Video game bosses — especially the big guy at the end — are always tough to beat.

For small caps looking to build their first mining operation, beating that “final boss” means getting their project financed. And winning the game means finally, you’re a producer.

Securing this funding, which can run into the billions, is one of the biggest challenges facing small cap stocks looking to move into production for the first time.

With no (or very limited) cashflow it can be a tough slog convincing lenders their money is safe.

Azure Capital is a Perth-based corporate advisory firm which specialises in mergers and acquisitions, and developing and executing financing for resources projects.

Aspiring producers have far less choice than established miners when it comes to financing, Azure Capital Partner Matthew Weaver says.

“[The] key difference is small caps don’t have other assets that can be secured as part of the financing — the mine being financed is the only source of security available to the lender,” Mr Weaver told Stockhead.

“This limits the styles of financing available and often makes the project financing more expensive and its conditions more onerous.”


Where does the money come from?

Mr Weaver says commercial banks, specialist mine finance funds, export credit agencies (such as EFIC) and development finance institutions are the main funding sources for small caps.

Freshly minted producer Dacian Gold (ASX:DCN) secured $150m in debt funding through 3 tier one banks for its Mt Morgan gold project in 2016.

Mineral sands explorer Sheffield Resources (ASX:SFX) has so far funded construction of its Thunderbird minerals sand project through an equity raising, a loan from the federal government’s Northern Australia Infrastructure Facility (NAIF) and debt financing through a mining finance fund.

And aspiring graphite miner Graphex Mining (ASX:GPX) announced a deal with US private investment firm Castlelake which could see its Chilalo project in Tanzania funded through to production – subject to conditions.

These conditions include things like completion of a Bankable Feasibility Study (BFS) and resolution of “legislative and regulatory issues in Tanzania” – or jurisdictional risk.

Miners usually undertake four different types of studies to determine whether or not a resource can be mined economically.

These are – in order of importance — scoping, preliminary feasibility (PFS), definitive feasibility (DFS) and bankable feasibility (BFS).

READ: What the JORC? Why miners use strange jargon and what it really means

Mr Weaver says the big four Australian banks seem to be limiting their exposures primarily to Australian-based gold or base metals projects.

“I wouldn’t say banks are shying away from the mining space – there would be very few banks not prepared to lend to the likes of BHP, Rio, FMG, Newcrest or Alumina, or indeed mid-caps such as Oz Minerals, Northern Star, Evolution, Regis, Independence, or Saracen, to name a few,” he says.

But banks are becoming more selective, with commodity and jurisdiction (is the project in a risky country?) playing a key role in their decision-making.

“Anything too ‘funky’ in terms of jurisdiction or commodity is off-limits for them,” Mr Weaver says.

It’s also a lot harder for the so-called ‘speciality metals’, like lithium, cobalt, and vanadium, regardless of their growth trajectory and positive market dynamics.

“This is largely a function of the opacity by which prices and other offtake terms are set for these products, which makes it harder for lenders and investors to understand and forecast the market (and therefore the borrower’s revenue line),” Mr Weaver says.

What  do lenders look for in a mining project?

Hedley Widdup, director of junior resources focused investment firm Lion Selection Group, says regular and sustainable cash flows are very important.

“Projects can pay back large capex quickly if a lot of cash flow comes in early, while even a small capex project can take a long while to repay if the margin is thin,” he says.

“Projects that are projected to make ‘just enough’ to repay debt will struggle to get debt funding – bankers like to see enough cash produced to pay costs along the way, repay debt and interest (and costs) and then have a comfortable ‘reserve tail’.”

Mr Widdup also says there is a fine line between raising just enough and not enough money.

“No investor wants a company to have to top up part way through development. It is always a stressful situation and pricing is often tough,” he says.

Lenders are heavily focussed on ensuring a project is fully-funded before being prepared to “release” their funding, Azure’s Mr Weaver  says.

These lenders require an independent technical expert to verify the borrower’s cost estimates, even if a project feasibility study has been completed by a third-party engineering firm.

Lenders also look at things like management’s experience and track record, jurisdictional risk, and the company’s environmental and social licence to operate.

And often, to ensure revenues are guaranteed to flow once the project is up and running, a percentage of production must be locked up in offtake agreements with customers.


Why is this taking so f$%&ing long?

Common misconceptions about mine project financing usually relate to three things – the time it takes, the lender’s appetite for risk, and the amount that must be raised.

First, it actually does takes a long time. The debt financing process rarely takes less than 6 months and can often stretch out to more than 12 months, Mr Weaver says.

“People [also] forget that lenders’ primary objective is to receive their capital back in full (with a return commensurate with the risk).”

“Unless they can be confident of achieving this, they simply won’t participate in the financing process.”

The upfront capex estimate is only part of the story – the real funding requirement is often far bigger.

“In our experience, total funding requirement can be somewhere between 1.5 to 2 times the upfront capex estimate,” Mr Weaver says.

READ: Here’s a plain language guide explaining how miners ‘grade’ mineral discoveries

Mr Widdup says many retail investors don’t understand the rigour that debt providers require, or the time it takes to attract and then deal with a debt provider like a quality commercial bank.

“This is possibly because company champions are often fairly promotional and dismissive about how hard this can be,” he says.

And for the junior small cap companies with large, multi-billion-dollar capex projects it’s even more of a challenge.

Even if it’s possible to secure debt finance on reasonably attractive terms, these projects still need to raise equity – which could be many multiples of their current market capitalisations.

“However, there are numerous examples of companies obtaining financing for projects that in the months and years prior many thought impossible,” Mr Weaver says.

“Often this is down to a combination of factors including having a robust project, management’s ability to sell the investment proposition, favourable market dynamics for the commodity in question … favourable equity market conditions, and as always, a little bit of luck.”