Submitted by Tekoa Da Silva, Sprott’s Thoughts:
“What would you like to talk about this time?” I asked my boss, after walking into his office.
“Well, I’d like to have a conversation for the issuers,” replied Rick Rule, Chairman of Sprott US Holdings, “in terms of what we look for, before giving a company our client’s money. What do you think?”
“I like it,” I said. And we chatted about it for a few more minutes. Later that day, I liked it even more for the following reason.
Over the last few years I’ve attended investment conferences with my boss. At these shows, we meet with clients of Sprott Global. You might be one of them.
If so, you probably remember the moment we sat down, and you explained to me (or my boss) how much trust you’ve given our group to protect (and in some cases) grow a portion of your family’s wealth.
What makes the experience more meaningful is when a person or management team sits at the other end of a negotiating table with us—and asks Sprott Global for those same client dollars.
In the following interview, Rick shares the process he disciplined our team to follow, before allocating client funds into a company seeking development capital.
If you are part of a team looking for development funds—listen up, because the following interview shares the key to opening Sprott Global’s client investment box.
Here’s how to ask Sprott Global for money.
Tekoa Da Silva: Rick, if the reader is learning about Sprott Global or you for the first time, how many years now has it been that you’ve been financing businesses directly? And how many company presentations do you think you’ve sat through throughout the years?
Rick Rule: I have been investing in natural-resource-based companies and originating and participating in financings for 38 years now if my memory serves me correctly. My partner Eric Sprott whose name is on our door was doing it a couple of years before I.
So I think it’s fair to say the Sprott organization in total has been doing this in many ways, shapes, or form, for four decades.
TD: Rick, a few years ago, you published a document called A Guide to Natural Resource Investing.
In that document, you laid out the most important questions you felt need to be asked by the investor to a company management team. For the person reading, could you give us a summary of that document?
RR: The document came about as a consequence of me watching many of our clients make mistakes investing. I watched our clients interviewing issuers (companies) at investment conferences and saw that the process they were going through in terms of accessing information to make investment decisions was faulty. What I tried to do was put together a guide that somebody could understand in an hour or less that would simplify and codify the process.
An issuer or an issuer’s agent who reads that same guide will be able to understand what is important to Sprott in 20 minutes or less. They will also be able to understand how to answer our questions efficiently.
If they don’t have the ability to answer those questions efficiently, they’ll know not to begin the process because it would be a waste of their time and ours.
TD: What would you say has been the most common mistake you’ve seen throughout the probably thousands of corporate presentations you’ve sat through?
RR: Well, 90% of the people that have come to pitch me, if that’s the right phrase, haven’t been prepared at all. What was important in their framework was raising the money and they paid no attention whatsoever as to what was important to me.
I would say the second critical mistake issuers have made coming to Sprott is they operate in the mistake and belief that we’re investment bankers, that we raise money for them. That is not the case.
An investment banker has the issuer as a client. We don’t have issuers as clients. We have investors. Our investors are our clients.
What that means is that we will never raise money for an issuer but we will allocate capital to an issuer. Our interests become aligned after our check cashes, and we’re shareholders of theirs.
But until the check cashes, we’re potential investors. They aren’t clients of ours. We’re representing clients in a discussion with them. It’s a very important difference.
Many financial services businesses operate under what I think is the illusion that they can simultaneously represent in good conscience, both the issuer and the investor—the issuer as investment banker and the investor as broker.
From my point of view that conflict is irresolvable. So we have decided at Sprott (and we decided before we were bought by Sprott) some 30 years ago that we would never raise money for companies, but we would happily allocate capital to companies.
TD: So Rick, there are about nine or ten important questions listed in A Guide to Natural Resource Investing. Let’s get into it.
I walk through the doors here at Sprott Global to ask you for development money. What do I need to tell you about my business in order to attract your client’s capital?
RR: The first thing I want to know Tekoa is what is my downside. Everybody has a wonderful upside story. So I always begin the question by asking the issuer, “What is the relationship between market capitalization and value?”
I say, “Tekoa, you would like to raise money on a $5 million pre-money valuation. Explain to me why your company is worth $5 million or explain to me what it is worth. Talk to me about my downside.”
I’m not trying to say that I need to buy $15 million worth of value for a $5 million pre-money market capitalization, but I am saying that I have to understand what my downside is before we begin to talk about my upside.
Too often when people talk about value, they’re talking about relative value, not absolute value. Somebody might say to me, “Well, I have 24,000 acres of caribou pasture in the northwest Yukon. Another caribou pasture incorporated as Consolidated Pasture Mines is valued at $1000 per acre. Therefore I have $24 million worth of value.”
I have to say, “No, that’s not the number I’m looking for. What I’m looking for is the amount of money that you could sell those assets for to a private buyer in a rational market.”
Again, I’m not trying to say that I have to get everything for dimes on the dollar. But I need to establish what my downside is before I talk about what my upside is.
Assuming a satisfactory answer in those discussions, the next thing I want to know about is my upside.
Now, Tekoa, if I were talking to an investor, I would say at this juncture that you have to let the issuer go through his or her presentation. They’re programmed to do and trying to stop them in fact is a waste of time. I will often let an issuer go through a canned presentation just to get it out of their system, so that we can get down to the parts of the presentation that I’m interested in.
But making money in natural resource venture capital (exploration) activities, really involves the process of answering an unanswered question. Many people don’t realize this but the natural resource exploration business is very much a research and development business. Answering a series of unanswered questions is what adds value.
So assuming that ‘Tekoa Da Silva’ the issuer, survived the downside question—“What is your company’s worth?” I would then say, “Tekoa in the asset that you’re talking to me about, what is the transformative unanswered question? What is the value proposition? How is it that you’re going to take this $.50-cent piece of paper and to make it into $5? How are you going to add a zero?”
So tell me what the unanswered question is. Give me the facts that support your thesis and also tell me how you propose to answer the unanswered question in an efficacious manner.
Now the way that you fail this Tekoa, is if you come to me with an unanswered question that doesn’t have very large upside. One of the things I’ve seen in the business over 40 years is that many entrepreneurs fall into what I call the “bootstrap fallacy”.
They go out to look for a small mine, figuring that small mines are easier to find than big mines. They hope that cash flow from a small mine will allow themselves to build bigger opportunities without share dilution.
It’s a wonderful fantasy but a fantasy is what it is. All the risks inherent in a big mine are present in a small mine but a small mine can never make you big money. It’s in effect “reward-free risk” which is not a particularly attractive option to me.
The second thing, Tekoa, is that the skill sets involved in finding a mine are very different than the skill sets involved in building a mine, and the skill sets involved in operating a mine.
So what happens often unfortunately is that people are successful. They find a small deposit. They build it (or try) and they do generate cash flow—negative cash flow. Losses. Cash flow in brackets. When that happens, a skilled explorationist spends four or five years of his or her time correcting a problem they don’t have the experience to correct.
So that’s a long-winded answer of saying,
1. Explain to me what the unanswered question is,
2. Explain to me what the upside associated with the question is,
3. Explain to me how you arrived at that question, and
4. Tell me the facts on the ground that led you to propose the thesis and tell me why the methodology by which you propose to test the thesis is the best available method.
The other thing you have to tell me Tekoa, is what exactly will constitute failure. Too often, somebody raises $10 million for an exploration program and they explore until the $10 million is gone.
I often have said to them in the aftermath, “Now tell me, did you drill your worst idea first? Is that what you tried to do?”
It’s important that you acknowledge defeat in the course of a $10 million program. If you do, shut the $10 million program down and save $7 million for a pivot.
But many people don’t have any idea what will constitute failure in the context of this drive for success. It’s important to know, and it’s also important to know that the chief executive officer of the issuer has firmly in mind what will constitute a yes answer and what will constitute a no answer. It’s important that they be able to articulate both of those to me.
The third thing you need to convince me of Tekoa, is a rational financial plan.
Let’s say you have convinced me as to the appropriate valuation you’re proposing, and let’s say you have convinced me that the unanswered question you’re asking is worth answering.
Now what I need to know is—“Do you have a rational financing scheme to get from here to a yes or no answer?”
Let’s assume the exploration program you envision will cost $3 million and it will take two field seasons (or 18 months) to complete. Let’s also assume it costs you $1 million a year in general and administrative expense (separate and apart from exploration expenses) to operate the company.
That means you have a $4.5 million ‘need’ if everything goes right, to get me through the 18 months, to get me a yes answer. And let’s say you have $1.98 in the treasury (ie. no money whatsoever), and you’re proposing to raise $2 million from me or the market at large.
The problem with this thesis Tekoa is that you have raised $2 million of the $4.5 million, which means your company won’t survive until I get a yes or no answer.
The most important problem associated with that outcome is the naiveté on the part of the CEO. Failure to plan is an absolute plan for failure.
So I need to know you have the means to get me to a yes or no decision point, and that you already worked out a plan. Both a technical plan, with regards to how you propose to answer the unanswered question, but also a financial plan that lets me know you are a rational investor yourself.
TD: Would that suggest you need to know where the remainder of the development funds would come from, on the hypothetical $4+ million?
Do you need the funds identified, and do you need commitment from the other financing parties before you write an initial check?
RR: Well, we might be willing to write the whole check, but I need to know the associated risks in writing that check. We are happy to be partners with other parties. But if you tell me you’re going to find $5 million, and you’re proposing I give you $1 million of it, and the other $4 million is identified—you better be ready to identify it to me.
Let’s call it a “preemptive truth.” Too many times in my career, people have believed they could raise the money and so they told me they had the money raised. That’s not good enough.
If you say to me, “Well, Dundee is going to give me $2 million.” I will say, “Tell me who at Dundee. I will have their phone number, you don’t have to have that handy.”
If Scotiabank is going to give you their money, I say, “Oh, that’s a good name. Who at Scotiabank?”
You need to be fairly specific because in this business (and particularly in this market condition) it’s very easy to find yourself undercapitalized. If you’re undercapitalized, the market will recognize it and your share price will go down. That means your cost of capital will go up very rapidly. You may be willing to expose yourself to that, but I’m not willing to expose my investors to that.
The other thing you need to tell me Tekoa (assuming you are still the issuer) is how much stock you own, because I don’t like doing business with managers. I like doing business with partners.
If you don’t have a substantial investment in your company, and if you aren’t going to get really rich if this works (or really hurt if it doesn’t), then I don’t have any interest in doing business with you.
I had the good fortune in my career of doing business with people like Lukas Lundin. The Lundin family characteristically owns 30% or 35% of their companies. I do lots of business with guys like Ross Beaty and Bob Quartermain, who have had substantial economic interests in their companies.
This has been wonderful because I’ve grown rich with these people. They have also gotten rich by making very large bets on their own capabilities, and being right and taking me along with them.
That aspect is a very important part of my methodology, of shepherding my client’s capital going forward. We want to do business with partners, not managers.
TD: Rick, outside of having mentioned those individuals, are there any corporate presentations that come to mind where you had the people, the asset, the plan, the supporting financial partners—all satisfying your concerns preemptively?
RR: Many times. The guy who (mercifully) always had my phone number was the late Adolf Lundin, father of Lukas Lundin.
First of all, Adolf and I thought in similar fashion. He obviously thought better than I because he became a billionaire.
But Adolf was predisposed to telling a story which would appeal to me because he and I had the same preferences. Adolf always understood the value proposition.
He would always come in and say something like, “The market cap of this thing is $30 million. We have $10 million cash, and the rest of it is truly speculative. The rest of it is optionality based on this deposit.”
Adolf would continue by saying, “What we’re intending to do is the following (abc), and what we’re trying to establish is that this idea (xyz) that I have, is true.”
“Now here’s why I think it’s true,” he would add. “And here’s how I propose to address that thesis. By the way Rick—it will be worth (X) if I’m right.”
Do you understand me?
In other words, he had the whole thing laid out, geared precisely for my thinking as an investor.
Now it also helped that Adolf was right many times and that he made my clients made literally hundreds of millions of dollars. So I was predisposed to listen to him.
One of the things that will amuse you about Adolf, is that he used to call me up and say, “Rick, I have an idea I would like to run past you.” He was always the consummate gentleman. He would continue by saying, “I would prefer to discuss over dinner. We’ve had so much fun together in the past.”
Then I would show up, and there would be Adolf smiling. I would sit down at the table and say, “All right, Adolf. Let’s get the business part out of the way very quickly, because we both know how it’s going to end—you’re going to get my check. Then we can enjoy dinner.”
He was superb.
Other examples of great presenters would of course include Robert Friedland. I think you’ve had the pleasure of watching him present. Ross Beaty who we’ve talked about and Bob Quartermain—again very competent, very mature speculators.
When Bob Quartermain started Pretium, he articulated the Pretium value proposition so well. You will recall that he bought the Sulphurets deposit from his former company Silver Standard. He bought it because it was a very large low-grade deposit, and it was the “other half” of the Seabridge deposit.
He bought it from Silver Standard for $250 million (if my memory serves me correctly), and the market capitalization of the other half of the deposit was a $1 billion. He said maybe Seabridge was selling for more than they’re worth, but the best way to establish the market value was by looking at the other half of the deposit.
So that was how he answered the value proposition. But importantly he said, “From my point of view this deposit doesn’t work at the current gold price. It has great optionality. But I believe that somewhere in the deposit, the gold had the ‘concentrate’, and there is a very long structural corridor which we call the Valley of the Kings (or the Brucejack fault).”
“I believe that that fault,” he continued, “could have generated the rock preparation necessary for all the gold that was in solution to concentrate and create a high grade deposit. My evidence of that thesis are these old Homestake Mining drill holes.”
“Look at this,” he added. “In this whole series of low grade gold holes, all of a sudden right along this fault, there are half ounce hits and one-ounce hits. Do you notice how it would appear that these hits occur at the conjunction of the Brucejack fault and crossing faults? We’ve identified nine places in the corridor so far where there are these coincident anomalies, and my exploration thesis is that by drilling these coincident anomalies, we will find ‘carrots’ if you will, in other words, ‘lenses’ of very high grade mineralization,”
Boy, was he right. That’s the type of presentation I love.
TD: Rick, at the time we’re having this conversation, the marketplace is in a pretty vicious bear market. For the person reading—if they are an entrepreneur or a management team that wants to make the most of it—what would you suggest?
RR: Well the truth is now is the best possible time to grow a company. Your cost of capital is high, but all of your competitors’ costs of capital are high too. This is a time when you can acquire properties that other people have spent $60 million or $70 million on. You can acquire them for $1-$2 million because the other guy can’t advance them.
To the extent that you can raise money, articulate a vision, and build a community around your company—you can attract attention in the market because most people aren’t doing it.
You weren’t with us yet, Tekoa, but the 1998-2002 bear market was really instrumental from this point of view. In the middle of that market in 2000, the very best issuers in the market came to realize that they couldn’t save their way to prosperity, because they had no cash flow.
They could only save their way to solvency. So they chose to raise equity any way they could at the bottom of the bear market. The cost of capital at least in historic terms was very high, but the opportunity to allocate the capital was higher.
When the best of the best issuers raised capital at the bottom of the bear market, one objection to buying the stock was gone. Many people wouldn’t buy the stock because they said, “Well, these guys are going to have to raise money.” When they raised money, that objection was gone. They didn’t have to raise money anymore.
The second thing, was they began to employ that capital in the absence of any competition whatsoever. They advanced their projects and generated news into a news vacuum. And the truth was, Tekoa, that at the bottom of that bear market, those stocks doubled and doubled again.
They doubled in 2000. They doubled again in 2001, and it was the success of those issuers I believe that was partially responsible for kicking off the recovery of the market in 2002. We’re in the same situation as we speak right now in 2015.
The best of the best are starting to raise money. It’s painful at current prices, but they’re advancing their projects. In the last three or four months in the market, we’ve seen a real bifurcation. The best of the best are up 20%, 30%, 40% while the rest languish. It’s an important lesson.
TD: Rick, before we wind down—are there any final thoughts you have on the discussion of raising exploration or development capital from the Sprott Global?
RR: Well, one thing I would add is that we look for management expertise that’s specific to the task at hand. If someone is coming to us and they are proposing to look for copper-gold porphyries in tertiary terrain, in the cordilleran, in the western part of the western hemisphere, I want them to have been a success previously at precisely that activity.
It’s OK with me if they were exploring for porphyries in Arizona and Northern Mexico and now they’re exploring for porphyries in Chile. I understand those rock packages are the same.
But if the success they claim is operating a gold mine in Archean ancient rocks in French-speaking Quebec, and they suggest to me that that experience is relevant to exploring for copper-gold projects in young rocks, in Spanish-speaking Peru—I’m going to have to say, “I don’t think so.”
When somebody proposes the value of an unanswered question and the methodology to answer that question, I want to know that the information I’m getting from that person is valuable.
In other words, I want to know, “Are you qualified to identify that question? And are you qualified to find the answer?”
So, specific expertise is important. Not just specific expertise in the context of the CEO or the person that tells me the story. I want to know what other kinds of expertise are available to me on the board of directors and management team and how that expertise relates to the task at hand.
TD: So does a mismatch of expertise—does that immediately disqualify a team?
RR: I asked nine or ten questions in the paper we discussed, A Guide to Natural Resource Investing, but the truth is that nobody gets an ‘A’ on all 10. Nobody gets ten out of ten or at least ten points for each item. It doesn’t happen. Believing in that is the equivalent of believing in the tooth fairy. But it’s important as I suggested, that an entrepreneur have a plan with regards to prosecuting their business strategy.
I have to have a plan too, in terms of managing the investment and knowing the strong suits and weak suits of the investment. Knowing where to expect success and where to watch for failure is very important to me.
So having an answer to all these questions, even if some of the answers are suboptimal, is something I have to do. At age 62, I understand perfectly well that not everybody is going to fulfill all my needs in every deal. Not going to happen.
TD: Rick, as a final question—if the reader wants to submit a deal or an opportunity, or get involved in some way, how can they do so?
RR: Probably the easiest way is to email me directly. Sprott is a pretty flat organization. My email address is [email protected]. It’s likely that the submittal will be passed around to various people at Sprott but the right way into Sprott is anybody that you happen to know at Sprott. We don’t make money saying no. We only save money saying no.
We are interested in seeing deals, but we are very tough. We probably do one deal in 40 submittals Sprott-wide. But for the right entrepreneur who has the right project, the right vision and wants to be our partner—we’re all ears. That’s how we’ve grown.
I think it’s fair to say the Sprott Organization was built to last and we’re here to help. We for 40 years have thrived by backing the very best junior resource issuers across their balance sheet in trying times just like these, and with young people like you in the organization, I suspect we will be doing the same thing for the next 30 years.
TD: Rick Rule, Chairman of Sprott US Holdings, thanks for sharing your comments with us.
RR: Thanks Tekoa.