With the market the way it is right now, some junior exploration companies are simply not going to survive. Since most of them are in Vancouver, we thought the city’s commercial real estate might offer some insight into which ones will.
We spoke with one Downtown Landlord about their experiences with resource companies as tenants. This slowdown in the markets shouldn't affect them. “We have been fortunate in having very few defaults over the years.”
The landlord talked about how they evaluate a junior exploration company as a creditor and how they structure a deal. Their method has been responsible for almost a decade of relatively trouble-free leases. That kind of deal making with negative cash flow companies is definitely worth noting. Here is how they do it.
Firstly, the company evaluates the longevity of a venture-funded tenant by calculating their burn rate and comparing it to their cash position. This gives them a historical picture of how many years they have left to survive if they continue to operate as is. It helps them decide the length of a particular leasing contract but is limited in that it cannot always reflective of what could happen in the future.
Secondly, the company usually negotiates a pre-paid rent component as part of the contract. This is actually a bit of a benefit for both companies as it decreases the likelihood of a default while keeping the payment as an asset on the tenant’s balance sheet.
Lastly, the company tries to get a personal covenant from the CEO or another executive in the contract. This is the kicker, and the one that stood out to us the most. By turning away companies with leaders who weren’t willing to personally attach their name to a rent liability, this company has been able to find and retain the best exploration companies in the sector. Management that is willing to sign a personal guarantee are genuinely the ones to succeed over the long term.
That little piece of knowledge is what you can’t find in an MD&A and would probably have a significant impact on your investment.
Disclaimer: As a CFA Level I Candidate, I am required to disclose the following: I am not qualified to be giving investment advice and this should not be taken as such. The contents of this article are an opinion drawn from material public information. I reserve the right to actively trade the companies named in this article without providing notice. I advise you to do your own due diligence and talk to a licensed investment advisor before buying or selling any security. All facts to be verified by the reader.
Personal guarantees are for desperate people. Why risk your family’s assets and future livelihood on guarantees most CEO’s can’t ever realistically pay if they were to default?
Enjoyed the post but not sure about this signal. Howe Street is famous for promoters who make commitments in bull markets they later regret.
I wouldn’t say that personal guarantees are for desperate people. I think they’re for believers. People who don’t believe in their project won’t tie their name to it, won’t put their own skin in the game and won’t put everything on the line for the project success.
As for risking family assets, it really depends on a person’s financial situation and their own tolerance to risk. That isn’t up to us to judge. A $100,000 lease obligation is a large number, but still affordable if your net worth is in excess $10,000,000 and you’re a director for multiple companies.
I believe this speaks of “character” on the management team of a company. It isn’t the be-all and end-all to a decision, and it isn’t always correct as Tommy pointed out. However, it was an interesting correlation for this landlord who has been quite lucky with the tenants he has had over the years, including what happened during 2008 and 2009.
The point of this post is to look at it from an investor who is interested in high-risk speculative stocks. This landlord in particular owns multiple buildings in Vancouver and exploration companies are roughly 30% of his portfolio.