Transcription
Hello everyone, welcome back to my channel. Today, we're gonna be talking about how gold companies finance themselves. And I'm gonna be walking you through the different financing options available at the different stages of the mining process in the gold sector.
There are usually four stages of the mining process. There's exploration, evaluation, development, and then finally, production, which is actually taking the metal out of the ground and selling it. And so, I'm gonna be first introducing the topics of the financing options available, really defining them, and then I'll be going into the different stages to really show you how financing options change with regards to the stage of development. So, it's really important to understand that if you want to skip ahead to a certain stage that interests you, I recommend that you just scroll a little lower in this video, and you'll be able to find timestamps in the video description and skip ahead to what interests you. So, let's get started.
The global mining industry is very capital intensive and requires hundreds of millions of dollars to take a project from exploration to production. This means that companies must be very good at raising capital to develop projects and create shareholder value. There are four key sources of financing available to gold companies. There's internal funds or cash flow, which is generated internally. There's equity financing, debt financing, and alternative financing, which we'll talk about.
So, equity financing. Equity financing are funds generated by selling equity shares in the business, either through public or private markets. In the public markets, there can be an initial public offering, an IPO, or a reverse takeover, an RTO, which we'll define later. A secondary equity offering is the offering of additional shares in a business if the company's already already listed. So, these are the options for in the public markets. In the private markets, there's private placements, which is very popular for junior companies who really don't have enough demand to go public. And there's also alternative investors. Now, usually when you think of alternative investors, you think of private equity firms. But the thing with private equity firms is that they have a very short-term investment horizon because they have to return that capital. So, alternative investors can mean a lot of different things. Sometimes it also means other competitors, more cash-rich gold companies who take interests in respective exploration interests for junior companies. And so, that's done through joint ventures, which we'll talk about as well.
Now, there can also be alternative financing, which is a realistic option for junior gold companies when debt financing options are not available due to the speculative risk of the company. And the reason why those companies are so risky is because with junior gold companies, usually they either don't even have the rights to a certain piece of land and they're just looking for a probable and potential land, or if they do have this potential piece of land that they've done some studies on and they see that, okay, this has potential, the next thing is they have to do further studies, develop feasibility studies to determine, is it really profitable to remove this? So, there it's incredibly risky and lenders stay away from junior gold companies. So, alternative financing options become available. The trade-off is that while equity holders are not diluted, future cash flows are, because in alternative financing, instead of selling shares in the business, you're really selling pieces of future profit or revenue from the project that you're expected to develop.
Now, there are two common alternative financing options. There's the royalty deals, which involve getting an upfront lump sum payment in return for giving up a small percentage of revenue or profits generated from future gold production, or they're streaming deals, which involve getting a series of payments based on various milestones reached in return for selling at a fixed price a portion of gold production or a byproduct of production. Now, I'm going to be talking about the differences, but I just want to clarify it right from the beginning with royalty deals and the difference between the two between royalty and streaming is that with royalty, you're getting one upfront lump sum payment, whereas with streaming deals, usually you get a series of payments based on milestones. And at the same time, with royalty deals, you're usually paying out money, you're giving a percentage of sales, percentage of income, depending again on the royalty deal itself. Whereas with streaming deals, you'll get your selling the production of that mine at a certain price. So, you're selling the ore that you actually extracted from the ground, rather than the money that you received from selling the ore itself. So, streaming is slightly different from royalty, but the structure of the deals are usually very similar.
Debt financing is less dilutive than equity financing, but leverages the business and either demands operators to commit to certain measures or avoid certain decisions, which are known as covenants. Especially with senior debt from banks, there are very, very strict covenants. And that's why for very volatile borrowers, such as a junior company that has never produced a mine before, debt financing can be very, very risky because there are such strict covenants that if you breach them, that debt can be called back and really can damage the business and really put it into bankruptcy. So, lenders need to balance risk and return when deciding on a certain type of loan.
The production profile of a gold company heavily influences the cost of debt, and that really is also very important. So, even though debt financing may be available to a company that's expected to develop a certain mine, where is that mine going to be located? Where are what are the cost, what is the cost of production? What is the expected cost? You know, when you produce a feasibility study, which determines the cost of removing that ore from the ground, the necessary infrastructure needed to develop that respective mine in that certain remote area, you know, if the costs are low enough, then the debt, the cost of that as well will be lower. But if the costs are high, then the lenders need to price in that risk, and so the cost of debt is going to increase, dependent again on the type of gold mine. So, that's very important.
Usually, companies pledge a producing mine as collateral to obtain the loan and reduce the risk for the lender. Non-recourse loans are popular, as lenders are able to seize the collateral but cannot seek any further compensation. And so, this is very popular not only in the gold industry but in the mining industry in general. So, usually companies, when they take out a lot of debt to develop a certain mine, they actually pledge that mine itself to the lender, so that in the case that they fail to develop the mine on budget, the lender can take control of that mine. Now, there are certain clauses within that loan contract, usually it's a non-recourse loan, which means essentially if you default on that loan, the lender can only claim the collateral that you put up for that loan and cannot seek further compensation, even though the value of that mine might have fallen due to a bear market or whatever it is. Right.
And so, from the lender, and I was actually reading this with regards to the oil industry, so back in the 1980s, a lot of banks lent on iron, which essentially means they provided equipment financing. They lent on collateral, which was the equipment of the oil and gas industry. And so, the thing is, as the oil and gas industry enters a bear market, and therefore, you know, these companies can't refinance their loans and default on those loans, not only does the lender claim that collateral, but the value of that collateral falls because again, no one wants to buy that equipment. So, the value of that equipment falls as well. And so, that's why recourse loans are very, very important for the borrowers to protect themselves against a scenario where, you know, they enter in a bear market, they're unable to pay back the loan, and the lender really doesn't receive collateral that really fully pays off the loan that they provided. So, in this case, they can't really seek out that difference by going after other assets of that company.
The last type of financing option is internal funds. And these are cash flow generated by operating mines profitably or property sales. This is the most ideal source of funding because it does not require third-party approval. Management has complete discretion over how it is spent. Now, producers with existing mines can generate these funds by taking after-tax profits from operations. And non-producers, like exploration companies with no mining operations, can generate these funds from asset sales.
So, let's look at the four stages of gold mining. There's the exploration stage, which essentially means you're looking for a potential ore body. Either you have some remote rights to some certain piece of land, or you have nothing. This is usually a private company. There's maybe three or four geologists that want to get rich, and so they all get together, they pull whatever money they have, and they start looking all over the world. At the evaluation stage, they've found a certain piece of land that has potential, and they start conducting feasibility studies to determine, is this going to be a profitable operation, or should we move on because the costs of developing this ore body is too expensive? At the development stage, you've conducted all your feasibility studies and you've decided, okay, you know what, it is profitable, it has a lot of potential, let's find the financing and actually build the mine. And then once you've built the mine, you can produce whatever you want from that, whether it's an open pit or an underground mine.
So, focusing on the exploration stage. Gold exploration is the first step in the gold production process. It involves looking for gold by identifying where to drill, then drilling for samples to determine the viability of the ore body. At this stage, the company does not have any gold, and most don't even know if the land they own rights to has anything either. So, this high-risk exploration stage eliminates all financing sources except for equity sales. So, the only option, the financing option for exploration stage companies, is equity financing. Lenders are not going to lend because they don't even know if the land they own is valuable. There's no information for any alternative financing options like royalty agreements because you don't know if there's ore in that ground. And at the same time, you know, internal funds, they're not producing anything, so they can't really generate anything from internal funds. So, the only option is equity sales.
So, the money raised in equity financing for exploration stage companies is used for drilling, sampling, and other studies, with the goal to generate positive results to make the property more valuable. As at that point, companies can sell out to more liquid producers or raise more money with the intent on developing the site many years down the road. For new exploration companies, there are traditionally two options to raise equity financing. There's the initial public offering, which is listing your company publicly, or the reverse takeover option, which essentially means going into the public market, but instead of spending all the money to go on a roadshow and really sell shares, you actually take control of an already public company, get majority control of the company, and then start selling shares by using that shell company as the controlling public company for your exploration rights.
So, let's look first at the initial public offering. Ownership prepares a prospectus outlining their ambitions for the company and sharing existing drilling results to generate demand. Because the company owns no revenue-generating assets, most exchanges are uninterested in listing these companies. The most popular markets for these high-risk companies are the TSX Venture, the Toronto Stock Exchange Venture, the Alternative Investment Management Exchange, the AIM in London, and the Australian Securities Exchange, the ASX in Australia, of course.
So, just a quick comment, because they usually don't own any revenue-producing assets, they're so high-risk that they can't even go to the Nasdaq or the New York Stock Exchange. It just doesn't make sense for those exchanges to, you know, spend all this time to list this high-risk company that's probably going to go bankrupt. Not all exploration companies are going to make it to the evaluation stage or even the production stage. Most of them fail because they just don't find anything, right? And so, these high-risk companies, which take up a lot of time to manage and, you know, to the regulatory requirements on all that, that's why there are separate exchanges where more high-risk companies are listed, and these are the top three options.
Now, the TSX Venture Exchange is the most popular market, based in Toronto, Canada, providing access to North American financing due to its proximity to the United States. Out of the total mining operations listed globally, 60% are listed on the TSX and the TSX Venture Exchange. So, it's the most popular market, the Canadian market. 57% of the global mining financing. So, this is not only gold mining, but also, you know, copper and silver and all different types of mining operations. Over 57% of the financing is done in 2016, were done in these two markets, in the TSX, the senior exchange, and the TSX Venture, which is a junior exchange.
Now, the TSX Venture has minimal listing requirements, providing a lot of opportunities for companies seeking financing, such as exploration companies. For example, there is no requirement for any net tangible assets or the ability to generate revenues, which is perfect for exploration companies because they don't have that. The main hurdle is that the business needs to have enough working capital to meet operating expenses for 12 months. That's the biggest hurdle to list on TSX Venture. Now, usually an exploration company has three or four employees. There may be geologists and a secretary, or maybe they hired their wife to manage the books or whatever it is. So, their working capital needs are just the salaries for themselves. And so, usually they take their life savings, they all pull it together, and then they fund their operations for at least 12 months. And so, they can usually get over this hurdle. So, it's very, very easy to list on the TSX Venture if you can meet that hurdle.
The second option is a reverse takeover, whereby management buys up majority control in an already listed shell company with no operating assets by entering into a stock merger with a private exploration company and exchanging shares. Management gains control in the business. Existing management is able to access the public markets while skipping out on the listing fees, and that's the main benefit of the reverse takeover. You don't have to list your company and pay an investment banker to underwrite those shares or whatever it is. All you need to do is take, find a shell company. Now, I've made a separate video on this already on my channel. If you want to learn more about the reverse takeover option, but let me explain it in simple terms.
So, say for example, you're a private company, Company A, and then you find Company B, which is a shell company. It previously had a business that maybe it sold its assets, and it's still publicly listed, but it's a shell company, doesn't have any assets, it has its registration, and this is about to be delisted. So, what you can do as the private company is take your money and start buying shares. And this really, it's probably five, six cents a share, so it's not that much. And you buy a majority control in this shell company. Has no assets, remember, Company B. Now, the moment that you've achieved, let's say, 51% ownership in that company, what you can do is then, through control of that company, engage in a stock transaction with your private company, Company A. So, Company B is going to buy Company A and its assets by issuing shares to Company A. Now, if you control 51% of Company B and 100% of Company A, by issuing more shares, you're diluting everyone else, the other 49%, or if you've bought up 80%, then the other 20% in Company B, and all of those shares are given to you, which for your Company A shares. And what ends up happening is you take control of your Company A assets using your Company B as the private public shell company. And then now you have your private assets publicly listed in that shell company and Company B. So, that's really the reverse takeover process.
Now, me explaining this to you, it already sounds, whoa, this takes a long time, and it can take a long time. There are a lot of, you know, potential risks, if especially if that shell company has, you know, outstanding liabilities with regards to lawsuits or whatever it is. So, one of the best things for gold mining companies, exploration companies, is the Capital Pool Program, the CPC program, offered by the TSX Venture. And so, this is why a lot of companies go to the TSX because of this program.
So, due to such high demand for equity financing by exploration companies, the TSX Venture has a unique program called the CPC, which allows for the efficient execution of reverse mergers for small-cap companies. So, what are, let me explain the process. And here's kind of this blurb you can read that, but essentially, what you need is a minimum of three individuals that want to raise capital for their exploration company. So, your three geologists. Now, you need to put up yourself from your own into personal funds, a minimum of the greater of $100,000 or 5% of total funds raised. So, what that means, if you are raising, let's say, a million dollars and the TSX Venture, you need to either put up the greater amount of 5% of that million or $100,000. Now, 5% of a million is $50,000, so the greater amount would be $100,000. So, in that case, if you're going to list your company through the CPC program, you'd put up $100,000 and you'd raise your $1 million. Now, if you raise anything above the $2 million mark, which 5% of $2 million is $100,000, then the greater amount would be the 5% of that raise, and therefore, you put up the 5% of that raise, right? So, that's kind of something that's really important to understand.
So, at that point, once you have that money, you then incorporate a shell company, which is the CPC, and issue shares to yourselves in exchange for seed capital, which you provided. They're usually at 50% of the price with the subsequent shares to be sold via the prospectus. So, essentially that means that, okay, I kind of scrunch this together, but essentially, say for example, you want to raise that that million dollars, okay, and you're going to be selling shares at $1 apiece. So, in that case, you're going to be buying, providing seed capital to your business and buying controlling shares in your company at 50 cents. So, you get a discount because it's your shell company, and then you go to the market and sell your shares at really the 100% price, which is a dollar, right?
So, once the shares are sold and listed in the secondary market within 24 months, the CPC identifies an appropriate business as its qualifying transaction. And that means you have the shell company that was listed, and you provided seed capital with the remaining shares being sold in the secondary market. So, you've raised all this money, and you have again your private company, which you also control. And in your prospectus, you can identify, I want to take my company public through the CPC. So, I'm raising money to then buy my own private company. And so, you raise that money in the shell company, and then you take that money that was raised and buy control of that company, the Company A that you had. You bring those assets over, and you use the remaining money that you raise in the market to fund that exploration company. So, that's how it is, okay? So, you provide either the greater amount of $100,000 or 5% of the capital raised. You then incorporate a shell company, the CPC. You buy shares in that company at 50% of the price that you're expected to sell to the market because you are the owners of that company and going to control that company. You then sell those shares, raise that money, and within 24 months, buy control of the exploration company that you intended to bring over into the public markets, and then you can operate that company with the funds that you raised. So, that's the CPC program, there you go.
Now, an important factor of success at this stage is that because you have really nothing, you need to identify demand and you need to generate demand. So, one of the key factors often ignored when considering where to list exploration companies is the infrastructure present to help advise and progress properties from exploration to development stages. With strong infrastructure comes market coverage from analysts at brokerages, which can generate interest for your issue. The challenge with raising equity financing when a business doesn't produce any earnings is generating demand for those shares. This requires outside validation and coverage, which in leading markets like Toronto can be essential to meeting financing needs.
And so, this is important. So, if you're an exploration company and you have this potential property or this zone that you've identified that has a potential ore body, you need to generate demand. And not only should you be, you know, marketing yourselves, but in a good market, such as Toronto Stock Exchange, the Venture Exchange in Toronto, where the investing demographic is very familiar with the gold mining industry, you can then market yourselves to this target demographic, and these are your potential investors. And that's really good. Whereas, say for example, you're going to market yourselves, I don't know, like in the Dutch exchange, right? And there, you know, I'm sure there are people who are interested in investing in mining companies, but there's not as many. So, you really want to increase your chances of success, which means targeting demographics, a large demographic of mining investors, which in markets like London, Toronto, or Australia are very strong. And that's why those those exchanges are most popular for exploration companies.
Now, in the private markets, we talked about private placements. If the company is initially successful in generating positive sampling results, management can raise further money by completing a private placement where securities are offered and it's exempt from registration with the Securities Exchange Commission, the SEC. So, no prospectus is needed, and only a private placement memorandum is issued. Those who participate are usually institutional investors or wealthy individuals. So, again, I made a separate video on private placements if you're interested in learning more about that. But essentially, if you're a business, regardless of whether you're private or public, and you want to sell shares without going through the whole offering again of registering, producing this prospectus, and going to the exchange and, you know, waiting for approval and all that kind of stuff, you can pursue a private placement route where you target yourself, your company shares, and sell them to wealthy wealthy individuals or institutions who usually are considered the smart money and much more patient. And all you have to do is really set up this private placement memorandum and set up a secondary market after several months where you can really resell those shares. But this is a much easier way to sell shares in your business and raise capital.
Now, warrants can also be sold to incentivize investors to participate in this private placement. The problem with private placements is that the liquidity of that market is much less than just a public market, which makes sense. People can still sell their private placement shares, but there's a smaller group of people that can buy those shares, and therefore, you know, they're usually discounted. And to incentivize investors to participate in this placement, warrants can be sold and paired with that private placement share. So, a warrant is a contract between the company and the investor, in which the investor has the right, not the obligation, to buy a certain number of shares in the company at a predetermined price, usually priced above what shares are currently trading for. So, it's an option to buy more shares at a price above the current market price. So, if the private placement shares increase in value and the company is successful, then the investors can buy more shares in the future at a certain price, which can be very profitable, and that's why it's an incentive for investors.
Now, additional funding options in the equity financing space are flow-through shares. Now, this is an option for Canadian exploration companies. And so, FTS, or flow-through shares, is a tax-based incentive that is available to the Canadian mining sector, whereby exploration companies that incur expenditures related to prospecting or pre-production activities can renounce the expenses to the shareholders, who then deduct the expenses as if they were incurred, as if they incurred them directly. So, the companies have 24 months to use these funds. So, this is amazing. Like, these are incredible ways for wealthy individuals to really reduce their taxes payable. So, in this scenario, if an investor buys $100,000 worth of flow-through shares from an exploration company, who uses that to for prospecting, the prospecting expense incurred by using that fund is then deferred and renounced and given to the shareholder that owns that $100,000 worth of FTS, the flow-through shares. And so, that $100,000 expense can now be used to write down their income for their respective tax bill. So, if they earn $200,000, this is very simplified, but if they are, you know, $300,000 in income, they can write down $100,000 of that. And so, really, the government only recognizes $200,000 of income. So, that's really great. So, that's a very important incentive, and that's why these shares usually trade at a premium relative to just simple common shares sold in the market for exploration companies. And it's a very good way and an option for Canadian mining companies to sell equity financing and raise money. So, a very good way.
Now, of course, a problem with this is because they've renounced these exploration expenses, the exploration company does not have a tax loss carry-forward, which they can use in the future when they start generating revenues. So, that's why there's this balance. You know, generate equity financing at a premium today to develop the project, or carry over tax loss carry-forwards to really take advantage of tax benefits in the future. And usually, companies are now leaning towards flow-through shares because at the end of the day, those carry tax, those those carry-forwards are usually realized decades later when they finally develop the project. Whereas right now, exploration companies need the money right now, and that's why they use flow-through shares.
And there's also super flow-through shares. And this, the only difference between this and FTS is that the companies that have grassroots exploration expenses, which are expenses incurred in the course of prospecting, carrying out geological surveys, drilling by rotary or diamond methods, or digging test pits, versus flow-through shares where companies can also do brownfield exploration, which is exploring adjacent mining areas beside already developed mines. So, that's a big difference. So, with flow-through shares, a company can be developing exploring a region, whether it's a very brand new or a region that is adjacent to an existing project. Whereas with grassroots exploration, which is recognized in the super flow-through shares, those are brand new exploration interests that are not beside any existing mines. And so, in this case, not only is 100% of the expense that was incurred by the company renounced to the investor of the FTS, but an additional 15% investment credit is used to reduce the individual's federal income taxes payable. I'm probably going to make a separate video on super flow-through shares, but for now, this is another, you know, just a quick summary of these two equity financing options available.
The second stage of the gold mining process is the evaluation stage. Now, in the exploration stage, the company locates a site and focuses on generating positive drill samples to confirm that the targeted ore body has production potential. In the evaluation stage, before any serious money is committed to developing the ore body, the company obsessively drills and continues to test to see if the project can be brought into profitable production. So, as more information is obtainable, the projects through various studies, certainty of production potential increases, which allows the company in the valuation stage to access alternative financing, which was not available at the exploration stage. So, a new financing option pops up in the evaluation stage: alternative financing.
So, now evaluation stage companies can not only raise equity financing, but they can access alternate financing. So, the goal for most exploration companies is not to put projects into production, but to evaluate their gold deposits to confirm production potential, to prove the value of their projects. There are two key assessments that need to be completed, and which cost money. There's the NI 43-101 technical report, which describes the size and quality, which is the grade of the deposit, produced by a third-party engineering firm. This requires lots of drilling and sample data from the company, and drilling costs a lot of money to drill, you know, a meter into a hole, depending again on the drilling method, if it's a diamond-tipped drilling or if it's just a rotary air blast drilling, it depends. It can range between, let's say, $60 per meter to $200 per meter. And so, if you're drilling a 100-meter hole, that can really cost a lot of money. So, that's why you need money still to drill these holes.
And the National Instrument 43-101 technical report is a report that confirms really the potential and really the quality of this deposit, and it's generated by a third-party engineering firm rather than the firm itself, to really avoid conflict of interest where, you know, a company could falsify records and generate false investor demand and take advantage of investors, right? And another report that is usually produced and used to take a project from evaluation to development is the Preliminary Economic Assessment, the PEA, which is a report outlining the economic analysis and potential viability of mineral resources. In this case, it looks at a potential deposit and it analyzes how much it will cost and the cost economies of offering a potential mine in this area, right?
And so, at this point, it's important to understand the evaluation stage company can either go and produce the mine itself, raise funds, and use these reports to develop alternate alternative financing options, or it can produce these reports, generate additional demand for its prospect, and then sell it to cash-rich gold companies who already are operating mines and can raise more money to develop this mine more quickly. And usually, that's what happens because geologists and prospectors are very different from operators that actually run the mines. And so, there are two different types of management teams, and usually management teams sell out at this stage to larger companies who then take it to the development stage.
So, let's look at the evaluation stage financing options. As results continue to remain promising and initial equity holders are seeing an increase in their investment, companies now have the option to tap into alternative financing options if they want to continue with the project. In addition to equity financing already covered, there are three options available at this stage. There's royalty agreements, earn-in ventures, and joint ventures. So, let's go through each of them.
So, royalty financing. Under a royalty agreement, a company enters into a contract where the evaluator receives some money upfront in return for a percentage of revenues over the life of the mine, the LOM, that's how I'm going to be referring to it. Now, there are three common royalty types, and you'll see them, it depends again on the royalty provider. Some are much more risk-averse and will go with the gross royalty, whereas others are much more risk-taking and will provide a net profits interest. But the three are the gross royalty, the net smelter return royalty, the NSR, the most popular one, and the net profits interest, the NPI royalty. So, let's define each one.
The gross royalty agreement is based on a percentage of gross revenues produced by the mine. So, no deductions are made before the royalty is calculated, which can be burdensome because they are paid out regardless of if the mine is profitable or not for the operator. So, to calculate any royalty and to calculate the gross royalty, you multiply the percentage of the gross royalty, so say for example, it's a 5% gross royalty, by the price of the gold realized for the mine. Okay? In this case, there are no deductions, so you don't deduct anything from the gold price. But in cases where you do deduct something, you deduct that cost on a per-ounce basis. So, you multiply the percentage of that royalty agreement times the price of gold, less any deductions, and the resulting dollar amount times the amount of ounces produced by the mine is the total amount of the total payment for the royalty agreement. So, let's go through an example, a better way to do it.
So, for example, with a 4% gross royalty agreement, where the operator realizes a price of $100,000 per ounce of gold and sold 100,000 ounces of gold in the past year, the royalty company earns 4% times the price of gold, which is $48 an ounce. So, for every ounce of gold the gold company sells under a gross royalty agreement of 4%, the company, the royalty provider, receives $48 per ounce. Now, times that $48 times 100,000, so in that year, the royalty provider receives $4.8 million in royalty earnings.
The net smelter return agreement is a percentage of the gross revenue produced by the mine, less deductions for off-mine costs, such as transportation, insurance, smelting, and refining. It is the proceeds the mine operator receives from the sale of impure gold to the refinery. So, in the gross royalty agreement, we talked about there were no deductions made, so it was just the price of gold, which is already determined in the market. Whereas with the net smelter return agreement, what happens is that the mine then needs to process the ore that is taken out of the ground, and because usually that's done off-site and done by someone else, the company doesn't really account for those costs that are required to really process impure gold, really pure gold, which is sold at the market price. Therefore, they deduct that expense, and that's the net smelter return agreement.
So, in this case, assume that in the previous example, off-mine costs total $100 per ounce. So, the transportation, insurance, and smelting, which is the big one, and refining costs $100 an ounce. So, in this case, the market price is still $1,200. We have a 4% net smelter return agreement, and we deduct per ounce $100. So, in this case, it's $1,100 times 4%, which is $44 an ounce. Now, for every ounce sold, you receive $44 as the royalty provider. So, in this case, $44 times 100,000 produced in that year is $4.4 million in royalty earnings. Now, that's less than the $4.8 million. And so, really, the big thing to realize between these agreements is the dollar per ounce received by the royalty provider. The lower the dollar per ounce, the less is received. So, it's ideal for the royalty provider to realize a higher gold price for the royalty agreement, whereas for the mine itself, they want to deduct as much as they can in order to pay out less. And that's why for gold companies, they love the net profits interest agreement, the NPI agreement.
So, NPI royalties are a percentage of the net profit, which includes deductions related to operating and production costs, also known as cash costs, in addition to off-mine expenses. So, in net profits interest agreements, no money is received by the royalty company until operating and production costs are covered, and usually the miner has recouped the capital costs it incurred in building the mine, which can take a lot of time. So, returning to the previous example, if the cash cost, assuming that the miner has recouped its capital costs, if the cash costs, which are the operating and production costs of paying the wages, the electricity to really fuel the operations, whether it's an open pit or underground pit, you know, the different capital equipment and the gas needed to operate the different trucks that are in that mining operation, if that all accounts on the per-ounce basis to $750 an ounce, then the NPI royalty is $1,200, which is the market price, less the off-mine costs of $100, which we talked about before, and less $750 an ounce, which is the cash costs, times 4%. That's only $14 an ounce, much less than the $44 and the $48 realized in the NSR and the GR agreements. So, in this case, $14 times 100,000 is only $1.4 million in royalty earnings, significantly less. And that's why usually mining companies prefer the net profits interest agreement relative to the NSR, the GR.
So, which royalty agreement is best? Well, balancing the interests of the royalty provider, which has the capital, and the mining company that needs that capital but doesn't want to pay out too much, the NSR agreement is the most popular, as it is the easiest to manage. However, each side prefers different agreements. From mining companies, a net profits interest agreement accounts for all production costs, which ensures that no payment is made if the mine is unprofitable due to commodity fluctuations. Whereas gross royalty agreements are preferred by royalty companies because it ensures the highest payoff for them. One of the biggest risks for a royalty company is cost manipulation by the operator, because in the case of, you know, cash costs, usually the operator can either increase costs to really drown out the amount of profit that they report on the balance sheet, not really what they earn, and therefore they pay out less to the royalty company, and that saves them cost. So, it's much more risky to go into an NPI agreement as a royalty provider.
So, with gross royalty, there's no operating cost accounted for. And in a scenario where there's a bear market and, you know, costs remain relatively stable, whereas earnings fall significantly, well, then all of a sudden, the mining company is unprofitable, but they still have to pay out a large sum because the royalty company is only paid based on the top line rather than the bottom line. Okay? So, the NSR argument is that middle ground, where it accounts for off-mine costs, but it protects against cost manipulation of cash costs by the company, the mining company itself.
So, the other option is joint venture financing. Now, we already know what joint ventures are, which are simpler agreements where, you know, a junior company sells a certain interest to a senior company, and then on a pro-rata basis, they finance the mine itself and receive on a pro-rata basis the revenues from that operation. But earn-in ventures are unique to mining operations, and especially gold mining. So, earn-in ventures are agreements where a more cash-rich company is granted the option to acquire a certain percentage of interest in an exploration project based on funding milestones. The more money they earn and partner invests in the evaluation of the ore body, the larger the percentage of ownership increases.
So, essentially, if you have an exploration project, so you are at that point where you've conducted the feasibility studies and you realize, okay, it has potential, I think we can actually develop this mine, you go to a more cash-rich senior gold mining company that already has gold mines and is profitable, and then you tell them, hey, you know, I need X amount of dollars to further develop and ensure that this prospect can be taken to the development stage. So, let me sell you initially for an upfront payment of, you know, a million dollars, X percent. And then, if you provide more money, your percentage of ownership in that prospect, in this region, increases. And so, we're essentially selling you more and more equity as you provide more and more capital, which is a great way to really earn control for the senior company, especially if they believe in that prospect.
So, the best way to look at the earn-in joint venture is to look at a real-life example. So, I randomly typed in "earn-in joint venture gold company," and this is one of the first results on newswire. Avala Resources announced in November of November 30, 2015, that Rio Tinto agreed to earn-in joint Avala to acquire up to 75% of its wholly owned exploration license in this region, and so it can incur up to $40 million in exploration expenditures. And so, there are three stages to this agreement. So, if Rio Tinto incurs total project expenditures of $3 million by X, it will incur a 51% interest in the project. If Rio Tinto incurs an additional $5 million, it will incur an additional 14% ownership in the interest, taking it to a total controlling interest of 65%. If Rio Tinto incurs an additional $32 million by X amount, by in this case, 2023, which is many years down the road, eight years, it will earn an additional 10% in the project, bringing its total controlling interest to 75%. So, this agreement, adding these three totals, that's $40 million in expenditures. So, if Rio Tinto believes that the project, yes, after initially providing $3 million, okay, great, you know, it has a lot of potential, they do more, they control more, and then eventually, if they put up the full $40 million, they'll be able to take a 75% interest in the project itself. And so, this is a really great way to participate as a senior with a junior.
And I believe the next slide is the challenges. And yes, so the problem with joint ventures, and especially traditional joint ventures, is differing agendas. So, consider the previous example. Rio Tinto employs 50,000 people, whereas Avala, on their LinkedIn page, says they have about 100 people. So, the organizations have different timelines. And so, because of that, and because of this difference in size, Rio Tinto, a massive billion-dollar company, and Avala, a million-dollar company, their way of offering, their decision-making process is completely different, and that can conflict when you are operating together on a project. Avala, this is their core baby, this is probably their only project, whereas Rio Tinto, Rio Tinto has hundreds of potential projects and multiple mines to manage. So, their mind is different.
So, if one of the big four joint ventures, and especially just traditional joint ventures, is how the money is spent. Juniors want to spend on key activities, while seniors want to control, cover all of their bases, and reduce downside. And so, what that means is juniors usually want to move fast so that can generate more interest in their share price and raise more equity financing, whereas seniors want to take their time, ensure 100% that this project has potential before they put up any serious money. Juniors are also glued to their share price, wanting to move quickly to raise their valuation, whereas seniors have a pipeline full of projects. They don't care about the junior's share price, and at the end of the day, they're going to move up their timeline because they have the money. Juniors are usually not expected to have the financing lined up to develop a mine. So, seniors usually look for complete control early on and usually push out the juniors. And so, that can really create a lot of lawsuits, especially if the junior wants to remain, if they see that, yes, this could be a potential billion-dollar project.
And so, looking back at the earn-in joint venture, these problems that we talked about, this difference, these differing agendas, is kind of dealt with. It's not completely dealt with, but it's dealt with with the earn-in joint venture. So, they incur more expenses and therefore take more control, and there are set deadlines, right? By 2017, by 2019, by 2023. So, if the junior company can agree to a certain timeline and encourage the mining company to perform up until that date, what happens is juniors can kind of speed up the senior company to be with them. So, if they're able to agree to a favorable contract, then they can reduce that differing timelines. At the same time, if the problem of control with the senior looking to control more, well, if the senior sees potential, they're probably going to incur that full $32 million to $40 million very quickly and early on, and therefore get more control. Whereas if they don't, and they kind of just sit down there like, whatever, here's $3 million, or a billion-dollar company, we don't really care about it, well, then they won't control as much as if they provide more capital. And so, you can really see, and as the name suggests, they earn more control, and they earn more responsibility in that project, which is very beneficial for the junior, which really depends on this project. So, that's, I just want to identify not only the challenges but really the benefits of earn-in joint ventures relative to joint ventures for exploration companies. We're not talking about development companies or production, that's completely different. Before exploration companies that are on the edge, on the edge of either developing or really.
Dying and losing their interest. So, moving on to the development stage. The development stage happens after the site has been proven to have enough reserves which can be extracted, extracted profitably, to warrant the high upfront costs of development. And so, that's determined by conducting that preliminary economic assessment and the NI 43-101 technical report confirming that, yes, the grade is high enough, it's profitable enough based on its region and the infrastructure needed to develop that this, this mining operation can be run profitably. So, a detailed feasibility study must, must be completed to show the design for the mine, a detailed process flow sheet, projected recoveries, and capital and operating cost models, which are then shown to lenders.
And so, at this stage, what happens is additional financing options become available. So, not only do you have equity financing and alternate agreements like royalty agreements, now debt financing and streaming agreements become available at the development stage. So, in addition to equity and alternative financing options like earn-ins, joint ventures, and royalty deals, as the project progresses to the development stage, streaming transactions become available. Streaming transactions involve an upfront payment and follow-up payments in return for a portion of future production at a predetermined price. This option is cheaper than equity and safer than debt. And like royalties, patient money with experience broadens, which understands the operational challenges. So, streaming transactions are similar to royalty transactions, as I indicated before. But in this case, you are receiving a series of payments rather than just one upfront payment.
And, and I wanted to focus on patient money because this is very important. The thing is, when you go to a bank and get bankers to lend you money, they don't know the mining industry as much as they will be able to really talk about Excel sheets and what they project the mine is going to be able to make. They don't really understand the ground-level operation. Whereas with royalty and streaming companies, their entire business is financing mines, right? You have Sandstorm, a publicly traded company in Canada, that provides this type of financing. And so, they understand the mining business. And so, they're much more patient. So, if there are challenges, if there are delays in mining, the development of the mine, they're much more patient than bankers who are like, "Hey, you have to pay us back at this time and follow these covenants and all that kind of stuff." So, this is patient money. It's encouraged for mining companies to pursue these agreements before they go to the much stricter and more ill-informed bankers.
So, streaming versus royalty. Where are streaming deals involve an upfront payment and follow-up payments in return for product delivery? Royalty agreements involve only one payment at the start of the project. So, here's an example of a royalty agreement. So, see, Silver Wheaton is a publicly traded company entered into a streaming agreement with one of HudBay Minerals' copper projects. So, Silver Wheaton acquired 100% of the life of mine (LOM) silver production and 50% of the life of mine gold production from this base mineral copper project. So, total consideration for the streaming agreement was $429.9 million, of which initially $294.9 million was paid in the first two years, with an additional $135 million paid once capex of $1.35 billion has been incurred at the project.
So, for each ounce of silver produced across the life of that mine, the Silver Wheaton will pay $5.90 per ounce. Whereas, oh, sorry, this is the ask for silver. And then $400 an ounce for gold. So, different from royalty agreements where it's a percentage of the price realized and sold. So, with royalty agreements, you have just a cash payment, whereas the streaming agreements, what you do is you give them money to develop that project or to, you know, really refine and add efficiencies to the project. In this case, HudBay wanted to develop the refining, refining productive capabilities. So, they took out this streaming agreement. And so, in this case, because it was a copper project, I'm assuming gold and silver production were a byproduct of the project, and that's why they sold out 100%, 50% of the life of mine gold production. But the consideration was used to add efficiency to the project. And in return, at this time, I believe this was done in 2012. So, the price of silver and gold were significantly above. I believe gold was at like both $1,300, $1,400, was starting to taper off, and silver was at about $8 or $9. So, it's significantly below the current market price. And so, it was profitable for Silver Wheaton to buy these ounces of gold and silver at these prices and then just resell them at the open market and realize a profit.
And so, this is how streaming agreements work. Whereas royalty agreements, you give capital initially, they develop a project, and then, you know, you receive money in return. In this case, you give capital in a series of payments. In this case, initially $294 million, and then on a condition that the company spends an additional $1.35 billion, you give them an additional $135 million, which really indicates commitment to that project from HudBay. And then, at that point, any production that is any byproduct from this copper project is then bought by Silver Wheaton. So, you still pay for that ounce, but significantly discounted relative to your expected market price when you expect to receive it. And so, that's really how streaming agreements work.
Now, an additional financing option at the development stage is a forward sale. In a forward sale, a mining company receives an upfront payment in return for agreeing to sell all or some of its production in the future at a predetermined price and date. It is similar to a streaming deal, except that under a streaming agreement, delivery is held off until production starts, whereas the date of delivery for a forward contract is fixed. Now, don't, the easiest way to think about this is a forward contract is similar to a streaming agreement, except that the date of delivery is fixed. So, with streaming agreements, there's, in this Silver Wheaton deal, there's no indication of when they were to pay this $5.90 per ounce. Whenever the project is to be completed, or in this case, whenever the mine processing facility was to be built, after that, when the mine is reopened and starts producing again, then they pay whenever that ounce is taken out. So, there's no date of delivery on a streaming agreement.
Now, on a forward sales contract, similar to a forward contract in any industry, there is a fixed date of delivery. So, in this case, if you engage in a forward contract at a certain date, but then there's, there's a delay in in the production of the mine, or if the, if you're developing a mine, expected to build it and finish building it in five years from now, but you know, there's a massive storm and, you know, maybe there's a fire on the construction site and all that, and all of a sudden you, it opens up in seven years rather than five. Well, where are you going to deliver that gold in the fifth year because you haven't produced anything, right? So, this is much riskier, in my opinion, and that's why, you know, a lot of companies don't pursue forward sales contracts, but it is an option.
And here's an example of a disaster. So, in August of 2011, Yukon Nevada Gold, I, I actually remember this. I was, I was looking at this company to buy it, so thank God I didn't. So, Yukon Nevada Gold entered into a $120 million forward sales agreement with Deutsche Bank, with an additional $20 million forward sales contract signed in February of 2012. So, they, this capital raised of $140 million was used to improve the company's processing facility in return for delivery of 200,000 ounces of gold over 48 months at a price of $800,000, $800 an ounce. So, in 2012, the price of gold was maybe at $1,600. And let's assume that at the end of every year, they returned, you know, 50,000 ounces, right? Because at 48 months is four years, 200,000 divided by four is 50,000. Every year they're expected to deliver 50,000. Let's just assume that, okay? So, in that case, you know, every single year, the Deutsche Bank would buy 50,000 ounces of gold at a price of $800 an ounce. And, and, you know, that's below the market of at that, at 2012, of, you know, $1,600 an ounce. And so, the company was expected to produce around 200,000 ounces per year. And with gold prices at $1,800 in late 2011, the deal looked sustainable. However, as the company ran into operational delays and the commodity price fell heavily, the Yukon, Yukon Nevada Gold couldn't deliver on its forward contract and declared bankruptcy.
So, they actually only produced about 150,000 ounces in the first year, and it started to fall off. And especially as gold was falling after, because gold peaked in 2011 and then fell off to about, you know, $1,200 by 2013. So, it wasn't profitable anymore, but they were still expected to deliver 50,000 ounces of gold at the end of each year, assuming that that was the agreement. And so, that really forced them into bankruptcy. And so, that's why it's much more risky to engage in the forward sales contract. So, stay away from that.
Okay, another option. So, this is debt. It's project facility loans, but it's a private form of debt. So, this is not like a corporate bond that is publicly traded in the bond market. It's a private debt agreement between usually a bank in that region and the mining company. So, these are privately held loans used to finance a specific project, usually set up at a non-recourse loan. So, the project facility loan is not made at the corporate level, but at the project level. There are two key tranches to this loan. There's the project facility, the PF portion, which is the main part of the loan and carries a lower interest rate. And then there's a cost overrun facility, the COF, which carries a higher interest rate and equals around 20% of the total project facility.
So, project facility loans are important to development stage companies because they are the ideal type of loan to raise money quickly and usually at a cheap cost and to develop the project. So, assuming that everything is going to be built on time and the company expects to be profitable, what happens is the company goes to the bank, takes out the project facility loan. It's a non-recourse loan. So, if they fail to build it on time, they can just default on the loan and they lose a mine and not the entire company. And so, usually around 80% of that project facility is is used. And in the case that, you know, they run over budget, which it usually does happen, there is a higher interest rate and they take out the remaining 20%. There is, there is that penalty of a higher cost, but at the same time, it's available for them. So, this is an ideal financing option and it's much better than just regular senior term debt with strict covenants offered by a bank.
So, the final stage and last few slides before the video ends is the production stage. So, the final stage is when the mine has been built and the company's producing gold, hopefully at a profitable level. At this stage, the company has probably been up-listed from a junior exchange like the TSX Venture to their senior counterpart like the TSX, which provides greater exposure to investor demand. And that's always key when it comes to equity financing. At this stage, all financing options are now available. So, remember to review. So, at the exploration stage, only equity financing is available. At the evaluation stage, alternative financing becomes available. At the development stage, debt financing, as in project financing, which we talked about in the last slide, it becomes available. And then, finally, in the production stage, when you're actually operating the mine, generating revenue, selling it, hopefully at a profitable price, then cash flows and internal funds finally become available.
So, internal funds are not available at the first three stages of development. It makes obvious sense, but people forget. You know, like when they look at a gold company in the investment pool company, they don't think about what stage they are in and therefore what are their options. So, that's very important to understand. So, just to quickly highlight, at this stage, equity, equity financing becomes very, very profitable in, in the sense that there's more demand, you can sell shares at a higher price, you don't have to dilute equity shareholders at such a high rate because now your shares are probably much more valuable, they're on the TSX rather than TSX Venture, and people are all excited, "Oh, you're finally producing and great, let's see what the company can do." Debt becomes more liquid because at this stage, you can take out debt like corporate bonds. So, instead of taking project facility loans where they're at the asset level, you take them at the corporate level, and these are publicly traded bonds that, you know, you deliver in the future, right?
An alternative financing, in this case, you still have the same agreements. You know, you can do a royalty agreement, you can do a streaming agreement, you can do a joint venture. Earn-ins usually fall off. You don't really do earn-ins anymore because you have the financing, you don't want to be selling such a high amount of interest in your, in your project. So, joint ventures are usually the option between those two venture options. And so, better terms are available on alternative financing when the production stage happens. And so, finally, there's the internal funds themselves. And so, internal funds are the cash flow generated by the business itself. And so, again, these are the, the best types of funds because, you know, management has complete discretion as to how they are being used.
So, let's talk about them. So, we've talked about the previous three, and so this is the only one I'm going to be spending time on. So, if the mining operation is being run profitably, the best form of financing becomes available. These are internally generated funds. The purpose of any publicly traded company is to generate value for their shareholders, and if the business is profitably generating cash flows, it needs to be used to fuel growth, to add value. So, cash flows, internal funds can be used for expanding production, increasing efficiency, increasing revenues, and the life of the mine, which is very important because usually this, this is a non-renewable resource, and therefore resource depletion is the biggest challenge. A resource company faces, especially gold companies. They can diversify portfolios by, especially if a company has only one mine, there is a single asset discount that usually is applied to that share price. So, even though it is much more valuable than when it was in the exploration stage because it has only one mine, if that, that single mine fails or there's a problem, then the company, the entire company suffers. So, at that point, you know, you want to use funds then to diversify at another mine or add more prospects.
Now, instead of you being the exploration company, you are the cash-rich senior company, and you start looking at junior companies to acquire and develop them as well. And at the same time, you can pay down existing debt which was taken out to develop the project itself. So, these are some of the options that, you know, you can use internal funds for. And again, these, this is very challenging. Like, it's great to have internal funds and all, but at this point, it's about balancing interests. What do you do to do use this cash to leverage yourself more and add more debt in order to add, diversify your portfolio, or you pay down existing debt and don't focus on the long term, which is, you know, reserve depletion? So, again, these are, there are a lot of options here, but this is a big option for companies. And in strong markets, internal funds are abundant, whereas in bearish markets, where the market price of gold falls, internal funds are usually in short supply.
So, in conclusion, last slide. The availability of financing is one of the most important factors impacting the future outlook for any mining company at each stage of growth. While different challenges exist at each of these stages, understanding the financing options available is essential to navigating the difficulties that most companies are expected to face. And so, it's important as investors to understand those challenges. So, if you are an investor in an exploration company, you have to understand that not only is there risk of the company not finding something in the ground, no, the biggest risk is them running out of money. Some companies have great potential, they have great assets, and they're right, they're about to be, yeah, like we have all this demand and this hype, but if they run out of money, it doesn't matter how much ore is underground, you can't take that out, take that ore out.
Now, you have to really develop and slowly finance the company, go from stage one to two to three and finally to four before you can actually realize that potential. So, it's important as the investor to understand that the biggest risk for especially junior companies is running out of money, and you need to understand the financing options available. And especially if you are an active investor and you want to ask questions of management, you need to ask them, "Hey, have you considered this or that?" Or if you're the management themselves, "Have you considered these options when you go and you consider ways to raise money?" Other than that, that's pretty much it for this video. I hope that you really found this helpful. If you did, please do like and subscribe. I talked for an hour and five minutes and, and it's a lot, but I really love this topic. I found it very, very interesting. If you have any questions, not only should you comment below, but if you, if you really want to talk one-on-one, reach out to me at my email, financekid@gmail.com. So, finance with two e's. And as well, if you're interested in learning more about equity research or learning about my, my own investment picks, I do publish a lot of research on Seeking Alpha. So, go check out the video description for a link to my Seeking Alpha page where you can really read up on some of my reports and my perspectives. Other than that, I hope you found this video helpful and have a great day, guys. Thank you.