All about private placements — volume one of four

Tekoa Da Silva of Sprott USA, sits down with Maurice Jackson of Proven and Probable in this exclusive 4 Part Series entitled all about Private Placements. This is one, if not, the most comprehensive beginners guide to understanding the value proposition of private placements. Credit: Thumbnail Image taken from Streetwise Reports.

Maurice Jackson: Thank you for joining us for aspecial four-part series entitled All About Private Placements. Joining us for a conversation is Tekoa Da Silva; he is an accomplished licensed financial advisor for Sprott USA, the preeminent name in the natural resources space. Full disclosure, the following is not a Sprott USA endorsed product, and is for educational purposes only.

Tekoa Da Silva: Hi, Maurice, pleasure to be with you.

Maurice Jackson: There’s a lot of ambiguity regarding private placements and we thought it would be good for readers to have a comprehensive overview regarding this topic. Tekoa, what is a private placement?

Tekoa Da Silva: My understanding is that it’s simply a vehicle that is used to allow an investor to fund directly a corporate entity. I’m guessing in the context of this conversation, private placement is probably in relation to natural resources and mining industries. And I believe the bottom two segments of that industry, in exploration and development-stage businesses, [private placements are] their lifeline, in terms of their primary source of capital infusion.

A private placement is a vehicle used to move cash directly into the entity, and then in exchange for your cash, you get some form of security or ownership. And the securities that you could get could be common stock, they could be stock options, warrants, debt securities. So that is what a private placement generally is.

Maurice Jackson: So it allows you to get either shares or a debenture. How do I participate in a private placement?

Tekoa Da Silva: Assuming that we’re talking about the North American context, and if you are, let’s say, based in the U.S., an accredited investor, how would you participate in a private placement? I think if a person is sitting in front of a computer at home and they see a press release come up for, let’s say, a gold exploration company, and they look at it and it says that the company is announcing a private placement and they say, how do I participate in that?, probably the first thing that a person would do, or could do, is to call the company or e-mail them and say, “I’d like to participate.”

What would happen next is the company would reply and probably provide a few documents. A private placement memorandum is the lead document and they would provide that to the person to complete and return, and that would start the process of participating in a private placement. The investor relations personnel of that company would sort of hold your hand and walk you through the process of that.

Maurice Jackson: What are the requirements to participate in a private placement?

Tekoa Da Silva: The requirements to participate in a private placement, again, from the North American context, is usually, firstly, being an accredited investor. So having a net worth of US$1 million or more, excluding the value of your main residence. There’s also an income qualification part of it too, that may change over time. So you always want to look online for the most precise definition announced by, I believe it’s the SEC [Securities and Exchange Commission] or FINRA [Financial Industry Regulatory Authority] in the United States.

That’s usually the case. Sometimes there will be offerings that don’t require an investor or a speculator to be accredited, but those are different types of offerings, and you’ll want to check with the company, to ask about the specific type of offering that they have. So that’s the first hurdle.

There are other hurdles that a person should consider and they have to do with participation amounts and also third-party processing fees. My experience is that it’s usually between $300 to $600—the third-party processing fees, not including a brokerage commission costs—that a person may encounter if they participate in a private placement.

So if you’re considering an investment or a speculation in something and your hurdle is $300 to $600 just to process it, and let’s say another 1% or 2% as a brokerage commission cost of the market value of the investment, and you’re thinking about it for $5,000 or $10,000—I mean really, if it’s $5,000 or less, and you’re putting up 10–15% of your capital just to play, in most cases, I think that’s pretty unreasonable. But if you increase the amount to US$10,000–15,000 or larger, then that fraction is smaller as a percentage of your capital and maybe it’s more considerable.

So you’ll get your technical requirement, in terms of being financially qualified and the specific type of offering that the company is making available to the market. You have your financial requirement, your qualifications there, and then outside of that it’s just jumping through the hoops, if you will, on completing the paperwork and moving the paperwork around the various parties.

Maurice Jackson: When is a good time to buy?

Tekoa Da Silva: Boy, that’s such a good question. I think there’s probably two answers. The first one is anytime is a good time to buy, depending on the terms, the deal and the quality of the company—because you may have a really good company, which maybe is composed of two basic things, like a management team as well as the collection of assets or income streams and such. And you just might come across a good deal. So anytime it could be a good time, I think, in that sense, when looking at quality in terms.

But the second answer I think is really dependent on the cost of capital market conditions. I always interpreted a stock market up or down as just thinking about it as stocks going up and stocks going down. But, there is this phrase that our good friend and, I think, mutual mentor Mr. Rick Rule taught us, which is, “the cost of capital.” And now I come to interpret stock markets moving up or down as being the cost of capital, either declining or increasing.

When you have dropping stock prices, you have an increase in cost of capital, the seesaw. . .and then when you have surging share pricing, you have a dropping of cost of capital for the issuers.

So ideally, a buffet—a feast, if you will—is usually during the market context, in which you have an absolute liquidation. Where there’s a panic, [there’s] a shortage of capital across an entire sector or an entire market. And when we’re looking at the context of resource markets, natural resource exploration or development-stage companies are generally non-income producing companies. So they live on, let’s say, blocks of capital that may be between nine to 18 months, where every time they do a private placement, they’re simply buying time to continue their business activities.

If you have a period of, let’s say 2008–2009, during that market crash, coinciding with a period of a small exploration company, if the corporate treasurer [is] running down toward two, three, four months of capital remaining in the bank, that’s an ideal context to be a capital provider, to a host of companies that are in that circumstance.

Why is it ideal? One, because they need the money most desperately at that time. So, they’re in a position in which they want to negotiate. And then second, your competition has been cleared from the field. Very few people want to buy shares of anything in that context, let alone shares in a company that can be illiquid for a period of time, in that they have to commit a large amount of capital to a non-income-producing high-risk business.

So the two-part answer to the question is again, anytime is a good time to buy a private placement, provided that you have a high-quality management team, a high-quality basket of assets, at good terms—which is probably a separate question of, what are the good terms?

That’s the first part of the answer. And then the second is market-clearing events can be wonderful opportunities to buy any assets, but certainly, buying assets via private placement.

Maurice Jackson: Maybe something we should have covered before is, in your experience, is it usually junior mining companies, or is it the mining industry as a whole, that offers private placements? And let’s backtrack that question. What’s the difference between a junior mining company and a mining company?

Tekoa Da Silva: There’s a really smart gentleman who works here at Sprott and his name is Mr. Jeff Power. I once walked into his office and I asked him that very question, and he explained to me a conversation that he called the core asset classes of mining. And he explained it to me that you’ve got four asset classes. You’ve got your major producers, you’ve got your junior producers, your junior development-stage companies, and then your junior exploration-stage companies. Four categories. Majors at the top and then the juniors generally populate those three bottom categories.

You may have a mid-tier that populates that second category down, the junior producers. Let’s say one, two or three producing mines. But if it’s one producing mine, depending on the size of the mine, you’d probably want to consider it to be a junior.

Maurice Jackson: So the junior mining company is actually not extracting anything out of the ground, and like you referenced, it’s a research and development exercise. So if they’re not extracting anything out of the ground, they’re not able to generate revenue. And that’s where the terms come in, where you can really make it a lucrative endeavor for yourself here. So let’s talk about some of the terms. What are private placement terms?

Tekoa Da Silva: The terms are what you get in exchange for your money. And if you’re looking at a press release that a company has put out about a private placement, you always want to look at the first and second paragraph, where the terms are usually spelled out.

Private placements—again in the North American context of natural resource exploration, natural resource industries—in that first and second paragraph, they’ll usually reference something that they call a unit. I would imagine a unit like an eggshell. You pop it open and there’s usually something inside. On the inside, there could be one thing or sometimes two things. If you’re buying shares, there should be one common share inside that shell. Sometimes they’ll add something extra, a warrant of some kind. A warrant is similar to a stock option. It gives an individual the right to buy an additional piece of common stock at a specified price, during this specified duration of time, and then it expires afterward.

A set of private placement terms could be something like this. A unit, a shell priced at CA$0.10, and inside the shell you’ve got two pieces. One is a common share and the second piece is a full warrant. And I say full warrant because sometimes it can be a half warrant, or some other fractional kind of warrant. But we’ll just say a full warrant.

So you’ve got a CA$0.10 cent unit, which includes one common share and then one warrant on the inside. And the warrant, let’s assume is exercisable at a CA$0.15 share price for a five-year period. That’s what they would call a five-year warrant. Exercise for CA$0.15 for a five-year period. And this unit is priced at CA$0.10.

And let’s just hypothetically assume also that the price of the common shares in the market, you’d be trading at CA$0.10, CA$0.11 or CA$0.12. So that’s maybe a typical set of private placement terms that you may see in a public press release. But these days, because market conditions are a bit more buoyant, capital is generally available, you don’t as often see five-year full warrants. You more often see 12-month, 24-month warrants, and quite often 12- and 24-month half warrants, as opposed to a full five-year warrant.

Maurice Jackson: Are private placement units sold at a discount?

Tekoa Da Silva: It may be. It depends on the appetite that is in the market for that issuer. If the cost of capital is a bit higher, they may offer it at a discount. If the cost of capital was temporarily low, like if there are surging prices, that placement unit may be offered at a premium in the market, because the market really want to have a warrant, and they’re willing to pay extra for it. Or the unit may match the price of the market.

It really depends on market conditions and it depends on the people that the issuing company [is] tapping for capital. It could be like a number of specialist, natural resource and brokerage firms. It could include newsletter publishers, other types of capital raising groups. The more interest there is, of course, the lower the cost of capital, or the worse the terms for the investor speculating, and the better the terms are for the issuer.

Maurice Jackson: Now, Tekoa, I don’t want to brag on myself, but I’d like to give a real life scenario here. So two years ago with a company, Novo Resources Corp. (NVO:TSX.V; NSRPF:OTCQX), they conducted a financing and it was at a $0.66, and then you had a full warrant, one year at $0.90. And we issued that financing opportunity to our subscribers. What occurred was Novo Resources, within four months, jumped to $8.55. That is a 1,400% return.

However, if you participated in the financing, irrespective of the current price, you were able to purchase the same quantity of shares that you purchased originally at $0.66, you could purchase them at $0.90, and that’s the value proposition that we’re trying to convey to you, regarding private placements.

I have one more question for you before we can conclude this first series and that is. . .what determines private placement terms?

Tekoa Da Silva: What determines the terms? Well, I think it’s kind of like a combination between cost of capital conditions in the marketplace, in the bidding atmosphere that is generated as a result, and the negotiating technique of both sides. I think it can be competitive. I have to tell you, I haven’t sat in on many private placement negotiations myself, watching two partners go at it. I’m usually one layer away from most of those direct negotiations. But I’ve seen some of them take place, I’ve been very close to and have participated in conversations in agreeing on price. And it can take as little as a few minutes of getting a sense of what both parties feel is reasonable, or it can be a more heated negotiation as some other people in the market may reference.

Maurice Jackson: This concludes part 1 on All About Private Placements. If you wish to have a conversation with Mr. Da Silva, e-mail [email protected]. If you want to find out which private placements have our attention at Proven and Probable, simply visit www.provenandprobable.com, place your correspondence in the subscribe box and let us know that you are accredited. Subscription is free, and we do not share your correspondence with third parties.

Maurice Jackson is the founder of Proven and Probable, a site that aims to enrich its subscribers through education in precious metals and junior mining companies that will enrich the world.

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