Sprott’s Thoughts: How to ask Sprott Global’s Rick Rule for money

“What would you like to talk about this time?” I asked my boss, after walking into his office.

“Well, I’d like to have a conversation for the issuers,” replied Rick Rule, Chairman of Sprott US Holdings, “in terms of what we look for, before giving a company our client’s money. What do you think?”

“I like it,” I said. And we chatted about it for a few more minutes. Later that day, I liked it even more for the following reason.

Over the last few years I’ve attended investment conferences with my boss. At these shows, we meet with clients of Sprott Global. You might be one of them.

If so, you probably remember the moment we sat down, and you explained to me (or my boss) how much trust you’ve given our group to protect (and in some cases) grow a portion of your family’s wealth.

What makes the experience more meaningful is when a person or management team sits at the other end of a negotiating table with us — and asks Sprott Global for those same client dollars.

In the following interview, Rick shares the process he disciplined our team to follow, before allocating client funds into a company seeking development capital.

If you are part of a team looking for development funds — listen up, because the following interview shares the key to opening Sprott Global’s client investment box.

Here’s how to ask Sprott Global for money.

Tekoa Da Silva: Rick, if the reader is learning about Sprott Global or you for the first time, how many years now has it been that you’ve been financing businesses directly? And how many company presentations do you think you’ve sat through throughout the years?

Rick Rule: I have been investing in natural-resource-based companies and originating and participating in financings for 38 years now if my memory serves me correctly. My partner Eric Sprott whose name is on our door was doing it a couple of years before I.

So I think it’s fair to say the Sprott organization in total has been doing this in many ways, shapes, or form, for four decades.

Tekoa Da Silva: Rick, a few years ago, you published a document called A Guide to Natural Resource Investing.

In that document, you laid out the most important questions you felt need to be asked by the investor to a company management team. For the person reading, could you give us a summary of that document?

Rick Rule: The document came about as a consequence of me watching many of our clients make mistakes investing. I watched our clients interviewing issuers (companies) at investment conferences and saw that the process they were going through in terms of accessing information to make investment decisions was faulty. What I tried to do was put together a guide that somebody could understand in an hour or less that would simplify and codify the process.

An issuer or an issuer’s agent who reads that same guide will be able to understand what is important to Sprott in 20 minutes or less. They will also be able to understand how to answer our questions efficiently.

If they don’t have the ability to answer those questions efficiently, they’ll know not to begin the process because it would be a waste of their time and ours.

Tekoa Da Silva: What would you say has been the most common mistake you’ve seen throughout the probably thousands of corporate presentations you’ve sat through?

Rick Rule: Well, 90% of the people that have come to pitch me, if that’s the right phrase, haven’t been prepared at all. What was important in their framework was raising the money and they paid no attention whatsoever as to what was important to me.

I would say the second critical mistake issuers have made coming to Sprott is they operate in the mistake and belief that we’re investment bankers, that we raise money for them. That is not the case.

An investment banker has the issuer as a client. We don’t have issuers as clients. We have investors. Our investors are our clients.

What that means is that we will never raise money for an issuer but we will allocate capital to an issuer. Our interests become aligned after our check cashes, and we’re shareholders of theirs.

But until the check cashes, we’re potential investors. They aren’t clients of ours. We’re representing clients in a discussion with them. It’s a very important difference.

Many financial services businesses operate under what I think is the illusion that they can simultaneously represent in good conscience, both the issuer and the investor — the issuer as investment banker and the investor as broker.

From my point of view that conflict is irresolvable. So we have decided at Sprott (and we decided before we were bought by Sprott) some 30 years ago that we would never raise money for companies, but we would happily allocate capital to companies.

Tekoa Da Silva: So Rick, there are about nine or ten important questions listed in A Guide to Natural Resource Investing. Let’s get into it.

I walk through the doors here at Sprott Global to ask you for development money. What do I need to tell you about my business in order to attract your client’s capital?

Rick Rule: The first thing I want to know Tekoa is what is my downside. Everybody has a wonderful upside story. So I always begin the question by asking the issuer, “What is the relationship between market capitalization and value?”

I say, “Tekoa, you would like to raise money on a $5 million pre-money valuation. Explain to me why your company is worth $5 million or explain to me what it is worth. Talk to me about my downside.”

I’m not trying to say that I need to buy $15 million worth of value for a $5 million pre-money market capitalization, but I am saying that I have to understand what my downside is before we begin to talk about my upside.

Too often when people talk about value, they’re talking about relative value, not absolute value. Somebody might say to me, “Well, I have 24,000 acres of caribou pasture in the northwest Yukon. Another caribou pasture incorporated as Consolidated Pasture Mines is valued at $1000 per acre. Therefore I have $24 million worth of value.”

I have to say, “No, that’s not the number I’m looking for. What I’m looking for is the amount of money that you could sell those assets for to a private buyer in a rational market.”

Again, I’m not trying to say that I have to get everything for dimes on the dollar. But I need to establish what my downside is before I talk about what my upside is.

Assuming a satisfactory answer in those discussions, the next thing I want to know about is my upside.

Now, Tekoa, if I were talking to an investor, I would say at this juncture that you have to let the issuer go through his or her presentation. They’re programmed to do and trying to stop them in fact is a waste of time. I will often let an issuer go through a canned presentation just to get it out of their system, so that we can get down to the parts of the presentation that I’m interested in.

But making money in natural resource venture capital (exploration) activities, really involves the process of answering an unanswered question. Many people don’t realize this but the natural resource exploration business is very much a research and development business. Answering a series of unanswered questions is what adds value.

So assuming that ‘Tekoa Da Silva’ the issuer, survived the downside question — “What is your company’s worth?” I would then say, “Tekoa in the asset that you’re talking to me about, what is the transformative unanswered question? What is the value proposition? How is it that you’re going to take this $.50-cent piece of paper and to make it into $5? How are you going to add a zero?”

So tell me what the unanswered question is. Give me the facts that support your thesis and also tell me how you propose to answer the unanswered question in an efficacious manner.

Now the way that you fail this Tekoa, is if you come to me with an unanswered question that doesn’t have very large upside. One of the things I’ve seen in the business over 40 years is that many entrepreneurs fall into what I call the “bootstrap fallacy”.

They go out to look for a small mine, figuring that small mines are easier to find than big mines. They hope that cash flow from a small mine will allow themselves to build bigger opportunities without share dilution.

It’s a wonderful fantasy but a fantasy is what it is. All the risks inherent in a big mine are present in a small mine but a small mine can never make you big money. It’s in effect “reward-free risk” which is not a particularly attractive option to me.

The second thing, Tekoa, is that the skill sets involved in finding a mine are very different than the skill sets involved in building a mine, and the skill sets involved in operating a mine.

So what happens often unfortunately is that people are successful. They find a small deposit. They build it (or try) and they do generate cash flow — negative cash flow. Losses. Cash flow in brackets. When that happens, a skilled explorationist spends four or five years of his or her time correcting a problem they don’t have the experience to correct.

So that’s a long-winded answer of saying,

1. Explain to me what the unanswered question is,

2. Explain to me what the upside associated with the question is,

3. Explain to me how you arrived at that question, and

4. Tell me the facts on the ground that led you to propose the thesis and tell me why the methodology by which you propose to test the thesis is the best available method.

The other thing you have to tell me Tekoa, is what exactly will constitute failure. Too often, somebody raises $10 million for an exploration program and they explore until the $10 million is gone.

I often have said to them in the aftermath, “Now tell me, did you drill your worst idea first? Is that what you tried to do?”

It’s important that you acknowledge defeat in the course of a $10 million program. If you do, shut the $10 million program down and save $7 million for a pivot.

But many people don’t have any idea what will constitute failure in the context of this drive for success. It’s important to know, and it’s also important to know that the chief executive officer of the issuer has firmly in mind what will constitute a yes answer and what will constitute a no answer. It’s important that they be able to articulate both of those to me.

The third thing you need to convince me of Tekoa, is a rational financial plan.

Let’s say you have convinced me as to the appropriate valuation you’re proposing, and let’s say you have convinced me that the unanswered question you’re asking is worth answering.

Now what I need to know is — “Do you have a rational financing scheme to get from here to a yes or no answer?”

Let’s assume the exploration program you envision will cost $3 million and it will take two field seasons (or 18 months) to complete. Let’s also assume it costs you $1 million a year in general and administrative expense (separate and apart from exploration expenses) to operate the company.

That means you have a $4.5 million ‘need’ if everything goes right, to get me through the 18 months, to get me a yes answer. And let’s say you have $1.98 in the treasury (ie. no money whatsoever), and you’re proposing to raise $2 million from me or the market at large.

The problem with this thesis Tekoa is that you have raised $2 million of the $4.5 million, which means your company won’t survive until I get a yes or no answer.

The most important problem associated with that outcome is the naiveté on the part of the CEO. Failure to plan is an absolute plan for failure.

So I need to know you have the means to get me to a yes or no decision point, and that you already worked out a plan. Both a technical plan, with regards to how you propose to answer the unanswered question, but also a financial plan that lets me know you are a rational investor yourself.

Tekoa Da Silva: Would that suggest...

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