Flow-through donations may be safety net for junior explorers

It’s no secret that tight equity markets are hurting junior mining and other resource exploration firms in Canada as they struggle to find the vein of capital to keep their operations running and their valuations from leeching away.

Yet, curiously, at a time when resource capital is harder than ever to access, a highly beneficial tool to expand the universe of capital sources — flow through donation financing (FTDF) — sits untouched by the vast majority of junior miners who are largely unaware of the existence of FTDF programs and how they work.

First, a few words to alleviate some of the mystery: Leveraging the tax benefits associated with exploration sector flow through share investing is a relatively new tax-shelter gifting arrangement under which individuals wishing to give to a registered Canadian charity can do so at a significantly reduced after-tax cost relative to simply making a cash donation.

The way it works is that the investor first buys into a subscription of mining sector flow-through shares (achieving one set of tax deductions), which are then donated to a charity (generating another tax deduction) and the shares are immediately sold on behalf of the charity, which receives the cash proceeds. The charity simply issues a tax receipt equal to what it actually receives in cash on the closing of the transaction, representing the best indicia of the fair market value of the involved shares.

The flow-through donation format, which has been existence since 2007, is a fiscally revenue-neutral tax shelter plan that benefits all parties in the flow-through donation universe, including Canadian resource companies, charities, donors, and investors. It should be noted, FTDF plans do not defer, circumvent or avoid any tax that would otherwise be payable. In fact, the net result of this flow-through financing activity is of significant social benefit to Canada in the way of a strengthened natural resource industrial sector and better funded charities.

Now, let’s go back to the dearth of Canadian mining companies taking advantage of FTDF opportunities. As I noted above, many exploration companies simply are not aware of the existence of FTDF programs and their associated benefits to issuers as an alternative source of capital. In addition, there is a common misconception that the pricing structure of such plans — which offer a market discount to institutional buyers — can create a downward pressure on the overall stock price.

The fact is the exact opposite. The typical transaction offers issuers a market premium while vesting the equity with institutional and strategic investors at a typical 10% discount to market. In every case, the owner of the equity, on closing, has a materially higher after-tax cost base than any flow-through retail investor or fund. The institutions acquiring these shares are doing so based on sound underlying fundamentals rather than a combination of tax and investment motivations.

In other words, the shares are much more likely to be placed in the hands of a trusted institutional investor whose interests are aligned with the resource company’s strategic vision. A further advantage is that the underlying equity can often be vested in the hands of global institutional investors, which would not be the case in a standard flow-through share financing.

The fact of the matter is that the pricing structure of the flow-through share donation format is a significant driving force in expanding the universe of prospective investors in the junior mining sector in Canada. When capital markets erode — as they so clearly have in recent years — FTDF provides an alternative source of funding. Donor subscribers acquire shares at a premium, which reduces dilution, and charities sell at discounts, thus bridging pricing expectations for both issuers and smart money global investors.

Flow-through donation financing is a natural and robust addition in the M&A resource financing toolkit. For example, in a series of financings spanning two years, Lake Shore Gold raised more than $40 million — orchestrated by PearTree Financial in concert with the brokerage community — in which hundreds of donor subscribers donated to dozens of charities, funding hospitals, universities and community foundations across Canada. All the charities sold to Lake Shore’s strategic investor in Peru. 

FTDF is transparent. Issuers and their intermediaries often introduce some or all of the end buyers or, alternatively, have the right to vet the end buyers.

Just how significant a driver can FTDF be? Flow-through donation financing, alone, contributed more than one-quarter of the mining flow-through risk capital raised across Canada in 2010 and currently represents one of the only dependable sources of exploration capital during these challenging times.

And perhaps the most compelling reason for considering a FTDF is its ability to enable greater public good. Junior mining companies rarely, if ever, have the budget to be socially generous. However, by participating in an FTDF arrangement, issuers can have a direct, positive impact on accelerating and increasing donation funding for everything from schools, to hospitals and medical research, to local food banks.

To take advantage of this largely untapped opportunity, mining exploration firms simply have to encourage their financial advisors to seek out an FTDF service provider to initiate a discussion about structuring an arrangement that meets their particular capital needs and work out the closing of a placement. It’s a remarkably easy process that can have an equally remarkable outcome for cash-strapped juniors.

– Lisa Davis, LL.B, ICD.D specialized in the areas of corporate and securities law with two of Canada’s leading national law firms, most recently with Heenan Blaikie LLP, and was general counsel for a national specialized investment fund business. She currently heads up the legal and operations team for Toronto-based PearTree Financial Services Ltd. Visit www.peartreefinserv.com for more information.