Until a mine is built, a junior has one product to sell: its own shares.
Part 1 covered the rock and the paperwork. This letter covers how a junior raises capital, the terms it offers investors, and the tax complications that arise on either side of the border. Most of the deals we see are Canadian companies, so the focus of this letter is there. I hope the Aussies and occasional Europeans forgive me.
The Money
Private placement. Shares sold directly to selected investors, usually at a discount, to fund the company’s next program. Maybe a PIPE (private investment in public equity). Most junior capital is raised this way, and it is where a speculator can buy at or below the market and get warrants as well. The early raises are pure speculation, raising money to convert hope into hope plus a treasury.
Accredited investor. A permission slip to partake in private placements. In the US, an individual qualifies with income above US$200,000 (US$300,000 with a spouse) in each of the last two years and a reasonable expectation of the same this year, or a net worth above US$1 million not counting the home, or by holding certain securities licenses. Canada’s tests run in Canadian dollars: net income above C$200,000 (C$300,000 with a spouse), financial assets above C$1 million net of related debt, or net assets above C$5 million. The US thresholds were set in 1982 and have never been adjusted for inflation. The premise is that wealth equals sophistication. It doesn’t.
Unit. The package sold in most private placements: one share plus a warrant, or a fraction of one. “Units at C$0.50 with a full warrant exercisable at C$0.75 for two years” means you pay C$0.50 for a share and the right to buy another at C$0.75 until the warrant expires.
CAD vs. USD. Most Canadian juniors report results, price placements, and set warrant strikes in Canadian dollars. Their US over-the-counter (OTC) tickers trade in US dollars. A US speculator therefore holds two bets: the stock and the exchange rate. Gold and copper are priced in US dollars while Canadian salaries and diesel are paid in Canadian dollars, so a weak CAD fattens a Canadian producer’s margins and thins a US holder’s returns when converted home. For US taxes, each purchase and sale has to be converted to US dollars at the rate on the trade date.
Brokered vs. non-brokered. A brokered placement is sold through an investment dealer, who takes a commission, often 7% plus broker warrants. A non-brokered placement is sold by the company itself, sometimes paying a finder’s fee to whoever brings in the money. Brokered deals tend to be bigger, and more due diligence is applied. Non-brokered deals tend to be cheaper for the company, with less disciplined analysis undertaken by those who invest.
Bought deal vs. best efforts. In a bought deal, the dealer buys the whole offering up front and carries the risk of reselling it. Dealers buy only what they’re confident they can sell, so a bought deal says something about demand. In a best-efforts deal, the dealer sells what it can.
Warrant. The right to buy another share at a fixed price before a set date, often attached to a private placement unit. It represents a potential dilution for existing shareholders, and potential funding for the company. Unlike buying shares on the open market, exercising a warrant puts money directly into the company treasury. Some warrants trade in markets. Most don’t.
Acceleration clause. A warrant term that lets the company shorten the warrant’s life if the stock trades above a set price for a set number of days. Holders then exercise or lose the warrant. The company gets its cash early. You lose the remaining time value of the warrant.
Hold period. In Canada, most private placement shares can’t be resold for four months, although some shares carry no hold at all: shares sold under a prospectus, a LIFE offering, or a rights offering, and shares from a warrant exercised more than four months after the warrant was issued, since the clock starts on the warrant’s issue date. US buyers face a separate US restriction: a year under SEC Rule 144 for most Canadian juniors, or six months if the company files reports with the SEC. Once the Canadian four months pass, a US holder might be able to sell on the Canadian exchange through a Canadian broker (if he has one) after some paperwork to remove the restrictive legend. Prices can sag when the hold expires. There is no guarantee—none whatsoever—that the stock price will be, four months or a year hence, above the private placement price. That will depend on the market as a whole and any catalysts/milestones that the company plans and accomplishes in that period. Often there are none.
LIFE offering. Canada’s Listed Issuer Financing Exemption lets a listed company raise money from the public with free-trading shares (in Canada) and no hold period. Most anyone can buy, accredited or not. A US buyer still needs a US exemption, and his shares are restricted under US law.
Rights offering. The company offers new shares to its existing shareholders first, in proportion to what each owns.
Fully diluted shares. Shares outstanding plus every option and warrant that could become a share.
Burn rate. Cash spent per quarter. Divide the treasury by the burn rate to help predict the next required financing. Is the company blowing money on unnecessary overhead? Is management paying themselves well with your money while they do diddlysquat? Will there be a catalyst reached to (hopefully) increase the value of the current shares before the next raise?
Dilution. What happens to your slice when more paper is sold and the pie is cut into more pieces. Every junior dilutes. The question is whether the dilution buys ounces in the ground worth more than you lose from dilution.
NSR royalty. Net smelter return—a percentage of revenue paid to a royalty holder off the top, profit or no profit. Junior miners offer it as a way to get control of land for cheap, or to get cheap money into the treasury today, but it becomes a permanent claim on revenue tomorrow.
The Deals
Strategic investor. A major miner or large fund that takes a stake, often 9.9% to 19.9%, frequently with the right to keep its percentage in future financings. Strategic money is a vote of confidence from people who read technical reports for a living. It can also be an exit in waiting. Getting such investments is good push for the stock price.
Insider ownership. How much of the company management and directors own. Shares bought with their own money, in the market or in a placement alongside you, are skin in the game, and they align management’s interests with yours. Options granted as pay are a free lottery ticket for management. They aren’t free for you: when exercised, they dilute your shares.
Rollback. A share consolidation: ten old shares become one new one. The share count shrinks and the price rises in proportion. Warrants consolidate too. A consolidation may be accompanied by the sound of warrant value being sucked into a vacuum.
Shell. A listed company with a ticker and little else, used as a cheap vehicle for reverse takeovers so that a new entity can become public with less hassle. The reduction in hassle comes at the cost of giving the shell’s current owners some of the potential future value. Shells that have a mine vended into them often become shells again, but with luck and skill, they can start producing.
Just a bit on the taxman
For Canadians (keeping in mind that I’m not Canadian)
Flow-through shares. Canadian shares that pass lucrative exploration tax deductions through to the buyer. Buyers pay a premium for the deduction, then sell quickly. Only useful for certain Canadians.
Charity flow-through. A Canadian structure that stacks two tax breaks. A high-income Canadian buys flow-through shares at a premium, collects the exploration deduction, then donates the shares to a charity and collects a donation credit as well. The charity often sells the shares at once, at a discount, to a buyer lined up in advance. The company gets the richest price of any tranche. US investors can’t use it.
Hard-dollar shares. The ordinary, non-flow-through shares in a placement, also called hard money. No tax deduction attached, so they price below the flow-through tranche. These are the ones US investors buy.
For US Persons
PFIC. Passive Foreign Investment Company. A pile of oppression by the IRS, wrapped in paperwork. A mass of stupidity the purpose of which is to screw you if they ever get an inkling to do so. A foreign corporation is a PFIC if 75% or more of its income is passive, or 50% or more of its assets produce passive income. Even though they weren’t the intended target of the IRS and Congress, many Canadian explorers fit this bill, since their only income is interest on their treasury. Making a Qualified Electing Fund (QEF) election in the first year you own a PFIC lets a later gain be taxed as a capital gain, if the company provides the annual statement the election requires. This is a complicated area of US tax law. We aren’t tax advisors. And we mean it when we recommend talking to your accountant. It’s best not to ask for any tax advice from me, because you’ll just get a rant.
That’s Part 2. Part 3 will cover the mine economics, the market, and the method that ties all three letters together.
Sincerely,
John Hunt, MD
Editor, Doug Casey’s Crisis Investing
Thanks. I didn't know how much I didn't know!