Where the Money Comes From: How Explorers Finance Themselves

In brief

Why fresh money is needed again and again

A resource company ahead of production sells nothing. It pays geologists, drill rigs, laboratories, permits and administration — all out of capital it raised beforehand. Between the first hole and a mine there are usually seven to fifteen years. Over that period a company has to finance itself repeatedly.

From this follows a rule that explains most of what happens in the segment: an explorer is never “fully funded”. The right question is not whether a capital raise is coming, but when, and from what position of strength.

The private placement

The standard route in Canada and Australia is the private placement: the company issues new shares to a selected group of investors, without a public offering. The issue price is usually below the market price — the discount is what it costs to persuade someone to put money into a company with no revenue.

For existing shareholders this means two things. First, their stake in the company shrinks. Second, there are now shares in circulation that were bought more cheaply than their own. Some of those new shareholders will sell as soon as the hold period expires — in Canada, typically four months.

That period is why share prices often come under renewed pressure four months after a placement, with no news behind it.

What a warrant is, and why it matters

To get a placement subscribed at all, a warrant is almost always attached: the right to buy a further share at a set price within one or two years. Half a warrant or a full warrant per share subscribed is the norm.

The warrant has two consequences. It dilutes a second time when exercised. And it acts as a ceiling: as the share price approaches the exercise price, supply reliably comes into the market, because holders exercise and sell straight away.

Anyone wanting to know what is holding a share price back should therefore look not only at the number of shares outstanding but at the outstanding warrants and their exercise prices. Both are set out in the quarterly reports.

Flow-through shares: a Canadian peculiarity

Canada has a tax structure that does not exist in the same form elsewhere: the flow-through share. The company passes its exploration expenditure through to the investor for tax purposes, who can set it against their own income. In return the investor pays a premium to the market price.

For the explorer this is the cheapest form of financing. For the outside observer the important point is this: that money must go into exploration; it cannot be used for salaries or administration. A high proportion of flow-through financing is therefore a good sign — it ties the capital to the drill.

The usual timing is the fourth quarter, when Canadian investors want to reduce that year’s tax bill. That accounts for part of the seasonality in the segment.

Telling a good financing from a bad one

Three questions are enough for a first assessment.

At what price? A placement close to the market price shows that investors want in. A discount of thirty or forty per cent shows the opposite — the company needed the money more than the investors needed the shares.

How often? Two capital raises a year is normal. Four suggests that only the next few months are being funded at a time. A company constantly raising money is rarely negotiating from a good position.

What for? The use of proceeds is stated in the announcement. If the money goes into drilling, the value of the project grows. If it goes largely into “general working capital”, the shareholder is funding the running of the business rather than its progress.

Common questions

Is dilution always bad? No. If the money advances a project by more than the stake given away is worth, existing shareholders gain too. Dilution is bad when it merely keeps the lights on.

Can I take part as a private investor? As a rule, no. Private placements are aimed at institutional and accredited investors. A private investor buys on the exchange — at the higher price and without a warrant.

How do I tell how long the money will last? The cash position is in the quarterly report, as is the cash burn. Cash divided by the quarterly burn gives the number of quarters remaining. Below two, a capital raise is a matter of weeks.