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Strategic Investment Case
Local Housing Delivery Company October 2018
GVA Real Estate Finance
Appendix 1
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October 2018
Contents 1. Background ................................................................................................................................................................................ 1
2. Council Objectives .................................................................................................................................................................... 3
3. Company Structure Overview ................................................................................................................................................. 5
4. Financial Considerations - including Initial Funding/Working Capital Facility/ Financial Relationship with the Company .................................................................................................................................................................................. 13
5. Council Land Transactions ..................................................................................................................................................... 21
6. Proposed Council Report Recommendations .................................................................................................................... 23
7. Next steps .................................................................................................................................................................................. 26
Prepared By: James Dair/ Ishdeep Bawa/ Nicolas Dent Status: Final Draft Date: October 2018
For and on behalf of GVA Financial Consulting Limited
Client: Stratford District Council Report Title: Strategic Business Case
Date: October 2018 Page: 1
1. Background
1.1 Stratford upon Avon District Council approved the strategic business case in April 2018 to establish a
housing delivery company. The strategic case established the key parameters and objectives of the Council
in establishing the company.
1.2 GVA have been commissioned to provide professional support and advice to Stratford upon Avon District
Council to help establish a housing delivery company, building on the advice already provided.
1.3 Our commission covers the following key areas of activity:-
a) Agree the final form of the company structure, building on advice already provided.
b) Propose a budget and indicative funding proposals for the working capital facility provided
by the Council to the housing company.
c) Provide a framework for the acquisition activity of the Company.
d) Provide a financial options analysis and structure to enable the transaction of the Council
land held as part of the proposed Canal Quarter development.
e) Propose a land disposals mechanism of Council owned land to the company to ensure the
Council achieves best consideration.
f) Advise on the corporate governance arrangements from the Councils perspective.
g) Provide a comprehensive risk management strategy for the Council in managing its interest
in the Company
1.4 GVA has worked alongside KPMG who have provided high level tax advice and Trowers Hamlin who have
provided legal advice to the Council. The previous advice is contained in the Strategic case report that was
considered by Cabinet in April 2018 and Full Council in July 2018. Our advice builds on the previous report.
1.5 The main purpose of this report is to set out sufficient detail to enable the Council to progress with
establishing the Local Housing Company. This report provides background information to the Cabinet report
which provides the constitutional mechanism for a decision to be made. Based on the workshop held in
September we have set out recommendations to the council in order to establish the Company.
1.6 The proposed recommendations that this report supports are as follows:-
a) Authorise the establishment of a limited company by using its “general power of
competence” under section 1 of the Localism Act 2011.
b) Approve a working capital budget up to £10m to facilitate the activity of the company.
c) Approve the arrangement by which LHC will draw down working capital.
Date: October 2018 Page: 2
Client: Stratford upon Avon District Council Report Title: Commercial Case
d) To appoint Directors to the company Board, yet to be determined
e) Delegate Authority to the S151 Officer and Monitoring Officer to undertake the following
activity:-
Produce the Memorandum and Articles of Association and Shareholder
Agreement
Register the Company
Apply for a company bank account
Appoint company auditors, legal advisors, commercial property advisors
Set up the financial systems
1.7 The contents of our report follows the activities set out in paragraph 1.3 above.
Date: October 2018 Page: 3
Client: Stratford upon Avon District Council Report Title: Commercial Case
2. Council Objectives
2.1 Housing represents one of the most significant challenges facing local authorities up and down the country,
this linked with continued levels of reductions in public funding and specifically ever reducing revenue
budgets is leading Council’s to consider alternative options to generate much needed revenue resources.
2.2 With the backdrop of significant regional demand and undersupply of housing of all different tenures, linked
with continued levels of public funding austerity and a broad agenda to become self-sustainable, Stratford-
upon-Avon District Council (SDC) has embarked on a key project to help address some of these challenges.
2.2.1 SDC has set a number of targets with regards to house building in its district. Pressure has been put on local
councils from central government to maximise housing delivery to try and compensate for the current
nationwide housing shortage the UK finds itself in.
2.2.2 The figure of how many houses to be built is stated in the Core Strategy 2011 – 2031, which was adopted in
July 2016, states that “at least an additional 14,600 homes (an average of 730 per annum) will have been
built across the district.” Within this figure the council seeks to ensure that “affordable housing will comprise
35% of the homes, unless credible site specific evidence of viability indicates otherwise”. The target area for
these houses is varied with 3,500 in Stratford, 3,800 in main rural areas and a total of 4,400 in new settlements
at Lighthorne Heath and Long Marston Airfield.
2.3 Over recent years house prices have grown in Stratford upon Avon, making home ownership for many an
unachievable goal. Although the Local Housing Company will be established with a commercial purpose, it
will in part seek to make a positive impact on both the quality and availability of affordable housing
products.
2.4 The main purpose for the Council to set up a Local Housing company is to help deliver the following strategic
objectives.
a) Maximise the Councils financial return from the disposal of its land and property assets, with
a preference to generate a secure revenue income stream(s) which positively contributes
towards the Councils medium/long term financial strategy
b) Secure local economic growth
c) Better utilise the Councils assets to drive socio economic change to secure a sustainable
future for the benefit of the community.
d) Ensure the Council is not exposed to undue financial risk
e) Improve the environment
f) Increase housing supply and in particular the level of affordable housing offered within the
Councils geographical boundary, either through self-delivery or acquisition (affordable
provision is likely to be cross subsidised through other commercial activity)
Date: October 2018 Page: 4
Client: Stratford upon Avon District Council Report Title: Commercial Case
g) Contribute to ensuring that businesses are encouraged to invest in Stratford.
2.5 The above strategic objectives have been considered at a Cabinet workshop held on 3rd September 2018,
and build on the objectives agreed in the Cabinet report of April 2018.
2.6 To positively contribute towards delivery of the above objectives the Council has decided to establish a
wholly owned company (WOC). Following the company being set up it will develop its own business plan
which will set out how it is going to achieve the objectives set by the Council.
2.7 WOC’s are relatively straight forward to establish. This structure should provide the Council with flexibility to
meet its objectives over the coming years. If necessary the WOC is capable of establishing subsidiary
vehicles, this could also include joint ventures with potential investor/developer partners.
2.8 The Strategic business case approved by Cabinet in March 2018 reviewed a range of alternative options
available to the Council to support delivery of its objectives set out above. This report builds upon previous
advice and provides appropriate analysis and explanation to support the next stage of the Council decision
making process.
Date: October 2018 Page: 5
Client: Stratford upon Avon District Council Report Title: Commercial Case
3. Company Structure Overview
3.1 It is recommended that four Directors should be appointed, with the potential for a number of Non-
executive Directors.
3.2 We have set out below what we believe are the key issues that the Council should be considering when
identifying the Directors of the Local Housing Company.
Governance
3.3 The Local Housing Company is a separate legal entity distinct from the Council and any other
owners/partners. The Council will need to consider a range of governance related issues, including:
a) the division of responsibilities between shareholders/members (as owners) and directors, and
matters reserved to the shareholders/members;
b) directors and company secretaries, their duties and potential liabilities (where the vehicle is
structured as a company);
c) board composition;
d) managing conflicts of interest, for both Council officers and elected members; and
e) the requirements of Part V of the Local Government and Housing Act 1989 and the Local Authority
Companies Order, where relevant to the particular company.
3.4 It is proposed that the Local Housing Company is a company limited by shares; the owners are its
shareholders. Shareholders ultimately control the company through the ability to appoint and remove
directors on the company's board and certain statutory rights to make decisions in the form of special and
ordinary resolutions. In addition, shareholders may exercise control in accordance with the rights given to
them either in the articles of association or a shareholders' agreement.
3.5 For local authority wholly owned companies, it would be normal for a shareholders' agreement to be put in
place to provide the Council with strategic control over the operation of the company through the right to
approve a business plan and certain "reserved matters". A sample list of reserved matters can be supplied,
but they reflect the decisions which are often important enough to the owners of a separate vehicle to
warrant the owners' specific approval. The type of decisions usually included in lists of reserved matters
include:
a) entering transactions of a significant scale;
b) changing the type of business undertaken;
c) buying or selling a significant part of the JV undertaking unless envisaged by the agreed
business plan;
Date: October 2018 Page: 6
Client: Stratford upon Avon District Council Report Title: Commercial Case
d) admitting new shareholders to the company;
e) changing the constitution of the company; and
f) winding up the company.
3.6 The reserved matters would need to be modified to suit the particular governance requirements of individual
vehicles and may require negotiation where third parties are involved in the vehicle as this is a key control
mechanism which the council can exercise over the vehicle. A balance needs to be struck between
maintaining appropriate control but also to recognise that the vehicle is operating with public money and
giving the vehicle sufficient freedom and flexibility to operate commercially.
3.7 The Council will need to decide who it wishes to exercise its shareholder function. Given the function is
about the strategic control over the company's activities, it would be usual for this function to be exercised
by the Council's members. Depending on the level of control retained under the shareholders' agreement,
this could be:
a) through all shareholder decisions going to Cabinet;
b) a committee of the Cabinet being established to undertake some or all decisions;
c) certain decisions being delegated to certain member(s) (e.g. a portfolio holder) and/or senior
officers.
3.8 If a matter is not by law or through the vehicles governing documents reserved to its owners, then it is
effectively delegated to those persons charged with management responsibility within the vehicle. In a
company, this group is the board of directors.
Directors and board composition
3.9 Directors owe a number of duties under the Companies Act 2006 and common law generally, a summary of
the principal duties and liabilities of directors is set out below. Additionally, it is commonplace, though not
essential, for a private company to appoint a secretary. Directors will be in control of the operation and
management of the company, subject to the control which the owner(s) have under the articles of
association and any shareholders' agreement.
3.10 There is no set template for the size or composition of the board of a company. There are however a
number of issues to be considered when deciding on the make-up of the board:
a) the appropriate size for a board;
b) the appropriate mix of skills and experience needed to lead a successful enterprise;
c) the need to demonstrate sufficient control; and
d) the potential for conflicts which could hinder the effective operation of the board (or indeed
the Councils).
Date: October 2018 Page: 7
Client: Stratford upon Avon District Council Report Title: Commercial Case
3.11 Although the company will be a body which is owned in whole or in part by the Council, it must be allowed
to operate as a separate enterprise. The company's board therefore needs to be of a sufficient size to
ensure an appropriate spread of skills and experience but not so large so as to inhibit fast and flexible
decision making, sometimes to tight commercial timescales. We would usually consider that a board of
between 4 to 7 individuals (with the ability of directors who cannot attend any meeting to send agreed
alternates/substitutes) to be a workable size.
3.12 The Council will need to consider ideally what skills and experience are needed from individual directors to
drive the company forward and make it successful. Council members and officers, who may not have a
commercial background, will need to be supported by a commercially astute company board.
3.13 In terms of the different "types" of people who may be considered for board membership, these can be
identified as follows:
a) elected members of the Council (non-executive directors);
b) officers of the Council (also called non-executive directors), i.e. officers who are not
transferring to the company but are staying in their Council roles;
c) senior managers/employees of the company itself (executive directors), i.e. officers who have
either transferred/been seconded from the Council to the company or have been directly
recruited by the company. It would usually only be the Chief Executive who would be
considered for a director role as well as their employee roles; or
d) independent people selected (ideally through open recruitment to adhere to good
governance principles) because they bring specific skills and experience (often referred to as
independent non-executive directors).
3.14 The question of whether elected members should be on the company board is considered further below
from a conflicts perspective. If a view is taken that elected members should be on the company board, it is
still relevant to consider what personal skills and experience they are required to bring.
Summary of Directors Duties
3.15 To act within powers – a director must act in accordance with the company's constitution and only exercise
powers for the purposes for which they are conferred;
3.16 To promote the success of the company – a director must act in a way s/he considers, in good faith and
would be most likely to promote the success of the company for the benefit of its members as a whole. In
doing so, s/he must have regard to (amongst other things) the following factors:
a) the likely consequences of any decision in the long-term;
b) the interests of the company's employees;
c) the need to foster the company's business relationships with suppliers, customers and others;
d) the impact of the company's operations on the community and the environment;
Date: October 2018 Page: 8
Client: Stratford upon Avon District Council Report Title: Commercial Case
e) the desirability of the company maintaining a reputation for high standards of business
conduct; and
f) the need to act fairly as between members of the company
g) to exercise independent judgement – this duty is not infringed by acting (i) in accordance
with an agreement duly entered into by the company that restricts the future exercise of
discretion by the directors or (ii) in a way authorised by the company's constitution.
h) to exercise reasonable care, skill and diligence – this means the care, skill and diligence that
would be exercised by a reasonably diligent person with (i) the general knowledge, skill and
experience that may reasonably be expected of a person carrying out the functions carried
out by the director in relation to the company and (ii) the general knowledge, skill and
experience that the director has.
i) to avoid conflicts of interest - a director must avoid a situation in which s/he has, or can have,
a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the
company. This applies in particular to the exploitation of any property, information or
opportunity (and it is immaterial whether the company could take advantage of the
property, information or opportunity).
j) not to accept benefits from third parties - a director must not accept a benefit from a third
party conferred by reason of (i) being a director, or (ii) doing (or not doing) anything as
director.
k) to declare interests - if a director is in any way, directly or indirectly, interested in a proposed
transaction or arrangement with the company, s/he must declare the nature and extent of
that interest to the other directors.
3.17 Where more than one duty applies in a given case, the directors must comply with each applicable duty.
The general duties also do not require or authorise a director to breach any other law.
3.18 The general duties apply to all the directors of a company. "Director" is defined in the Act to include any
person occupying the position of director, by whatever name called (and can include so called shadow
directors being a person in accordance with whose instructions a Director is accustomed to act). The Act
makes no distinction between executive and non-executive directors.
3.19 The general duties are owed to the company. Two broad implications follow from this:
a) Directors must act in the interests of the company, even where they are appointed to the
board by a third party, such as the Council. The nominated directors will need not only to
avoid conflicts of interest but to avoid the perception of any conflict.
b) Only the company will be able to enforce the general duties, although in certain
circumstances individual members may be able to bring an action on the company's behalf
(often referred to as a derivative action) and creditors may be able to do so where the
company is (or may become) insolvent.
Date: October 2018 Page: 9
Client: Stratford upon Avon District Council Report Title: Commercial Case
3.20 It is important to note that the Companies Act 2006 did not codify all common duties and law rules or
equitable principles which directors need to consider when exercising their functions as directors. Directors
will continue to owe certain equitable and common law duties to the company, such as:
a) the duty of confidentiality (this can be particularly problematic where directors are appointed
by a third party with potentially overlapping interests); and
b) the duty to consider or act in the interests of creditors when the company is insolvent, with a
view to minimising losses to them.
3.21 Liability for breach or threatened breach of the general duties is personal to the directors concerned and
unlimited in scale. Accordingly, it is not possible to quantify the potential exposure of a director. There may
be a need to consider insurance and/or indemnity for directors.
Conflicts of interest
3.22 In relation to conflicts, there are a number of issues to consider which can impact on the composition of the
board and in particular, what role should elected councillors and/or council officers play in relation to the
board.
Council officers as directors
3.23 Our advice is for councils to appoint officers to a board of a corporate entity which it owns. This is because
it is easier to manage the conflicts for an “officer director" than for an elected member - the Council
can agree to the officer continuing to act as an officer despite potential conflicts; agree not to take
action against him/her where s/he is required to act contrary to the interests of the Council due to his/her
role as a director; and agree to his/her remuneration as a director (or that the person will not receive any
additional remuneration from the Council).
3.24 There are three caveats to the recommendation of appointing officer directors which may affect who is
identified to undertake this role:
3.25 We would advise against statutory officers (the Monitoring Officer and s.151 Chief Finance Officer in
particular) being appointed as company directors as they may be required to undertake their statutory roles
in relation to the company at some point which would raise difficult conflicts;
3.26 There needs to be consideration of the "retained client" role i.e. if all officers who know anything about the
services being delivered are either transferred to the company to run them and/or on the company board
as a director, who is left to provide the expert, impartial advice to the Council to make decisions about
service performance by the company and about decisions in relation to the company in their capacity as
owners;
3.27 If officers, who are also company directors, are making decisions (at Council level) about the company,
those decisions will potentially be open to challenge because the decision is influenced by bias or the
perception of bias (because of their role at the company) and/or by pre-determination (that they have
made their minds up because of the company role and are not making the decision objectively and fairly).
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 10
3.28 It is a criminal offence for officers, under the cover of their office, to accept anything other than their proper
remuneration. Accordingly, where officers are appointed as directors by reason of their post within the
Council, they may not accept any payment from the company for their services as a director, unless the
Council agrees that the additional payment shall form part of the proper remuneration for that role. It is
therefore recommended that any officer director should be formally appointed and should formally notify
the Council of their interest, and their declaration should be kept on the officer declaration file.
Elected members
3.29 Although it is completely lawful for elected members to be directors of Council companies, there are some
intrinsic conflicts which need to be carefully addressed. These relate both to the Code of Conduct for
Members but also to the risk of decisions made by a councillor where s/he is also a director of the company
being challenged on the basis of bias or predetermination. It is not possible for the Council to avoid
accusations of bias or predetermination, especially if the member is senior. Directorships can therefore
constrain elected members' "Council side" activities and inhibit members carrying out their elected strategic
policy direction and scrutinising roles.
3.30 In the light of this, local authorities often decide only to involve officers in director roles, ensuring that elected
members are free to decide key issues about the organisation (i.e. the reserved matters) on behalf of the
Council in its strategic role as sole or part owner.
3.31 Directors' remuneration (if any) with the company will be governed by the provisions of the Local Authorities
(Companies) Order 1995, which restricts the amount of remuneration that a member can receive. This
means that they cannot receive any additional remuneration from the company for acting as a director
which is beyond the special responsibility allowance they would have received had the activities of the
company been discharged by the Council. Any remuneration they receive will be deducted from the
special responsibility allowance that they receive within the Council and they may only claim mileage and
subsistence at the rates that apply to members. Remuneration would also potentially amount to a
Disclosable Pecuniary Interest.
Practical points
3.32 If members or officers are appointed as directors of the company, there will be a number of
arrangements/processes to be put in place to ensure that conflicts are properly addressed and managed
as follows:
3.33 The constitution of the company should address "inherent situational conflicts" of the Council-appointed
directors on the board given that these conflicts can be foreseen because of the links between the councils
and the company – this helps to ensure openness of decisions making and probity at the company end of
activities;
a) appropriate conflicts and interests should be declared and recorded at all relevant
company meetings;
b) at the Council end, any officer serving as a director on a company must declare interests
(and be given the necessary consents to act);
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 11
c) under s.117 of the Local Government Act 1972;
d) under his/her contract of employment; and
e) under any relevant code of conduct for officers;
f) any elected member serving as a director of a company must declare an interest under
the Councillors' Code of Conduct) and comply with other rules about members on
companies (including a restriction on any remuneration); and
g) there must be arrangements at the Council end to ensure that decisions can be made in
relation to the company which are robust. Although all the necessary conflicts and
interests can be declared, if decisions are made by the Council by members or officers
who have an interest in that decision from a company perspective, there will always be a
risk of an allegation of bias or pre-determination being made to challenge that decision.
3.34 Although the detail around which Directors are likely to be appointed has not been agreed, it is still
appropriate to set out the company structure that will need to be in place. This section of the report provides
an overview of the basic company structure requirements.
3.35 It should be noted that all key decisions taken by the company will be undertaken in accordance with the
governance documents, which include the Memorandum of Understanding and Articles of Association.
3.36 Although the structure will evolve over the initial period of activity, it will need to provide oversight for certain
elements of the business even initially. The diagram bellow illustrates the overview of responsibilities needed
during the initial period. We have assumed that for each area a Director will be appointed and this is
intended to be the basis for the Company Board.
3.37 We would suggest that a number of Non-Executive Directors are appointed to support the Board, however
we would recommend forming the Board first and allowing it to become established before introducing the
Non-Executive Directors.
3.38 Initially the Board will need to be resourced either from interim external advisors or from staff seconded
across from the Council. Longer term we would anticipate the Company properly recruiting staff to support
the company.
Approach to risk management
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 12
3.39 Risk will be managed through two alternative mechanisms, as set out below:-
a) Council led risk management Business plan and land transaction mechanism – the
company is required to submit a business plan to support each site drawdown, this will be
independently assessed by the Council to establish whether the Council is achieving best
consideration at the point of disposal. In addition to each site being reviewed the
Council will also need to approve the annual business plan for the company. Both
mechanisms provide a way of controlling and managing the Council’s reputational and
financial risk exposure. The detail associated with these mechanisms is provided
elsewhere in this report.
b) Company Board led risk management – as part of the annual business planning and
monitoring process the Board will need to establish and review the companies risk
register, and take appropriate action where appropriate.
3.40 The company Board will be required to identify two types of key risks. Firstly risks that impact on the delivery of
the business plan and risks that impact on the shareholder.
3.41 The business plan for the company will need to set out the key elements of the risk register as well as
identifying how risks are to be managed and mitigated.
3.42 The Company will have to arrange Professional Indemnity Insurance and Personal Liability Insurance.
Client: Stratford upon Avon District Council Report Title: Commercial Case
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4. Financial Considerations - including Initial
Funding/Working Capital Facility/ Financial
Relationship with the Company
Funding of the Company
4.1 As set out in the Strategic Business case, the Council as sole shareholder of the company will need to provide
initial working capital for the Company’s operations along with the seed capital to make investments in the
residential market place. In this section of the report we set out the market analysis conducted to shape the
quantitative analysis for the company including the investment and return of the company as well as the
Council.
4.2 Our analysis is set in the context that the Council wishes to ensure that the Company is active in the market
as soon as possible and that it is able to reach a scale that allows it to start making a genuine impact in the
local housing market. As part of the quantitative analysis we have set out an initial investment of £10m which
would enable the Council over a 3 year period reach a reasonable scale, however this will be heavily
dependent on the on the market conditions along with the quantity and quality of stock available to
purchase. The £10m should not be seen as either a minimum or cap on investment and the analysis should
be seen as what could be achieved within that envelope of funding. At this time the Council will be
agreeing in principle to provide the Company with up to £10m to acquire properties; however the funding
will be drawn down based on a business plan which will be set out by the Company and individual business
cases going forward for each acquisition.
4.3 The Council as shareholder and approver of the Company business plan will be able to increase that limit in
the future, however at this stage the approval of £10m would enable the Company to be established,
operate and acquire properties over a 3 year phased period.
4.4 The Council will provide funding to the company and it is likely to be in the form of debt and equity. Until the
final business plan of the company has been agreed it is not possible to determine the optimum balance
between the two. In structuring the working capital as a combination of shareholder equity and debt
funding, the structure must avoid “thin capitalisation” in that the company should have sufficient equity
funding to meet any debt and interest obligations to the Council and run in a financially solvent manner.
4.5 The Council will be the sole shareholder in the subsidiary and will own 100% of the share capital. The Council
could provide all the funding to the company by way of share capital. However, this would result in any
benefits of the funding to the Council being paid by way of dividends after tax and hence would not
represent an efficient use of the Council’s funding.
4.6 The Council can provide debt funding to the company by way of loans or loan notes (shareholder loans)
with an interest charge to the company. The interest would be tax deductible and would result in the
Council receiving interest on the loan before tax, the Council would also receive dividends on its
shareholding after tax.
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Date: October2018 Page: 14
4.7 Utilising our presence in the funding markets and experience of residential investments we have
benchmarked the debt/equity split for the housing company at 70%/30% based on loan to cost ratios. This
has been the basis of our financial evaluation for the Company’s operations.
4.8 It is recommended that the Council’s intention in lending to the company should be based on market rates
to avoid any Transfer Pricing issues as well as to ensure state aid compliance. It is assumed that the Council
and the company are connected parties for tax purposes; as such transfer pricing rules will apply. Transfer
pricing rules are the cost of supplies, goods and services (revenue not capital, including loans) between
connected parties. These prices need to be market related. This issue becomes significant where the Council
charges higher than market prices for supplies, goods, services and interest, as this would result in a lower tax
liability (i.e. lower than market) to the company and provide the Council with an advantage.
4.9 Where the Council charges more than market value, transfer pricing rules would apply to the company,
adjusting the tax to be paid by the company.
4.10 The company will initially be funded by the Council committing funds for the set-up and establishment of the
vehicle; operational expenditure and project development costs. Given the differences in the tax status of
the Council and the company it is recommended that these funds will be provided by the way of a loan
(loan note) to the company, this loan will carry an interest rate to be State Aid compliant.
4.11 The Council would provide funding or assets (land) to the SPV by way of existing resources, Public Works
Board Loans (PWLB) or the transfer of property. Where property is transferred this would also be provided on
a loan (loan note) basis. For the purposes of our analysis we have assumed that the Council will be
borrowing in order to on-lend to the Company, however we understand that an element of internal
borrowing is possibly dependent on the overall scale of investment agreed as part of the business plan
process.
4.12 The loans provided by the Council to the company will be at a higher interest rate than the PWLB loan rate
to ensure the Council receives a margin (profit) for the risk of providing a loan to the company and to ensure
compliance with State Aid regulations. Where the Council is internally borrowing, the margin received will be
greater due to the PWLB borrowing costs being replaced by the opportunity cost of cash investments, which
is significantly lower.
4.13 The company’s initial business plan is likely to evolve around the acquisition of properties on the open market
and therefore the company will borrow on the basis of investment loans. The loan terms could be either an
annuity payment which pays back an element of interest and principal or an interest only facility with a
bullet payment for the principal at the end of the loan term. The exact loan structure will again be
determined once the business plan has been put in place, but it will be important for the loan structure to be
sustainable and enable the company to operate on a sound financial footing. This will inevitably require a
balance between the desired returns of the Council as both lender and shareholder and the requirement for
a financial sustainable business.
Operational Budget
4.14 The Company will need a working capital to operate. The types of costs that the Company will occur over
time will include:
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 15
Salaries
Back office functions (Finance, Audit, HR, I.T)
Professional Fees (External Advisors – corporate finance, business planning, due diligence)
4.15 Upfront costs will need to be incurred prior to the Company acquiring assets such as incorporation of the
legal entity, memorandum of understanding and articles of association alongside the development of a
business plan. Costs will increase over time as the Company scales up with respect to its operations but in the
early years, the Company will not want to be burdened with significant costs especially before it is
generating income through its activities. Indeed some of the items above will not necessarily be cash items
but will be resources that the Council will provide to the Company through service level agreements. While
the exact level of working capital facility will be determined by the exact governance structure and business
plan agreed, for the purposes of this report we have set out an indicative budget of £300k over the first 3
years.
4.16 The diagram below sets out what the expected flows of cash will be from the Council to the Company and
vice versa
4.17 The Council is also considering the disposal of land to the Company for the canal quarter (this option is
considered in more detail later in the report). Any Council land that is disposed of to the Company will need
to transfer at a value that achieves best consideration. The transfer of the land can be either before or after
planning has been achieved but should be based on an independent valuation to demonstrate that value
for money has been achieved. Land transferred to the Company after planning has been achieved will
maximise the capital receipt that the Council receive whereas pre planning disposal to the Company will
see a financial benefit accrue to the Company and enable proceeds to be recycled by the Company.
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 16
4.18 One of the options being considered for the Canal Quarter includes the Company receiving residential units
in lieu of a capital receipt. In these circumstances, the Company will not have a cash receipt to pay the
Council for land. The Council would therefore need to structure the sale of the land as either a loan note
which would accrue interest and be repaid as and when surplus cash is available in the company or
potentially structure an arrangement whereby the company pays the Council a ground rent over a period
where the value of the lease is equivalent to the best value consideration required on any disposal.
Market Analysis
4.19 In order to develop a financial model to assess the company’s forecast performance and subsequent
Council returns; we have undertaken local market analysis to understand the types of properties currently on
the market, the acquisition costs that the Company may incur and the resulting residential rental values that
could be achieved. We understand that the Council wishes the Company to acquire a greater percentage
of smaller units sizes and therefore we have assumed that the acquisition portfolio will be split as follows:
50% - 1 Bedroom Properties
30% - 2 Bedroom Properties
20% - 4 Bedroom Properties
4.20 We have taken the assumed portfolio split and the market data to calculate a weighted average cost for
both acquisition costs and rental income received per annum. The table below summarises this analysis.
No Beds Average Rent
(pcm) (£)
Average Rent
(Pa) (£)
Average house
Price £
Yield % in
Portfolio*
1 Bed 674 8,088 171,000 4.73% 50%
2 Bed 876 10,509 206,588 5.09% 30%
3 Bed 1,238 14,850 362,717 4.09% 20%
Weighted Average 846 10,362 220,020 4.71% 100%
*The actual portfolio split will be determined through the business planning process
4.21 The table shows that across the portfolio split, the average rental per property that could be achieved is
£846 per calendar month (pcm) which equates to £10.4k per annum (pa). Based on a weighted average
acquisition price of £220k, this would give the Company a gross yield of 4.7%.
4.22 We have assumed that the Company will deploy capital equally over a 3 year period and this will need to
be refined during the business planning process. As set out above, we have set this analysis in the context of
available funding of £10m over the 3 year period. Assuming that there will be a need to put aside c£100k for
the on-going operations, this leaves £9.7m for acquisitions. Accounting for transactions costs (professional
fees and stamp duty), this would leave a net of c£9.1m to bid for and acquire properties in the market. This
would enable the Company to acquire around 14 properties annually over the first 3 years which would
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 17
result in a portfolio of 41 units. The actual drawdown of funds by the company and therefore the size of the
portfolio will be based on company business plans.
Financial Implications
4.23 We have looked at the financial implications from both the Company and Council perspective. The analysis
in the table below are an indicative representation covering a 30 year period including the 3 year phased
acquisition programme as set out above. Key assumptions for the modelling are set out below:
3 year acquisition programme for 41 units
Interest only loan from the Council at 4.5% (including a 1.5% Margin over and above PWLB)
Disposal of portfolio at year 30 to enable loan principal repayment
All surpluses available for distribution to the Council
Working capital facility for the first 3 years (£300k) injected as equity – this however may be in the
form of resources as opposed as pure cash.
Rental increase of 2.5%
Housing Price Inflation 4.5% - utilised to calculate vacant possession value at year 30 (Historical average going back 20 years has been 6% for Stratford)
4.24 The table below shows the key financial metrics for the Company
Company Financial Position
£ Acquisition Costs 9,700,000
Funded By:
Equity 2,910,000 Debt 6,790,000 Total Investment Funding 9,700,000
Working Capital Facility 300,000
Total Funding Received 10,000,000
Income: 30 Year Period
Net Rental Income 13,216,599 Portfolio Disposal @ Yr 30 16,271,916 Tax Liability (740,478) Total Income 28,748,038
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 18
Debt Interest Repayments 8,860,950 Debt Principal Repayment 6,790,000 Surplus available as Dividends (after tax) 13,097,088 28,748,038
4.25 The Company’s rental income shown in the table is the net position after accounting for gross to net
efficiency of 30%. This means that 30% of the gross rents have been allocated for items such as, voids,
management and maintenance, bad debts etc. The surplus shown above is a post-tax position and
applies the current know rates of tax as set out by the government, with the rate being 19% in 2019 and
reducing to 17% in 2020. The tax liability is calculated on the profit and loss the company makes and while this
can differ from the net cash surplus generated by the company we have taken this as a proxy for the profit
that could be liable to tax.
4.26 In many ways the Council’s financial position will mirror that of the Company’s given the shareholder and
lender relationship between the two. While we understand that the Council would potentially be able to
utilise internal borrowing for initial cash injection into the Company we have taken the approach of the
Council borrowing and on-lending the full amount. This will be a treasury management decision as and when
the Company draw down on the approved funds and to be conservative we have assumed that the
Council will need to borrow.
4.27 The table below shows the Councils returns as both shareholder and lender.
£ PWLB Borrowing 10,000,000
Invested as:
Equity 2,910,000 Debt 6,790,000 Total Investment Funding 9,700,000
Working Capital Facility 300,000
Total Funding Provided 10,000,000
Surplus received as Dividends (after tax) 13,097,088 Interest Payments Received from Company 8,860,950 PWLB Interest Payments (8,700,000) MRP Provision (5,800,000) Net Revenue Surplus/(Expenditure) 7,458,038
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 20
4.28 As set out in the assumptions the financial analysis is based on an acquisition programme of 3 years. In
practice the Company will have a rolling business plan which will be updated annually and over time the
Council and Company will be able to agree to upscale the investment proposition (or indeed scale back if
market conditions are not favourable). We have also assumed that the entire surpluses generated by the
Company are available for distribution; however those surpluses could be reinvested by the Company.
4.29 Should the Council choose to prudentially borrow then considerations will need to be given to minimum
revenue provision (MRP). MRP is the minimum amount which a Council must charge to its revenue budget
each year, to set aside a provision for repaying unsupported external borrowing (loans). The Council will
need to agree its MRP policy as part of its wider treasury management policy and whether there will be a
charge in relation to Company loans.
4.30 For the purposes of modeling GVA has been provided with assumptions by the Council and utilised a 2%
straight line annual MRP charge. On this basis the stabilised annual MRP provision that the Council would put
aside is £200k. This is a significant provision in the context of the annual cashflows that the Council would be
receiving from the company and will result in a net budgetary pressure for the Council until rental growth is
sufficient to cover the MRP charge. Based on the assumptions made this would peak at £179k reducing
annually.
4.31 The net budget position for the Council will therefore be dependent on the decisions made around MRP and
therefore the analysis should be seen in this representative context and not the actual returns that the
Council will receive once the local housing company has been established.
Tax Considerations
4.32 As we have set out above, this report does not look to quantify the tax implications of the activities of the
Company in any detail but utilising representative figures. Below we have included a summary of the
high level tax implications that will need to be considered during the business planning process. While
this was covered in the strategic business case along with a more detailed opinion by KPMG, it is
important to reiterate the potential tax issues that the Council and Company will need to consider.
4.33 A limited company is treated as being opaque for tax purposes (i.e. as a separate taxable entity from that of
the owners and directors).
4.34 Trading profits - a company will pay corporation tax on its trading profit. Corporation tax is charged at 19%
regardless of the level of profits distributed by the company.
4.35 Trading losses - a company can off-set losses of its trade generated in any given accounting period against:
other income and gains of that company generated in the same or previous accounting period (e.g.
Capital Surplus 2,590,000
Total Surplus 10,048,038
Consolidated IRR 3.24% Consolidated NPV (293,679)
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 20
income from other trades or capital gains) (current year and carry back relief); and profits generated in the
same trade in that company in future accounting periods (carry forward relief).
4.36 A company can also off-set trading losses generated in the last 12 months of a trade that permanently
ceases, against other income and gains of the company in the same accounting period and the three
previous accounting periods (terminal loss relief).
4.37 Stamp duty land tax will need to be paid on acquisitions of properties. The stamp duty cost will be
dependent on the bands that the properties acquire will sit in. Should future activities include land transfer
from the Council to the Company (e.g. Canal Quarter) then group relief would be available and there
would not be a stamp duty liability that will need to be paid for those transactions.
4.38 Capital gains - a company pays corporation tax on its chargeable gains (other than gains on properties that
have been subject to the annual tax on enveloped dwellings, which will be instead be subject to capital
gains tax at 28%).
4.39 A company is entitled to indexation allowance when calculating its capital gains, which effectively allows
for inflation over the period of ownership of the asset.
4.40 A company may also be able to take advantage of roll-over relief on disposal of an asset.
4.41 Capital allowances - a company may claim capital allowances on eligible assets which it uses in its business.
The allowances are the tax equivalent to the depreciation of capital assets and, if claimed, reduce the
trading profits generated by the company and therefore the amount of corporation tax payable.
4.42 VAT - VAT registration is mandatory once the value of VATable supplies made by the company in the year
exceeds the registration threshold. A company may only have one VAT registration regardless of how many
trades it carries on.
4.43 NICs - NICs are only payable by a company when it pays remuneration to an employee.
4.44 When a company pays an employee:
4.45 The employee is required to pay (usually by deduction from salary by the employer) primary class 1 NICs of
12% of earnings between the primary threshold and the upper earnings limit (£157 and £866 earnings per
week, for the 2017/18 tax year) and 2% of earnings above that upper earnings limit; and the company, as
employer, is required to pay secondary class 1 NICs of 13.8% of earnings above the secondary threshold
(£157 earnings per week for the 2017/18 tax year).
4.46 From 6 April 2016, a company that pays secondary class 1 contributions is entitled to an "employment
allowance" of £3,000 broadly to be set off against class 1 secondary NICs (albeit, from 6 April 2016, a
company where the only employee is also a director of the company cannot qualify for this allowance).
4.47 Dividends - a company may distribute taxed profits to its shareholders by means of a dividend. Dividend
income, in the hands of the recipient, will be taxed in accordance with the tax status of the recipient.
Client: Stratford upon Avon District Council Report Title: Commercial Case
Date: October2018 Page: 21
5. Council Land Transactions
5.1 Alongside the investment acquisitions that the company will be making over the next few years, the Council
needs to determine how it should invest land and potentially property into the Local Housing Company and
importantly have a clear process for considering the disposals on a site by site basis. This section of the
report identifies the preliminary issues to be considered as well as various risks and challenges that are likely
to be faced and provide some suggestions for tackling or minimising them.
5.2 The Council in due course will prepare a list of sites that may be transferred to the company. This is separate
from the Council's ongoing disposals programme and ad-hoc disposals to other developers or other
collaborations.
5.3 The Council needs to ensure that it obtains best consideration for any land and property that it agrees to
transfer to the company (and this will be tested through independent valuation). Sites will generally be
transferred on a freehold basis. The drawdown of sites from the list will be as agreed between the council
and the company, through the preparation of business plans for each site. The drawdown of sites will be
subject to the decision of the Council (and the discretion of the Council may not be fettered in this regard).
5.4 Probably the most important element is finding the most appropriate power under which to dispose of land
for development. Local authorities have very wide powers to acquire, sell, appropriate and develop land,
as set out below;
a) S.120-123 Local Government Act 1972 (LGA 72);
b) Ss.227 and 233 Town and Country Planning Act 1990 (TCPA 90);
c) Housing Act 1985;
d) Local Government Act 1988; and
e) Local Authorities (Land) Act 1963.
5.5 A combination of these specific powers would usually be sufficient for the Council to undertake any property
related project, both within its area and potentially outside its area where the motivation is connected with
the benefit or improvement of the area.
5.6 Because there are a number of options, the Council needs to be clear as to its primary purposes for
undertaking any land and property investment and development. We would normally advise that "powers
follow purposes". Powers must also be exercised properly, taking into account all relevant considerations.
5.7 Clearly the Council's audit trail needs to back up what are its stated objectives as part of taking any decision
to authorise a project.
Date: October2018 Page: 22
Client: Stratford upon Avon District Council Report Title: Commercial Case
Best consideration
5.8 The Council has a fiduciary duty to tax payers to manage its commercial estate effectively and to generate
a commercial return. On the sale of any land and property under s.123 LGA 72, s.32 Housing Act 1985 and
s.233 TCPA 90, local authorities are required to get "the best consideration that can reasonably be obtained"
(otherwise the Secretary of State's consent is required for disposals longer than seven years at an
undervalue). Sales at an undervalue may also constitute state aid.
5.9 The Council needs to obtain best consideration, even where it transfers land to a company in which it has an
involvement, for example a wholly owned separate legal entity. Failure to dispose at best consideration
could result in claims of unlawful state aid and/or there may be a breach of section 123 LGA 72 (or similar).
5.10 The Council should obtain professional valuation advice on whether best consideration is being achieved.
Whilst such advice may be provided by in-house valuers, it may be more appropriate to obtain independent
advice since the Council will be making a disposal to a connected body and this could raise questions over
how the valuation was made. Where the Council considers it may be challenged as to any valuation it may
therefore wish to seek external valuation advice; also in circumstances where there is any question of being
unable to agree upon best consideration, then a second professional opinion may be sought (consistent
with the state aid guidelines issued by the EU). The rules are now set out in the "Commission Notice on the
notion of State aid as referred to in Article 107(1) TFEU" published in May 2016 and require, in the case of sales
of land, "an independent expert evaluation prior to the sale negotiations to establish the market value on
the basis of generally accepted market indicators and valuation standards".
5.11 Best consideration may only be assessed close to disposal – it would not be possible now to give a binding
valuation of all of the indicative sites that could form part of the initial phase of development of the
company as values will fluctuate over a number of years. The drawdown process will require appropriate
valuation at the time (or just before) the sites are transferred. Best consideration may include overage or
whatever may be usual for the nature of the site and type of development. Where consideration is deferred
it will be important for the Council to consider what security may be available in relation to the land (eg. a
restriction on title).
5.12 It will be the responsibility of the company to determine the timing of any sites to be acquired from the
Council. We would expect the company to develop a business case for each site it wishes to acquire the
business case will set out the following information:
a) Production of a development appraisal for the site, including the residual land value for
the site.
b) How the land purchase price and construction costs are to be funded, including the
implications on the working capital facility.
c) Forecast profit/long term income arising from the completed development.
d) We would envisage that a combination land price, interest rate margin on the working
capital facility and profit share will form the basis of the Councils assessment of best
consideration for the purposes of satisfying the legal requirements.
Date: October2018 Page: 23
Client: Stratford upon Avon District Council Report Title: Commercial Case
6. Proposed Council Report Recommendations
6.1 Following Cabinet approval to progress with a local housing company in March 2018, the Council has taken
the opportunity to review and refine the proposition. The process of refinement has included reviewing what
is required for the company to be established. Our advice to the Council has set out a two stage process to
achieve this objective.
6.2 Initially the Council must form an appropriate corporate vehicle and agree the legal framework used to
establish the vehicle. Alongside forming the corporate vehicle and importantly the Council needs to provide
an envelope of funding that can be made available to the company. The envelope of funding is generally
referred to as “working capital” and the company will call down the facility from time to time to enable the
company to deliver its objectives.
6.3 As part of the workshop held in September with Cabinet, we identified what we believe should form the
basis of a set the recommendations that will need approval from Cabinet to enable the establishment of the
company to process.
6.4 The recommendations are as follows:-
a) Authorise the establishment of a limited company by using its “general power of
competence” under section 1 of the Localism Act 2011.
b) Approve an initial working capital budget up to £10m to facilitate the activity of the
company.
c) Approve the arrangement by which LHC will draw down working capital.
d) To appoint Directors to the company Board
e) Delegate Authority to the S151 Officer and Monitoring Officer to undertake the following
activity:-
e.1. Produce the Memorandum and Articles of Association and Shareholder
Agreement
e.2. Register the Company
e.3. Apply for a company bank account
e.4. Appointment company auditors, legal advisors, commercial property advisors
e.5. Set up the financial systems
6.5 Following receipt of legal advice from Trowers Hamlin, the Council has now been able to satisfy itself of the
legal route to enable the company to be established. In this case the legal powers are the Localism Act
2011, which identifies the general powers of competence as a way forward.
Date: October2018 Page: 24
Client: Stratford upon Avon District Council Report Title: Commercial Case
6.6 The form of the corporate vehicle is to be a company limited by shares, and the shareholder in the first
instance will be the Council. Obviously this structure does not prohibit changes in the future and the
potential for subsidiaries to be established with alternative shareholding, if the circumstance arises. One
circumstance we have envisaged which could arise is if the Council were to transact the land referred to as
the Canal Quarter into the local Housing company, and then establish a joint venture with a potential
developer of the site across the Canal. If this is pursued it might be appropriate to from a new vehicle which
would sit beneath the Local Housing Company, however is likely to have a different share structure and
could be a 50:50 ownership structure.
6.7 In this option the local housing company enters a joint venture with a development Partner for the delivery of
the canal quarter development, in most examples, the public sector party transfers its land into an external
vehicle, the value of which represents its equity investment in the vehicle. In this case the Council will transfer
its land to the local housing company which will then transact the land with the Joint venture.
6.8 This value is matched by cash from a development partner. The land is then used as collateral to source
debt, which coupled with equity funds are used to develop the scheme. Returns are then used to repay
equity investments and pay returns to the two Partners. This is another development option which could be
considered for the Canal Quarter.
6.9 The diagram below illustrates the way a normal joint venture operates.
6.10 We have identified a minimum working capital facility of £10m, the justification and rationale for this sum is
set out in section 4 of this report. It is important to note however that if the Council wishes to increase the
level of working capital, for a range of potential reasons this will be subject to a new Cabinet authority. We
have assumed that this sum is sufficient to fund the operational requirements of the company and also for
the company to make some initial acquisitions.
6.11 The arrangements associated with drawing down the working capital facility are set out in section 4 of this
report. It is important to note that although the local housing company will have its own Board and
Date: October2018 Page: 25
Client: Stratford upon Avon District Council Report Title: Commercial Case
governance arrangements it will be required to agree periodically with the Council the bases by which it will
drawdown the working capital facility. The company will be required to establish how it will repay the
Council for use of the facility.
6.12 As stated the Council will need to identify suitably qualified Directors to the company. We have provided
advice which we would encourage the Council to review prior to confirming the appointment of its
Directors. Our advice is set out in Section 3 of this report.
6.13 The final recommendation identified above relates primarily to some of the practical issues associated with
establishing a company. Rather than burden the Cabinet approval process with some of the practical
decisions associated with the company we have recommended that these points are delegated to the
S151 officers and the Monitoring officer of the Council to progress.
Date: October2018 Page: 26
Client: Stratford upon Avon District Council Report Title: Commercial Case
7. Next steps
7.1 Following Cabinet approval of the recommendations set out in section 7 of this report, the company will
need to be formed and properly constituted.
7.2 The council must also consider and agree an appropriate name for the company; this will be required prior
to forming the company, unless a temporary name is adopted in the short term.
7.3 Its first task will be to start to develop the business plan for the initial three year period. We anticipate that the
company business plan will cover the following areas:
7.4 Background -
a) providing strategic and market context,
b) outlining any perceived delivery issues
c) Its regulatory structure
d) Basis of access to finance and funding, this will include the working capital facility.
7.5 Objectives – What it intends to achieve over the plan period
7.6 Investment Strategy – how it intends to achieve its objectives and the basis for acquisitions, such as types of
homes and quantum of homes etc.
7.7 Delivery Plan – including long term aspirations as well as the projected delivery plan over the business plan
period
7.8 Financial Plan – including the initial budget 2019/20 and 2020/21
7.9 Governance and operations –
a) Human Resources and Executive support
b) Policy, strategies and corporate board
c) Professional and financial registrations
d) Procurement strategy
e) Legal and contractual agreements
7.10 Key performance indicators – these can be monitored by the operation and Shareholder Boards going
forward.
7.11 Risk management strategy – A clear risk register including mitigation measures.
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Client: Stratford upon Avon District Council Report Title: Commercial Case
7.12 We would anticipate the business plan for the company being completed over the next few months
alongside some of the delegated actions from this Cabinet report.
7.13 We would recommend that the business plan document is refreshed annually and presented to the
company Board in the first instance for approval. It would be normal practice for the business plan to be
presented to the Board no later than three months before the start of the new financial year.
7.14 Although not set in stone, we envisage that following the Board approval the business plan will be presented
to Cabinet to approve on behalf of the shareholder.
Contact Details
Enquiries James Dair 0121 609 8297 [email protected]
Visit us online gva.co.uk
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