage state facilities or buy state assets.

Regulations and related revenue procedures regarding these rules are complex and legal counsel should be consulted regarding the procedures.

Example: The New Jersey Economic Development Authority provided $100 million in tax-exempt financing for the private development of a water supply project serving three counties by using private activity bonds. The use of tax-exempt bonds resulted in millions of dollars in savings for the consumers.

A private developer of a project used for public purposes will want to have maximum flexibility in determining user charges in order to maximize the rate of return on investment.

In order to prevent certain pricing practices which might be considered by the public to be an unfair use of a monopoly franchise, or in order to encourage certain types of use, a government may limit the developer's ability to set user charges, or may limit the permitted rate of return to an amount sufficient to ensure the financial viability of the project.

Example: As part of a transaction granting a private franchise to build and operate a toll road, the state requires toll pricing which would encourage car pools, prohibit tolls above a certain price, and limit the overall rate of return to a certain percentage above which profits are returned to the state.

Risk unbundling is a means of facilitating the development of public-private partnerships for the development of capital improvement projects.

It calls for the segregation of private and public risks with the private sector preferring to assume those risks which are commercial in nature and which can be appraised and controlled, and leaving the residual risks to the government.

Under a sale-leaseback arrangement, the owner of an existing asset sells the asset for needed cash to another party who leases the asset back to the seller. If the owner is the state and the buyer is a taxable entity, the buyer can take advantage of certain advantages which accompany ownership. The new owner will often finance the purchase with long-term debt secured by the lease from the state.

Example: The state sells an underutilized building to a private developer who renovates it and leases it back to the state. The state receives cash from the sale of the building, tax revenues generated from private ownership, and the private developer capitalizes the building and gets the tax advantages of depreciation on the building.

A service contract is a means of financing facilities or equipment used for a public purpose. Pursuant to such a contract, a private firm will provide a facility or equipment to the state for its use in return for agreed compensation. Unlike a build-operate-transfer (BOT) transaction or a lease-purchase financing arrangement which shifts title to the state, the contract resembles a build-own-operate (BOO) transaction and makes no provision for the transfer of title to the state. Advantages to the state include treating contract payments as operating expenses rather than long-term debt, and avoiding a voter referendum. The private firm retains tax benefits associated with ownership.

Example: A private developer enters into contract with the Hampton Roads Sanitation District to provide water storage space. To fulfill the terms of the agreement, the developer designs and builds a water tower designed to be suitable for other commercial purposes when the term of the service contract expires. The District's payments are based on the cubic feet of water stored in the tower. At the end of the term, the parties could negotiate an arm's length agreement for the sale of the tower based on its fair market value.

Service shedding means the state stops providing the service leaving it entirely to the private sector. It is similar to a spin-off, or getting out of the business.

Example: The Commonwealth of Virginia sold the assets of the Virginia Education Loan Authority (VELA) for $59.3 million. The trends in the student loan marketing business rendered VELA as redundant.

VELA, which had made guaranteed student loans to Virginia residents, was sold to Sallie Mae, a federal government corporation. The proceeds of the sale were deposited in the General Fund of the Commonwealth.

In the context of privatization/competition, a spin-off is a financial transaction that turns a government function over to the private sector through corporatization. This approach to privatization/competition is most feasible when ther