Private Placements in Canada’s Resource Industry

One of the most common ways that Canadian resource companies raise capital is by issuing securities offerings known as private placements.

In 2020, for example, gold-focused companies on Canadian stock exchanges raised more than C$10.1 billion in private placements, according to data compiled by PrivatePlacements.com.

One of the highest amounts for a private placement on the TSX Venture Exchange last year was raised by Artemis Gold (TSXV:ARTG), which brought in more than C$175 million in a July financing. The company allocated the majority of the proceeds to fund its acquisition of New Gold’s (TSX:NGD,NYSEAMERICAN:NGD) BC-based Blackwater gold project.

In general, July was a rewarding month for gold companies issuing shares through private placements, with nearly C$1.2 billion in proceeds. Eighty-three percent of that amount was earmarked for resource exploration and development projects, with another 15 percent intended for acquisitions. Slightly more than half of those private placements were brokered transactions versus non-brokered.

It’s clear that private placements play a key role in funding for the resource space, and it’s important for investors to know the ins and outs before jumping into this arena. Read on for insight on private placements, including risks and rewards for both individuals and companies, as well as the difference between brokered and non-brokered placements.

What is a private placement?

A private placement is an offering of securities to people who are “not the public.” Securities issued under a private placement do not have to be transacted on a stock exchange, and the securities don’t have to be listed — these are known as unregistered securities. Private or public companies can conduct a private placement. The distinguishing aspect is that it’s not offered to the public.

Those taking a position in a company via a private placement may be friends, family members or business associates. They may also be high-net-worth accredited investors, or institutional investors such as banks, brokerage firms and hedge fund managers. However, larger institutional investors are typically not involved in private placements for small-cap junior resource companies. Institutional investors usually come along later, when projects are much more advanced and the company in question has shown it has a quality asset and a respected management team.

Advantages of private placements

As a capital-raising strategy, private placements have advantages over more open-market routes. Notably, issuers offering securities to the public are required to file a prospectus — a legal document needed by securities regulators that contains details about the investment being offered for sale to the public. A private placement doesn’t require the filing of such a document, which saves time and money.

A private placement can be done in a week to 10 days, whereas if a junior resource company hasn’t filed an annual information form, the prospectus process might take two months.

Private placement exemptions

To qualify for a company’s private placement transaction, the pool of investors getting in on the deal must qualify for a private placement exemption.

Securities law provides private placement exemptions for sophisticated investors who may not need the kind of investor protections afforded through a prospectus. These are known as private placement exemptions, and can apply to groups such as accredited investors. Under the regulatory system, buyers with accredited investor status are those whose financial and business knowledge minimizes their need for the additional information normally provided by a prospectus for a public offering.

There is also a private issuer exemption if the company hasn’t exceeded 50 investors who are not members of the public, not including employees and former employees. If the investor lineup for the private placement exceeds 50 investors, then there are certain notice filings that the company has to make with regulatory authorities in Canada for any further offerings.

Non-brokered or brokered?

Resource companies looking to bring outsiders into a private placement in Canada may turn to a broker to introduce accredited investors to the company. This is called a brokered financing. There is a marked distinction between brokered and non-brokered private placements.

Brokered placements involve a broker who is a registered representative in their jurisdiction, meaning they have a professional duty to know their clients and to conduct due diligence on the company they are recommending to their clients.

A non-brokered placement may or may not involve a finder (who may or may not be a broker). If the finder is not a broker, the company can only pays a finder’s fee in cash if the private investors involved in the deal are within the province. Non-brokered placements allow companies to avoid expensive broker fees, but carry more risk for those involved given the greater chance of failure to conduct the necessary due diligence, either on the part of the prospective investor or the company.

However, there are further protections in the private placement process that help to mitigate such risks, such as a document called a subscription agreement. These agreements contain the terms of the investment, as well as representations and warranties made by both the issuer and the investor.

For example, the issuer guarantees that their public filings on SEDAR are accurate, and the investor guarantees that they are who they say they are and that the company can rely on the information they have provided for their prospectus exemption. Subscription agreements are negotiated between companies and investors. Some larger or institutional investors are represented by their own counsel.

Shares at a discount

Typically, private placements in Canada are done at a discount to the market price. This is because the prospectus exemption that’s being relied on entails a four month hold period on the stock, which means that investors can’t resell shares for four months. If the issuer is listed, the applicable stock exchange has rules regarding the maximum discount that’s allowed.

The other main advantage of private placements it that most include a warrant as part of the offering. Participants are not just buying a share, they’re buying a warrant, which entitles them to buy more shares in the future — typically one to two years, but up to five. That makes a private placement a lot more attractive to investors because if the resource project works out, they have an opportunity to buy further shares at a fixed price that could be a lot lower than the market price.

It’s worth remembering that if an investor buys a security on the market, they have a lot more flexibility and can immediately resell it. They’re under no obligation to hold it unless they are a control person, which is someone who owns 20 percent or more of the issued capital.

Private vs. public companies

If a private placement is with a private company instead of a public company, there is less liquidity and more risk for investors. That’s because there is no market for reselling the company’s shares. Additionally, a private company will likely have restrictions on reselling shares, so once a person buys the stock, they might be locked in forever; they also might not be able to sell without board approval.

Despite these risks, a private placement in a private company is not without the possibility of reward. The attraction of a private equity offering is the opportunity to build wealth by buying shares at a low price and then biding time until the company goes public with an initial public offering (IPO). If a company has a good project and good management, once it’s developed to a certain point it will likely list the company to raise more capital with an IPO, often at a higher share price than the private buy in.

Stock exchanges have rules to prevent investors from taking a position in a company at the pre-IPO price at the last minute and then selling those shares once the stock is listed. The TSX Venture Exchange has a seed share resale matrix. Regulators look at what an investor paid for the stock compared to the IPO price and the length of time the investor held the stock to determine the applicable hold period.

The TSX Venture Exchange also has a rule about the seed threshold for founder shares (which are shares sold for less than C$0.05 each). The seed founder shares threshold essentially cannot exceed 15 percent at the time the company is listed (including IPO shares), so there is a limit to the amount of “cheap stock” a company can issue pre-IPO.

How can investors mitigate private placement risks?

One important step an investor can take in practicing due diligence and mitigating risks is to look at a company’s management team and their track record, including which other companies they have been involved with. Knowledgeable and successful management members tend to only go after good projects.

It’s also key to investigate a company’s project itself. If it’s a public company, investors can use SEDAR to research documents, including technical reports prepared by independent geologists.

Another crucial step for those wishing to participate in private placements would be to hire a lawyer to negotiate a subscription agreement and ensure protections are in place.

If it’s an IPO situation, the company’s prospectus will provide access to relevant information. If it’s a private company and it hasn’t filed a prospectus, investors may need need to grill management for project details. The company may require the signing of a non-disclosure agreement confirming that potential investors will only use the information provided for the purpose of their investment.

This is an updated version of an article first published by the Investing News Network in 2012. 

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Securities Disclosure: I, Melissa Pistilli, hold no direct investment interest in any company mentioned in this article.