The 1/9th Rule - An assessment of the valuation and structure of Canadian exploration agreements 1988-1992

CIM Bulletin, Vol. 98, No. 1090, 2005

L. Kilburn

The file is a zipped PDF document.A survey of 281 mineral exploration agreements from 1988 to 1992 examines the ratios between the three ways to purchase an interest in a mineral property, viz. pay cash, pay shares, and make future expenditures on the property.The Northern Miner is used as the source to create a database for this study. Information about each agreement has been collected from volumes 74, 76, and 78 for the years 1988, 1990, and 1992, respectively. All agreements for which a complete set of data was available have been used.The three years covered by this survey represent very different economic conditions in the Canadian mineral exploration industry. The ‘boom’ year, 1988, benefited from flow-through share tax provisions, whereas 1992 was a ‘bust’ year that suffered from the removal of the Mineral Exploration Depletion Allowance (Income Tax Act of Canada) from flow-through shares. The transitional year of 1990 is located both in time and amount of expenditures halfway between the other two years.The 281 agreements were found to consist of 15 all cash, 7 all shares, 14 cash plus shares, 88 cash plus expenditure, 8 shares plus expenditure, 14 cash plus shares plus expenditure, and 135 all expenditure.Buyers and sellers would be expected to have opposing priorities for the way that they prefer to purchase a mineral property.  Buyers prefer expenditure on the property only, whereas sellers prefer payment of cash and/or shares. These opposing priorities must be negotiated to a perceived 50:50 balance between cash/share payment and expenditures to satisfy the idealized situation described by most definitions of fair market value.However, the results from this survey show that dollar value of expenditures exceeds that of cash or share payments by about nine times in most of 110 agreements that contain cash-expenditure or share-expenditure components (see diagram). In addition, cash and shares seem to be treated at face value in agreements that contain cash and shares only.This imbalance between cash/share payments and expenditures appears to be rationalized by negotiations to a fair market value where face value of expenditures are nine times greater than those of cash and/or payments.On the basis of this apparent rationalization, it is proposed that the fair market value of a property may be determined by aggregating the dollar amount of the cash/share payments and one-ninth of the dollar value of expenditures, as set forth in the respective purchase agreement, and proportionally applying such aggregates to full property value.  The value of an interest in a property is valued by multiplying the interest proportion by the full property value as determined by the 1/9th Rule. For example, if an agreement provides for purchase of 75% interest in a property, then: FMV of the property = [cash payment + share payment + (1/9 of expenditure)] / 0.75 This application of one-ninth of the dollar value of expenditures for property valuation is called the 1/9th Rule of mineral exploration agreements. Examples are presented which show the determination of value for three properties from the survey.
Keywords: Mineral exploration, Option agreements, Property valuation, Canadian, 1/9th Rule, Fair market value