7. Private sector sources of funding
Private sector mining companies finance their projects in several different ways. They can be funded by cash reserves of a mining company, borrowing/debt, or equity. The size and risk of mining projects mean that joint ventures are a common way of sharing risk.
Cash reserves: avoiding debt and share dilution
When companies operate at a profit, the board of directors makes decisions on how to use profits after tax. A successful mining company may accumulate a pool of funds to finance capital projects during the operating life of a mine. These funds may be applied to all legitimate purposes: funding replacement capital and funding project capital for improvement projects, expansion and life extension. New mines represent expansion or an extension of life for the company.
Financing new mines out of accumulated cash has the advantage of avoiding debt and interest liabilities and of keeping equity undiluted, i.e. no additional shares need to be issued. However, even for a large corporation with a hefty bank balance, financing a large new mine internally can be onerous. In addition, alternative mechanisms have the advantage of sharing risk. It is common, therefore, to internally fund new mines partially and to employ other mechanisms to provide the remaining cash requirements. The cost of construction of a new mine is often beyond the resources of a company and must be funded entirely by other means.
Debt funding: meeting due diligence requirements
Banks and other types of financial institutions are willing to consider lending for new projects, including mines, and are constantly, actively seeking investment opportunities.
However, mining is a relatively-high risk sector. This has two important consequences for borrowers:
Lenders are likely to exercise caution; and
Interest rates may be higher than for other sectors.
“Caution” in this case means “due diligence,” i.e. financial institutions will take all reasonable measures to assess the risks and ensure that a project is both technically and financially sound before committing funds which they really hold in trust for other parties. This is the main purpose of a feasibility study. Since financial institutions do not necessarily have in-house capacity for such reviews, they often use reputable consultants for this purpose. A financial institution may engage consultants but typically a mine operator will commission an independent review by appropriate experts who will sign off on a feasibility study, business plan or other document supporting a project proposal.
The professional integrity and reputation of the consultants provides all interested parties with assurance that their report is totally impartial, regardless of who is paying them, and gives a professional factual assessment of the project proposal. There are many reputable consulting organisations operating internationally.
These companies retain their independence by having no interest in the form of equity in mining operations.
Financial institutions also exercise care in ensuring that their funds are not applied to projects which may in any way be accused of human rights violations, abuse of the environment or other aspects of life which are likely to attract negative media and NGO comment. Some 84 of the major financial institutions in 35 countries are signatories to the equator principles, an international convention providing a minimum standard for due diligence in risk-based decision-making regarding loans in all formats, covering social and environmental protection, including climate change.
In some countries, such as Canada and Australia, there are requirements for guarantees of protection of the rights of indigenous communities.
Lenders will review the history of a company making loan application, its assets and proven level of competence and will make a decision, and possibly fix interest rates, taking account of those factors. A junior may face more onerous conditions than a larger, established mining house.
Equity: offering shares or making IPO
In order to raise funds without resorting to debt finance, or in combination with it, companies have the option of offering equity, i.e. an opportunity for other parties to participate by investing in shares. A new company just embarking on a mining venture might make an initial public offering (IPO). The stock exchange chosen for the listing may be in the mine’s host country, the country where the company is headquartered, or another venue, and a listing may be sought on more than one stock exchange. An existing company requiring to raise funds beyond its internal capacity may also offer a special issue of shares, with priority being given to existing shareholders.
The parties investing in shares may be individuals or a variety of organisations, including governments. Other companies or organisations might decide to invest venture capital, i.e. funds invested in a situation where the risk is known to be relatively high and there is anticipation of good rewards. The shares offered may be preference shares which have priority when dividends are declared, and in the disbursement of funds from disposal of company assets.
A public share flotation is for a stated number of shares of prescribed value, the total value of which is called authorised capital. However, the shares may be offered at a different price from their nominal value, e.g. “$1 shares” may be offered at $1.50 each.” This commences the process of trading and many investors buy new shares speculatively with the intention of selling immediately an increase in their trading price is realised. Not all of the authorised shares are always offered or sold and the value of those actually sold is called the issued capital. The company itself, its directors or the parent company often subscribe to a portion of the offering in order to retain financial control.
A flotation on a stock exchange is a costly process and these costs are counted as part of the cost of capital for purposes of financial assessment. Countries and stock exchanges have strict legislation governing trading in shares. A new flotation requires a PROSPECTUS, i.e. a detailed report on the company and on the purpose of the equity offering; details of the directors; an independent report by a technical advisor (usually a consulting firm) verifying the soundness of the business plan or feasibility study, and a report by the auditors.
Joint ventures (JV): useful for risk-sharing
A useful risk-sharing mechanism is a joint venture between two or more partners who may be mining companies, other companies, financial institutions or governments. Usually, in addition to funding, each participant provides other resources to the venture, in the form of specialised expertise, contacts or physical assets. The company holding the primary asset, e.g. a mineral deposit with a mining license and perhaps a completed feasibility study at one level or another, usually proposes the structure of the JV, often retaining a controlling interest of 51% or more.
The structure of a JV is embodied in a contract, whose legal provisions may vary considerably. The JV agreement normally specifies how many executive and non-executive directors each party may appoint. (An executive director is one who is a full-time employee of the company, normally in a senior management role). Some partners may be required to contribute funds at the initial stage and possibly at later stages of the contract, whilst other partners may have a carried interest, meaning an entitlement to future benefits of the project such as dividends, in return for non-monetary contributions, e.g. expertise, grant of mineral rights by a government.
Making investment decisions
Feasibility studies for mining projects
The law in some countries requires government approval of mine feasibility studies. Governments have a responsibility to the public to ensure that health and safety, environmental and social risks are properly managed and sometimes therefore insist on having the right to approve feasibility studies. In other cases, governments limit approval to business plans or, as a minimum, environmental and social impact assessments. A feasibility study can also be a risk management tool. An example can be found here.
Purpose of mine feasibility studies
I. To demonstrate whether a project is technically feasible & financially viable:
Can it be done at all?
Will it repay the money to be invested?
Will it provide a reasonable return, i.e. An acceptable profit, to investors?
What are the risks and how will they be managed?
II. to provide a consolidated, coherent, comprehensive report on the entire project; all the information in one place for all authorised stakeholders;
III. To provide a record of all research & all alternatives considered;
IV. to convince the board of directors, company management, shareholders & investors that the project is sound in all respects;
V. to convince financiers that the project is robust and worth funding;
VI. to reassure governments that a project is sound & that risks will be adequately managed.