BJ2 Can Venture Capital / Private Equity create value for Junior Miners and explorers?

Ordinarily, firms will first seek to use internal funding (i.e. retained profits) to finance their activities as this usually has the lowest opportunity cost. If external funding is required then firms will prefer to use debt financing in the first instance, with external equity usually a last resort. Large resource firms typically follow this model of funding because they have operations that generate positive cash flows, which usually allow significant retained earnings and a capacity to service debt repayments. In contrast, junior explorers rely largely on listed equity to fund themselves because they generally produce little in the way of consistent revenue and so are unable to rely on internal sources of capital. A lack of stable earnings and the risky nature of exploration also make it difficult, nearly impossible, for them to obtain debt funding. An analysis of the share registries of junior explorers suggests that large resource companies have only minimal holdings, which indicates that large resource companies rarely sponsor these small companies. About $400 million was raised through fewer than 30 deals in the spring and summer of 2012, compared with roughly $2 billion raised via 80 deals a year earlier, according to Oreninc (Orenic tracks financing activity among junior miners listed in Canada on the TSX and TSX-V). With declining share prices and volatile markets the access to capital for junior mining companies is tight. Given their inherently speculative nature, around 80% of junior resource companies record a net loss in any given year, although if these companies make a discovery, the payoff is usually very large. It is this high-risk/high-return profile that makes these companies attractive to some investors. These investors will typically spread out their investment over a number of companies, with the expectation that a few of them will make discoveries and provide a large payoff. In response to the market malaise, some junior mining companies have turned to the debt markets to fund operations and development projects. While others are looking to strategic partners and royalty streamers like Sandstorm Gold (Stock Profile - TSX:SSL & NYSE.MKT:SAND). In today's market, some form of connection to off-take is becoming an important advantage to have in securing capital. Some of the financing options mooted include partnerships with major producers, royalty or streaming arrangements, investments from state-owned enterprises, private equity, and even listings on other stock exchanges that may be closer to projects. The life-cycle of junior companies provides shareholder gains as metal deposits evolve towards production and the start-up nature of junior explorers and their high-risk/return profile would suggest that they are relatively well suited to the private equity/venture capital model of investment. The emergence of private equity investors seeking Junior explorer acquisition targets started around 2009 and has become more common place. Generally private equity has targeted distressed assets. After all, this is exactly what private equity does, acquire underperforming assets, turn them around and sell them off at a handsome profit.

Our analysis shows that the returns on private equity investments outperformed investments in comparable public companies by a factor of up to 8 times. Mainly due to proactive strategies employed by PE owners to build value. Private equity is very focused on process efficiencies and management, exactly what is required for Junior miners to be successful. A further advantage is quick turnaround times in decision making which allows the funding to flow when it is needed, reducing the capital raising downtime experienced by most Juniors. Private equity investors have a clear intention to exit at a substantial profit. They therefore bring with them a built-in liquidity event for Juniors. As the effects of the global economy continues to impact adversely on Junior explorers we will see the advent of more creative ways of financing early stage mineral and exploration projects. The conclusion is inescapable; venture capital and private equity can create value for Junior explorers. This source of funding has not touched the tip of the iceberg of need and there is much scope for growth in venture capital / private equity financings in the future.
Brian Barrett is Chief Executive of RBS Consolidated Investments Ltd a boutique investment house that provides bespoke knowledge-based services to select clients in the natural resources sector and a leader in the financing of pre-resource definition and early stage mining projects.