THE PITFALLS OF GOING PUBLIC: DIARY OF A CYNIC

So, you want to go public. You figure you can get together some money, start a public company to explore that mineral showing, find a mine. And get rich. I’ve been through that process during the past couple of years. Well, almost the whole of it except for the last part, that bit about getting rich. That hasn’t happened to me. At least not yet. If you want to take your first exploration company public and have its shares trade on a stock exchange, you are probably very ambitious. What you may not realize is that you are also harboring latent desires for self-abuse (or masochism, to use the clinical term). In any case, expect at the outset more grey hairs than you have now. If those brief cautionary notes won’t dissuade you from launching your own public vehicle for exploration financing, please read the following. It might save you grief and put you on the right track.

You need a sound reason for wanting to go public in the mineral exploration business. I have seen people over the years do it because they think having a public company will provide them with a lot of fun and make them a lot of money. Most discover that it does neither. If you want fun, go to Club Med. If you want money, stick with your day job.

There are only two valid reasons for going public. One is that you have a project that can best be developed further by going that route. The other is that you have an idea, a clear idea, that you think is better than anything out there right now. I don’t know how many would-be mining magnates have said they were looking for a project with which to go public. The only real criteria for this project were that it have a saleable story behind it and be affordable.

When I started my own public company, my idea was based on the following premises: First, it is a lot cheaper, on average, to buy into someone else’s discovery than to make one yourself. The major companies have known about this for a hundred years. The second thing I wanted was a project that my small company could handle, an easy-to-mine project that we could bring to production ourselves without excessive share dilution and resulting loss of equity control and without bringing in a major. In my mind, small, high-grade mines always get the short shrift in this business. Yet, they are out there, ready for development by small companies. If my idea was not unique, it was at least uncommon.

What I am getting at by example here is that in starting a public company, start with a solid definition of what it is you want to accomplish by raising money publicly. If it is to further develop a project in which you are already involved, be sure there is no private money available for development. Is there another company that will combine with you in a joint venture? The point is, going public is a serious diversion in your life, and you have to really want it.

Probably the most important thing off the start is a good grounding across the spectrum of the business. For example, geologists or prospectors should learn as much as posible about the brokerage business and about managing a small company (this latter aspect is one of the most overlooked in the junior mining sector). Stockbrokers and financiers should learn about geology, exploration and mining. Take courses if possible, or read books. I would recommend Mining Explained, recently revised and published by Northern Miner Press, and Free Gold, a brilliant history of the Canadian mining business, written in 1947 but still valid today. From here, a little more specialization may be required. For geology, read a first-year university text and even sit in on university lectures if possible. And enrol in the Canadian securities course offered by the Canadian Securities Institute. Anyway, you probably get my drift: learn as much about the business as you can. That includes getting as much free advice as possible from friends and others in the business.

The next necessity, unfortunately, is to hire a good securities lawyer. I say unfortunately because a lawyer, no matter whom you choose, will cause a lot of grief. You can lessen this by making a good choice up front. Never, under any circumstances, consider taking on a lawyer who doesn’t specialize in the securities business.

Engaging a lawyer can be tricky. As a fledgling company, it may be a good idea to avoid those big law firms on Bay Street or Howe Street (many of them won’t want your business anyway). You don’t want to be the one paying for those posh offices with their deep pile carpeting and fine china.

Instead, contact a good independent or a small firm. Spend an hour or two discussing your ideas, and listen closely to what is said. Talk to more than one lawyer and don’t be afraid to talk to some of his or her clients. A law firm is a business entity like any other; asking for references is a valid question. Another thing to be wary of is the “good news” type of lawyer, one who tells you things are straightforward and should go smoothly. As far as I know, this has never happened in the history of taking companies public. A lawyer who outlines some of the likely problems is probably more honest. After discussing your ideas with a lawyer, decide whether you still want to go public.

If you do, the next thing you need is the project (unless you are doing a blind pool in Alberta). This project has to fit different criteria, depending on the province it is in. For example, you are going to need an independent geologist’s report explaining the merits of the property and why money has to be spent on it. In some jurisdictions, you have to spend at least $60,000 in privately raised money on exploration before going public. Your lawyer should have all the details.

At this particular intersection, I had a problem. I didn’t have enough money to acquire the kind of property I eventually wanted, that is, a significant mineral discovery. In fact, I hardly had any money. Therefore, I had to start with a smaller property, adding a second focus to my initial idea. So I acquired a property I had worked in the past, a grassroots gold play in northern Ontario. This gave me a valid reason to raise the initial money and begin trading publicly. And, as I was to learn, money was not to come in for some time.

Once the direction is decided, incorporate your company in a manner that eases the effort of going public. Your lawyer can help you here. It is also time to start thinking about money. Selling seed stock for initial exploration funding and, if necessary, funding through to final prospectus, is the first step. It is important to have enough money so that the company can still pay the bills if the final prospectus fails to raise the required sums. Otherwise, you may be on the hook yourself. The rules on seed stock are generally that it has to be sold to friends and business acquaintances. This is the time to get people who believe in you in on the ground floor. Even though the shares they buy are subject to hold periods, they are buying it cheaper than anyone else and unless your company does poorly, they should do alright.

I seeded my junior at 15 cents per share, and at this price the stock sold out easily, raising $35,000. This, as it turned out, was enough a few years ago, but more might be needed today. Following the seed-share issue, you will see just how many hands are after a piece of the action. There are lawyers, brokers, government bureaucrats, accountants, geologists, et cetera, et cetera. Since it is lawyers, brokers, government bureaucrats, accountants and geologists that make the rules, they are unavoidable. Probably the best way to start is to draw up a budget with your lawyer and add 50%. If it isn’t enough, you can always sell a little more seed stock down the road. Whatever you do, don’t sell too much seed, because you are diluting your company at unnecessarily low prices.

After “seeding,” your company should acquire the property or project. Again depending upon which jurisdiction you are in, you can receive shares for this. You can also receive, for your promotional efforts, founder’s stock at a nominal pri
ce. The details of this are complicated, so have lawyers explain the various options.

At this point, you are faced with something all too often overlooked by rookie promoters, the selection of a board of directors. You want people who are going to make a difference to your company. Many people try to attract big “names,” who are often too busy to help you at all. Others satisfy the board requirement with friends who act merely as designates and do nothing for the company. What you should go for is a mix of professionals who can help you along. (Hint: it is also a way to get some professional work done in exchange for stock options rather than precious cash).

At this point, your salary (or, more precisely, whether you should or should not get paid) must be decided. Running a junior exploration company is a full-time job. (People who start public companies as a part-time diversion or hobby inevitably fail, unless the company is well heeled and can hire a full-time manager). If you can afford to do without a salary, the company will benefit in the early going. Besides, some securities commissions limit salaries of promoters of junior companies, except in special circumstances. (This was brought in to prevent unscrupulous promoters from raping corporate treasuries in salaries. However, it can be counter- productive because the cap is so low — a maximum $24,000 per year in Ontario, $30,000 per year in Vancouver — that it literally forces the person to moonlight.)

The next step is probably the most difficult. You have to find a brokerage firm willing to underwrite your property or your idea. What you will find first is that you are looking for someone to underwrite you. Most financial people look more closely at the individual than at the project. If you have no track record and don’t know anyone in the brokerage community, expect a tough hustle. If you have been involved in successful deals in the past, it might be a bit easier. If you have a broker friend willing to quarterback the deal, (as I had), it is much easier. It will help if you are in a hot junior market, although stock market conditions could easily shift before you reach final receipt on the prospectus. In any case, once you find a brokerage firm willing to take you on, expect to be roughed up (in a financial sense, of course). It sounds cynical, but it is true. The reason is simple: people with access to money call the shots. Remember, it is other people’s money to which I refer. Human nature being what it is, they want to pocket as much as they possibly can. They are interested in making money and making it fast. This is especially true of brokerages dealing in junior companies.

For starters, there will probably be an agency fee, which is an up-front payment to cover their efforts if the public offering of your company shares sours. Then there is the commission, which is negotiable. Frequently, as the prospectus evolves, the sponsoring brokerage firm will want to renegotiate this upwards. Once they have your agency fee (and unless you have another firm wanting your deal), you don’t really have much bargaining power. Also expect to pay the brokerage firm’s legal bills (try to negotiate a cap on this at the beginning), as well as the printing bills for the prospectus. They will also push you for the lowest possible price for the issue, so that their upside potential is greater. Finally, there are stock options for the firm and the brokers, and a “greenshoe” option, which means that if the issue is going well, the brokerage house can sell up to 10% more than the total issue.

To add yet one more note of cynicism: don’t be surprised when the firm doesn’t pay much attention to the merits of your project or your idea. As I mentioned above, they will look at you and perhaps your board of directors. They will look to see that you are not going to run out of money three weeks after the financing. But the bottom line is that some brokers do not even care about your deal, and there are others who don’t even believe in their own deals. They think the stock price is going to go down in the months after the deal closes. They will likely insist that you have some “heavy buying” lined up for opening day. If your stock is unusual and does go up, some brokers might even sell out their clients to bring the share price back down. If they have a greenshoe, and the stock price goes up, they might short your stock and cover it by exercising the greenshoe, pocketing the difference and collecting yet another commission. There are brokers in Canada, and lots of them, that will do this for pennies per share.

As if all of this weren’t enough, the firm will usually expect you to find a good percentage of the buyers, sometimes more than half. You will be expected to hand the firm a list of friends and business acquaintances so they can open accounts to buy stock. In street jargon, this is called the President’s List. In other words, even though you do the selling, they get the commission.

The other thing you have to do is decide how much you want to raise. That is, how much work can you justify doing on the first go-round and how much extra do you need to run the company? Remember that it takes as much effort and nearly as much money to raise $200,000 as it does to raise $1 million. With my company, we settled on selling 1.1 million shares at 32 cents per share with a 4 cents commission. After all the payouts, we were left with about $250,000 (from a total of $387,000, including the $35,000 raised in seed. You can see how many hands are out for a piece of the action).

The next step is to prepare the prospectus. Prepare to be baffled by the securities legislation. As one wag involved in drafting Ontario’s legislation was quoted as saying, “there are two things in life, the manufacture of which you don’t want to know: sausages and securities legislation.” Believe it. While securities laws are essentially a good thing meant to protect an unwary public, there are many weird rules. (Lawyers don’t wonder about this, because it was their brethren that drafted the policy).

The prospectus is a document designed to provide the investor with complete disclosure about your company. Nothing could be more fair, in principle. But the document was conceived and designed by lawyers and poiticians. The language commonly used is usually so carefully crafted, from a legal standpoint, that 90% of investors simply don’t bother reading it.

For example, in our prospectus, the following statements were made: “While the corporation has no plans (to acquire other mining properties) at the present time, monies in its treasury as available may also be used to defray the cost of programs of acquiring, exploring, and developing other properties either alone or in concert with others and generally to carry out exploration programs as opportunities and finances permit, but no such properties will be acquired and monies will not be expended thereon without an amendment to this prospectus being filed if the securities of the corporation are then in the course of distribution to the public.” If you read the last sentence to the end, congratulations. Why not just have: “The corporation may get involved in some other deals.” While it is not as complete, at least people will read it.

To me, the weirdest statement of all is on the front page of most prospectuses: “There is no market for the shares of the corporation and none is expected to develop as a consequence of this distribution.” This is ridiculous. If no market were expected to develop as a consequence of the distribution, why go public in the first place? Why go through the securities commission? Of course a market is expected to develop.

When the investing public telephones the brokers to ask about this seeming contradiction, the answer is usually something like: “Oh, that’s just some legal mumbo-jumbo they have to put in there.” And it is, but I don’t for the life of me know why.

Don’t get me wrong. I believe in shareholders getting the facts. What I don’t believe in is something that can cost as much (or more than) a new Mercedes and is pre
pared in a manner that is unintelliglble to most investors. And it is being done with their own money. If you want to go public, you are stuck with it.

But I am getting ahead of myself. You still have to go through the arduous process of preparing the prospectus. As the lawyer preparing our prospectus warned me in advance, these things tend to take on a life of their own. That is, after the first draft gets into the hands of the brokerage firm, their analysts, brokers and lawyers all have a go at it. Then it goes through a number of other drafts before you have a document ready to go to the securities commission (and the stock exchange, if you are going for an immediate listing.) They all take another run at it, except this time each draft has to be approved by three or four parties. Frequently, one change affects many others and people forget to change the others. It really gets frustrating when one lawyer changes a sentence and the next lawyer changes it back. Compromises become the rule, and guess who has to make most of them?

Once you have hacked your way through five or six drafts, and taken up about six months of your life, and assuming market conditions haven’t collapsed, you are ready to go public. This is the fun part, opening up the morning newspaper and seeing your stock quoted for the first time.

Epilogue

One morning I got a call from my lawyer who told me we had received a final receipt from the Ontario Securities Commission. It was seven months since I had begun the process, so it seemed like time to break out the champagne. But hold on. When I called the brokerage firm to tell them the news, all I got was a groan from the other end of the telephone line. Problems in the market. You see, it was October 19, 1987. Actually, the brokers managed to come through and completed the underwriting, the first in Canada after the crash (not including British Petroleum).