Royalty funding set to become a low risk finance route

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Iron ore pellets

ROYALTY agreements, and their legal cousins, streaming agreements, are set to become an increasingly popular mine funding mechanism, especially in times of legislative uncertainty pertaining to mineral rights, and formal lenders unease.

But what is it?

Royalty funding has no relation to royalty taxes. Simply put, in exchange for an one-time upfront payment to the miner, being the royalty payment (usually structured as a deposit), the depositor receives the right to acquire a fixed percentage of the total mine production, usually for the life of the mine.

What are the benefits to the miner?

Firstly, the miner monetises its future production relatively painlessly prior to the actual mining / mine expanison commencing.

By painlessly, I mean the miner avoids the time and rigours associated with secured bank lending. Unforseeable delays in production are not usually penalised, as the royalties (delivery of the agreed percentage of the mined product) become payable only on production, not on a set date following a drawdown on a loan facility. The miner is not bound by repayment schedules, numerous events of default, cash waterfall traps and quarterly submissions of various financial ratio calculations.

What are the benefits to the depositor?

The depositor receives a guaranteed percentage of the minerals produced or in lieu of actual product, a fixed price for this percentage. The depositor can obviously sell the product at market value, or should the price increase, achieve a higher return than originally calculated. Unlike a shareholder, the depositor faces no cash calls, share dilution risk, or dividend income uncertainty.

Secondly, most royalty agreements endure for life of mine. Should the miner expand the mine due to newly discovered reserve, the production of this new reserve is almost always included in the royalty agreement, which, as it is calculated as a percentage, means an increase in actual mineral delivery.

What are the risks to the depositor?

A depositor is only entitled to a percentage of the mine producton and not a fixed produced amount. Should the resource not produce the expected output, or the expected grade, the forcast return will not be achieved by the investor.

Unlike bank funding, the obligations between the depositor and recipient is usually only contractual, and depositors are not usually secured debtors. On insolvency or business rescue of the mining operation, the likelihood of recovery of the value of deposit amount is low, akin to ordinary shareholders rights.

Assuming no bank involvement, this risk can be overcome either by taking real security over the mining assets, or practically securing ownership of the mineral immediately on it being seperated from the orebody.

Finally, should the miner also have received formal bank debt, the royalty agreement will need to work together with the miner’s obligations to the bank.

Conclusion

Royalty funding is best suited to medium sized operations, a management team with a proven track record, mining a viable mineral resource.

Brandon Irsigler is the founder of Strata Legal: www.stratalegal.co.za

2 COMMENTS

  1. Question that this raises is who truly “owns” a mine if a portion of its production has been sold to another party in perpetuity – assuming with all the assets of the mine as security should the mine fail to deliver into the royalty contract. You need rock solid rule of law and sanctity of contract to make it work. I don’t think our politicians are on the same planet.

  2. Excellent point Joe. The financial model must apply a discount to this risk and price / decline investment accordingly.

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