Oil and gas startups have been around since Colonel Drake drilled his first well. Much has changed since 1859, but the industry is still characterized by an entrepreneurial spirit that encourages risk-taking and opportunity-seeking. So what characterizes a successful oil and gas startup today? What are the factors that can drive success or portend failure?
Today’s environment is different, characterized by large amounts of capital, many capital providers, and larger capital needs. Twenty years ago, only a few private equity firms invested in oil and gas startups. There weren’t many alternatives: institutional investors, high net worth individuals, friends and family. Now there are hundreds of potential providers, a boon for companies looking for capital but also a risk, as many investors are not experienced in oil and gas and therefore have little familiarity with, or patience for, the risks and cycles of the business.
At the same time, current capital needs of startups are higher. The combination of high commodity prices and technological advances have led to the advent – and dominance – of resource plays, which require large amounts of capital and longer cycle times. More risk capital is needed on the front end to buy nonproducing acreage and drill expensive science wells. Entry costs are high, horizontal wells are expensive, and the learning curve is steep and long. And, the very availability of so much capital increases competition for opportunities, driving up costs, making it harder for the little guys to compete. Reallocation of capital to onshore North America by the large industry players is another factor in driving up costs and competition for projects and services, as is the increasingly contentious and restrictive regulatory environment, which also causes delays and adds internal G&A cost. In the late 1990’s, startups were raising $20 – 30 million; now they are raising hundreds of millions, even into the billions.
So what is the basic formula for startup success in this environment? Interviews with successful entrepreneurs, capital providers, and intermediaries generated a surprising amount of unanimity on the basics, with differences in nuance and emphasis.
It’s all about the team. Twenty years ago, it was about the assets: finding investors to promote into projects and raising capital around tax attributes and exploration concepts. Now there is universal agreement it is about the team – assembling the right mix of skills, chemistry, leadership, and track record. Asset opportunities, technology and the macro environment all change, but smart operators know how to adapt, recognize opportunity, and capture value in a way that puts them at a competitive advantage. Cover the major disciplines: geoscience, operations, reservoir engineering, land, finance and accounting. “Track record” in this context means a demonstrated ability to create value, whether as part of a small group in a large organization who understand that there is a right owner for each stage of an asset’s life or as senior managers who have successfully built companies in the past. Top talent is essential, but effective leadership is also critical in order to manage the talent and create accountability. Team chemistry and integration is also important: the ability to work together cooperatively and creatively toward common goals.
Have a focused strategy and business plan. Design and follow a focused strategy that engages the strengths of the team and gives it competitive advantage. Having specific experience in a type of play, geographic area, or growth strategy creates a dependably positive risk-reward ratio. The goal is to identify opportunity others either don’t see or can’t exploit as well and in which demonstrated, repeatable value can be created. Don’t take on too much: the better projects get overwhelmed. Know who you are and what you do best, and be disciplined in sticking with the plan.
It’s all about value creation. Remember at the end of the day the goal is to create value efficiently with good returns. It’s about making money and returning money to equity holders, not producing oil and gas. Stay lean, control costs, stay focused. Having skin in the game is an effective ongoing reminder of this point for management. Value can be created in many ways. The larger equity providers are focused on resource plays but there are still many other tried and true opportunities that have good rates of return. They may not scale the way resource plays scale but smaller companies with limited capital can make good returns applying technology or other tools.
Manage risk effectively. Accurate assessment and management of risk is critical. Risks can involve land, technology, geology, capital availability, operations, availability of services and equipment, regulatory constraints, financial management, and marketing – the entire life cycle of project development. Mitigate your risks by balancing higher risk in some areas with lower risk in others, Know when to reduce risk and take money off the table, whether by diversifying your asset base, selling down and bringing in partners, selling assets, hedging your production and other financial management to balance leverage, or adjusting your opportunity portfolio. Know when to get out of an asset rather than putting yourself in a deeper hole.
Be open and adaptable. Stay open and adaptable to opportunity and change. Failures are characterized by less sophisticated management teams that are unable to deal with and adapt to changing industry conditions. In assessing strategies, talk to a lot of people doing different things, be open-minded to let peers and mentors help influence thinking, assess the market. Be open to opportunities. Things change. Vision is important – and courage.
Align investors and management. It is important for the management team to pick the right capital provider – strategy, philosophy and expectations should align. Identity of interests and business plan is critical. Management must have access to sufficient capital to execute its business plan and needs investors who understand and support how capital will be deployed and the pace of deployment. An “acquire and exploit” strategy, for example, requires large upfront investment and staying power to develop the asset base; an exploration strategy requires less upfront money but an appetite for risk. The team needs to be in sync on the strategy and to be able to function consistently during the ups and downs. Management needs investors who understand the industry, who have patience and staying power when things go upside down, who recognize the need to exploit opportunity even (or especially) in downturns. Missed opportunities can result from a failure to understand the strategy well enough. During the downturn in 2008 – 09, some investors were telling their companies not to call for capital, but that can cause loss of opportunity and squeeze the company exactly when it needs support
Understand the exit strategy. Equity providers need to exit at some point, and it is important that the parties understand how this will occur and that they continually re-evaluate the strategy as conditions change. Is the goal to sell down continually, look for the big payday at the end by selling the company, or build a legacy company? Selling the company may not always be an option, depending on asset mix and market conditions. Whether through selling off assets, taking the company public, or other strategies, the management team needs to have the ability to take the assets full cycle, and ideally investors and management should be aligned in their expectations on what this entails.
Communication is key. Transparency is vital on both sides – management needs to be transparent to investors on the strategy so investment is made with clear appreciation of risks and objectives, and investors need to be transparent regarding their expectations. Management needs to provide timely and high quality information – especially financial information – to investors so they can adequately manage their investment. Err on the side of excessive communication. The game plan can change based on external circumstances; investors hate surprises, and management needs to be able to talk with investors on why change is required. Trust is critical, and trust requires honest and effective communication.
Understand your deal – get a good lawyer. This was one I was not expecting but which I particularly appreciated. An equity provider said that it was critical that the management team have capable counsel to help them understand the deal going in and facilitate full opportunity to work through the issues up front, to avoid problems down the road. Having good counsel can benefit both sides in helping the relationship function smoothly.
Get lucky. A surprising number of folks mentioned this. Put yourself in a position to be lucky with careful positioning, preparation and creativity. Branch Rickey said that “luck is the residue of design.” Stay out in front of your program and identify what could affect performance, put yourself in good places, maximize your ability to recognize and respond to opportunity. Earn your luck.
This is an industry characterized by remarkable achievement, much of it fueled by entrepreneurs with skill and creativity, a willingness to work hard and assume risk, and the ability to recognize and capitalize on opportunity. Those fundamentals have not changed, and neither has the formula for success. Opportunities and challenges continue to arise, and oil and gas startups continue to thrive. The principles outlined in this article provide the roadmap for continuing success.