I had the chance to sit down once again with Rick Rule, the president and CEO of Sprott U.S. Holdings, Inc. The topics of discussion covered what can often “go wrong” with general and administrative expenses, change of control provisions, changes in corporate strategy (referred to as “mission drift” in this context), and uniquely structured insider private placements.
“Many junior mining companies don’t regard shareholders as partners, they regard them as unsecured creditors,” explained Rule. “[So] anticipating outcomes based on the self-interest of the executives is the best way to understand [how] things are going to unfold.”
Commenting on general and administrative expense items, Rule noted that, “I have seen several circumstances where $10 million market cap companies with $800 thousand in the treasury were paying the CEO $450 thousand a year. In other words, the CEO’s salary alone was taking up 5% of market cap — on an annual basis. That means the CEO, him- or herself (if you assume they have $800 thousand left in the company), will bankrupt the company in [less than two years].”
Speaking toward change of control provisions, Rule recounted that, “Many people raise money from private parties with the view that they’re going to make a discovery and sell the discovery. And what you learn is that many management teams get paid twice. I have seen, in a number of circumstances, management teams [install] change of control provisions … where if the company is sold (which was their stated intention), they get compensation on sale equal to five years of their average salary and bonus expense, and five years of ancillary expenses — things such as rent and health benefits.”
“That’s one of the reasons why some management teams are willing to entertain merger and acquisition,” Rule added, “where their only participation in the company is as option holders. I’ve had a lot of bad experience, frankly, with change of control provisions, which is one of the reasons I study them.”
On the subject of oddly structured insider private placements, Rule explained that, “Private placements, where the company loans the executives the money to [buy] the private placement, … [are] the private placements … I really dislike. In other words … the private placement is just a recycle that allows the management team to sell the stock and strip the warrant — which is an artificial way of increasing their [own] options position. And that’s fairly common.”
When asked how one can protect themselves from the aforementioned (and more), Rule explained that, “One of the ways you can defend yourself … is by limiting your speculations (irrespective of apparent prospectivity or promotion) to companies that are headed by people who have been serially successful in the past … With a class-1 team at the helm [you’re] more likely to be successful.”
“As a speculator,” Rule concluded, “your gains are [usually] hard won. I’m reminded of the scientists’ observation that the harder they work, the luckier they get.”
To watch the full video interview with Rick Rule, the president and CEO of Sprott U.S. Holdings, Inc. click here.
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