HP sores

The government's private finance initiative (PFI) is in several sorts of trouble. Increasingly colleges will rely less on PFI, and more on schemes that give them some control over their own destinies. This summer saw the launch of a pioneering finance organisation which gives them access to city capital.

PFI is a means of buying new buildings on the never-never. A private sector partner designs, builds and operates a building, and the public sector body - the college, for example - pays an annual sum for its use.

Governments of all parties like it because it gets the spending off the Public Sector Borrowing Requirement (PSBR.) They can take the credit for the building without the odium of raising taxes to build it, because the cost is passed on to the next generation. Of course, the cost is probably higher in the long term, because no one can borrow money more cheaply than the government, but that doesn't worry Gordon Brown, whose wise stewardship, as you may recall, has reduced the PSBR.

This is important for schools and for local councils. But it is less important for colleges, because they were split off from local councils, and became free-standing institutions legally owned by their corporations. This means that their expenditure is no longer counted within the PSBR anyway, so Brown is less keen to force them down the PFI route.

And in recent weeks, PFI has lost its gloss. First there was the Railtrack debacle, which left city moguls huffing that if the government treated shareholders that way, they shouldn't expect anyone to invest in public services in the future. Then there was the bad publicity about inadequate PFI hospitals.

And - in what looked like the coup de grace - the EU announced that having a preferred bidder for a contract was anti-competitive and will be outlawed in two years' time. Preferred bidder status enables the private sector partner to examine the books, knowing that it is going to get the contract. Without this, it would have to spend a lot of staff time speculatively, says Kevin McNeany, head of the edubusiness Nord Anglia, which has worked on several PFI contracts: "We need to be in a position to verify past expenditure."

The Association of Colleges has called a conference next week at which colleges will be urged to rush their PFI bids through before the EU directive kicks in. But this may be a panicky over-reaction. There have only been three full-blown PFI contracts in further education. This is partly because PFI is only recommended for contracts worth at least £10m (some experts reckon it does not work well under £25m).

"It is often more suitable for a local authority which is able to bundle a number of its schools together. We have relatively few very large projects in our sector," says a spokesman for the Learning and Skills Council (LSC), the new funding body for colleges.

There are, he points out, several half-way houses between the two extremes of PFI on one side and traditional public sector financing on the other. These are very popular in further education, and most of them will not be affected by the Brussels ruling.

Prospective private sector partners find colleges' relationship with the LSC reassuring, he says. Though colleges are free-standing autonomous institutions, "we have a financial memorandum with each college, because most of its money comes from the LSC. They must get our consent for any deal over £1m or 5% of their annual turnover, whichever is less."

The LSC asks searching questions about affordability, viability, and value for money. And even though colleges are legally owned by their corporations, if the worst happens, the education secretary has the right to transfer the assets of a college to another college, or to the LSC.

Of the three PFI contracts, one - New College Nottingham's £16m conversion of a grade 2 listed building - has been completed. The private sector partner was Scottish developer William Morrison. The second, still under construction, will be a new campus for Newbury College with developer Galliford Try, and the third will be at Canterbury College.

At the other end of the spectrum, the LSC has encouraged the formation of a not-for-profit company called Education Capital Finance, whose job is to raise city finance for college development. The company borrows money from banks, and lends money to colleges for capital projects costing between £500,000 and £7m at good, but commercial, rates.

"PFI is complex and suffers from high set-up costs," says Education Capital Finance general manager Peter Impey. "Colleges can borrow from us on the strength of their own operations and balance sheets. We raise our funds from city banks who agree with our analysis of the importance of the college sector, and who see colleges as relatively safe places to invest - there are not huge returns, but the probability of default is relatively low. We act like a bank and loan them the money."

Since June Impey has lent £7.5m altogether. The money has gone to Walsall College of Arts and Technology and Brockenhurst College. As the LSC points out, "colleges own their own assets and can use them for security for money they borrow".

That's the minimalist approach to private sector financing. Between that and PFI there are many different levels of private sector involvement available to colleges. Kingston College has a £40m contract with Mount Anvil development group for new buildings, jointly financed by the college and the company. Stockton and Billingham College is moving on to one site in Teesdale, and selling its two existing sites for residential development. It can invest the proceeds of the sale, and eventually buy the new building from the developer. Two east London colleges, Barking and Havering, are to join together to build a training and conference centre, which will be partly financed by training revenue from Ford - the LSC is also putting in £1m. Weymouth College is giving up its existing site as part payment for its new building.

On the one side, there is traditional funding from the public purse, but that is frowned on by the government, desperate to clean up the look of its books. On the other there is PFI, which is complicated and leaves the college ultimately powerless, with its destiny and priorities controlled by a private company for the next 30 or so years. But colleges are finding a third way.