Shared Services Funding in the Public Sector

Public sector shared service vehicles are seen as opportunities to reduce costs and create business efficiencies. We review some of the funding issues that clients often come up against in their quest for savings and productivity improvements.

Set up funding will be needed to enable the shared service vehicle to acquire the assets transferred from the public sector partners. Consideration for these assets could be met by the issue of shares or loan stock or a combination. The former would yield a return to the shareholders by way of dividend payments and could be structured as partly preferential shares attracting a fixed dividend that could accumulate providing the vehicle with some breathing space on payments.

Alternatively by way of ordinary stock that would yield variable and undetermined dividends and would allow the vehicle to establish positive cash flow and profits before making a dividend payment. If the loan stock route is adopted then the vehicle will require cash to meet the interest payments in the early months before it becomes cash positive. The local authority partners will therefore need to invest in the vehicle from the outset or agree to defer the loan stock interest.

In any event the vehicle will need cash funding from the outset to meet its working capital requirements which will primarily include set up costs that are incurred from outside suppliers (e.g. the costs of IT set up) and secondly the ongoing costs of salaries, rents, VAT etc.

This working capital investment could be provided by way of a combination of: (i) cash injection from the partners (ii) extended credit terms with outside suppliers that are guaranteed by the partners (iii) on account payments by the partners against invoices rendered by the vehicle and (iv) bank funding possibly with a short term guarantee from the partners

In the longer term the vehicle will need to re-invest in its business to remain competitive and to maintain and expand services provided to its customers.

Such funding would be required to recruit & train personnel, acquire new equipment, to finance maintenance and support contracts, software applications to improve business management etc. This funding could be provided from a combination of:

  1. Retained profits. This would impact both the return that is provided to partners by way of dividend because the vehicle would need to retain more profits and distribute less. It would also impact the price of services from the vehicle since, as noted above, the vehicle would need to maximise its profits in order to generate sufficient profits for reinvestment.
  2. External Funding. The vehicle would obtain this external funding probably from bank borrowing since it is unlikely that the partners and/or third party partners would agree to fund the ongoing investment needs unless they were to lead to very significant expansion and growth in the business of the vehicle.

Of course the whole area of funding could be very much simplified but some consideration should be given to slightly more complex structures that allow greater flexibility of funding.

A McLaren
29 Sept 2010