Digging around: Assessing funding options for junior exploration companies

Early-stage resource exploration is vital to uncovering the natural resources that power the modern world. Yet, despite its importance, exploration is inherently cost-intensive and risky – many projects do not result in the discovery of commercially viable deposits for extraction, and exploration generally is not guaranteed to deliver any returns on capital investment.

Without revenues from production operations, junior explorers lack the steady cash flows necessary to fund their projects and must instead rely on external funding to cover the costs associated with exploration and drilling, usually in the form of debt financing or equity financing, or some combination of both.

Securing such funding, however, can be difficult (if not impossible) unless lenders / investors expect receive some financial benefit from their investment. Exacerbating factors such as fluctuating commodity prices, environmental restrictions, regulatory hurdles and lengthy project timelines increase the risk-profile of exploration projects and make it challenging to attract third-party funding.

There are various monetary support programs available, at a federal and state level, to assist junior explorers to overcome these funding challenges. For example, the Junior Minerals Exploration Incentive (JMEI) program has established a tax credit mechanism intended to encourage investment in early-stage exploration by reducing the financial risk to investors, thereby assisting junior explorers to secure the external funding necessary to advance exploration projects and access potential mineral discoveries on their tenements.

In Part 2 of HopgoodGanim's Mining Project Lifecycle Series, we examine the funding options available to junior explorers by considering the benefits and shortfalls of debt financing and equity financing, as well as the various government grants and financial incentives which are available to support the resources industry generally.

Debt financing vs equity financing

The two primary financing options available to junior explorers are debt financing and equity financing.

Equity financing involves raising capital from new and existing investors by issuing shares or other securities in exchange for capital, allowing companies to fund their operations without taking on debt.

For junior exploration companies, equity financing is a crucial funding mechanism to support exploration activities where cash flow is uncertain and therefore debt financing is too expensive or high-risk.

However, depending on the structure of the raising undertaken, equity financing can result in a significant dilution of the company’s existing shareholders. Directors should therefore have a clear understanding of the impact of their chosen equity financing structure before undertaking any capital raising. Some relevant considerations for the board include:

1. Impact on shareholders: the board should consider the dilutive impact of any raising on existing shareholders and, where possible, structure the equity financing to minimise that impact as much as possible.¹
2. Pricing, timing and disclosure: most equity financing structures can now be undertaken with limited disclosure required to be given to prospective investors. These ‘low doc’ raisings can be conducted in a relatively short timeframe, giving companies quick access to capital and allowing for tighter pricing to be achieved (i.e. shares are offered at a smaller discount to the prevailing market price). However, it remains critical for directors to ensure that a robust due diligence process is undertaken in connection with any equity raising to ensure that all material information is disclosed to the market.²
3. Availability of incentives: the global focus on critical minerals has seen governments establish incentive programs, including flow-through share schemes such as the JMEI program, designed to encourage investment in early-stage exploration companies.

Debt financing, on the other hand, allows a company to avoid diluting its existing shareholders by borrowing funds from a third-party lender. These funds are often lent at high interest rates,³ but the cost is generally considered worthwhile for companies seeking to retain control over their assets⁴ and strategic direction.

However, debt financing also involves a high risk of default if the company fails to make timely repayments under the loan. Higher interest rates are intended to compensate lenders for the increased risk inherent in speculative exploration projects, and these loans are generally structured with fixed repayments which must be met regardless of the company’s financial circumstances at the time. While interest expenses may be tax deductible, the tax benefits must be considered against the pressure which regular repayments will place on the company’s cash flows.

If the company does not generate sufficient revenue to meet its payment obligations under the loan at the time of repayment, the company risks financial distress and potential insolvency.

For these reasons, debt is generally not a common option for exploration companies seeking to fund their projects.

Funding programs

There are various national and state programs offering funding solutions for junior exploration companies, which are broadly offered in the form of grants, loans or tax incentives. Some examples of these programs are discussed below.

Government grants

• (Collaborative Exploration Initiative) Under the Queensland government’s Collaborative Exploration Initiative, junior exploration companies can apply for grants of up to $250,000 to fund exploration activities. However, companies should be aware that a condition of the grant is that, at the conclusion of activities (and following a six-month confidentiality period), the geoscientific data from all successful programs will be made publicly available online.
• (Critical Minerals Development Program) The Critical Minerals Development Program supports early and mid-stage critical minerals projects. The current round will provide up to $50 million over three years for competitive grants to support early and mid-stage critical minerals projects.

Loans and similar funding

• (Northern Australia Infrastructure Facility) The NAIF is a Commonwealth Government financier which was established to provide concessional loans for the development of infrastructure projects across a range of industries, including resources. The NAIF supports territory covering 50% of Australia’s landmass and has committed $4.4 billion of funding across 32 projects to date.
• (National Reconstruction Fund) The Australian Government has established the $15 billion National Reconstruction Fund which will act as an independent financier providing debt, equity and guarantees to selected recipients in seven priority areas of the Australian economy, including resources and renewables and low emission technologies.

Tax incentives

• (Research and Development Tax Incentive) The Research and Development (R&D) tax incentive program also plays a pivotal role in the funding structures of many junior explorers. According to the Australian Government, the R&D tax incentive aims to “boost competitiveness and improve productivity across the Australian economy” by improving the incentives for smaller entities to undertake research and development and creating financial incentives which encourage research and development which may not otherwise have been conducted.
• (Junior Minerals Exploration Incentive program) The JMEI program was introduced by the Australian Government to encourage investment in junior explorers by allowing eligible exploration companies to pass on their tax losses to new investors in the form of tax offsets and franking credits.⁵ The JMEI program allows junior explorers to effectively transfer a tax benefit which the company cannot otherwise utilise, thereby making investment in that entity more financially appealing for investors and encouraging capital inflows to high-risk exploration projects which are critical to discovering new mineral resources.

Hybrid financing

Many junior exploration companies use a hybrid financing strategy, which utilises a combination of equity financing, debt financing and strategic partnerships with larger industry players or institutional investors to diversity their funding sources.

For example:

• Loans made via convertible notes give lenders the option to convert debt into equity, and reduce cash flow pressures on the company (while having a dilutive effect on existing shareholders).
• Royalty or streaming agreements allow a company to sell future production or revenues in return for access to up-front capital. In royalty agreements, the royalty entity is granted a share of the revenue generated by the company from the sale of the commodities produced from the project (i.e. settled in cash). In streaming agreements, the streaming partner is granted a share of future production at an agreed discounted price (i.e. settled by the physical delivery of resources).
• A company can collaborate with larger industry players or institutional investors by way of a joint venture or other strategic partnership to share the costs and risks associated with project development.
• The availability of government grants and tax incentives helps with corporate cash flows and supports eligible entities in funding their operations.

Implications

Securing funding is one of the most significant challenges faced by junior explorers, and debt financing and equity financing each offer distinct advantages and disadvantages. A well-planned financing strategy, whether through debt, equity, or a combination of both, is essential to ensuring that junior explorers have the capital required to progress their projects and unlock mineral potential.

Government grants and other incentive structures have emerged as a valuable tool to support junior explorers to finance their operations in Australia. It is hoped that these initiatives will assist many junior explorers to either obtain or attract funding to advance their operations in an otherwise (currently) unfavourable equities market, thereby supporting further resource discovery and the long-term growth of Australia’s mining sector.

^1. For example, a private placement to sophisticated and institutional investors will significantly dilute retail shareholders and any existing institutional shareholders that do not participate in the placement. This impact can be limited by combining the upfront placement with a concurrent Share Placement Plan or Rights Issue.
^2. Unlike in capital raisings undertaken with a prospectus, the directors will not be able to access the ‘due diligence’ defence for any equity financing structured as a ‘low-doc’ raising (i.e. placements, rights issues and share purchase plans). A robust due diligence process will assist to minimise the possibility of the board being liable for defective disclosure being made to the market.
^3. At least as compared to the rates which would be available to more established entities who generate revenue from their operations.
^4. Subject to any securities granted to lenders as part of the debt financing arrangements.
^5. Junior explorers often accumulate significant tax losses due to high exploration expenditures. However, since they do not generate any revenue from their operations, these losses typically cannot be offset against any taxable income in the near-term.