Considering the size, scope and swagger of Alberta’s oil and gas sector, it might be tempting to think it’s a place where you can make easy money. Entrepreneurs like Don Gray, the founder of Peyto Exploration & Development and a man who resigned as CEO at age 41 when he was worth an estimated $120 million, make it look easy. But getting a company like Peyto off the ground – and thereby into it –isn’t just a matter of picking a play and putting some rigs to work. It also requires money – and usually lots of it.
Gray says you can still start an energy company with a few million, but not everyone agrees with him. “Most are now being launched with $100 million or more of financial backing to contend with the higher costs and increased investment required in the [Western Canadian Sedimentary] Basin,” says Steve Meston, the senior vice-president of commercial banking at CIBC Western Canada. To get there, you need an idea you can sell to investment companies, startup junkies, governments, colleagues, family, friends and frenemies.
Get the Idea
If you think the market is oversaturated with ideas, well, you’re wrong. Billions of dollars in new investment will flow into Alberta’s energy sector in the near future (an estimated $55 billion in 2012 alone), and that growth offers opportunities for smart oil workers to trade their Timberlands for Oxfords. “If I was an Encana geologist and they let me go, man, I tell you what, I would take advantage of that situation,” Gray says. “If I spent the next month just looking at the map, and every section of that map, something I never had time to do at that other company, I can guarantee you I’m going to come up with a whole bunch of ideas.”
Public or Private?
In 2007, Kim Davies launched Martin Head Oil & Gas, a company that would develop long-term, low-risk oil wells. It was attractive enough that a third-party investment company raised two-thirds of the required capital from a Texas investor on Martin Head’s behalf, which made the other third easier to raise between a New York hedge fund, herself and the management team, plus friends and family. Martin Head was a private company because her initial investors wanted it to be that way, but her second startup, Terrex Energy, an enhanced oil recovery firm, was public. Both have their advantages, she says, and their pitfalls.
Going public can be a good way to quickly scale up a new business and keep it faithful to your original vision, because the investors are typically the hands-off type. But it also leaves you vulnerable to the impatience and unpredictability of the markets. After the 2008 crash, taking an oil company public went from difficult to straight up impossible. The appetite for risk wasn’t there, so neither was the money. “These are the type of cycles that you have to consider,” Davies says. “They’re really outside of the people’s control.” Publicly traded companies also tend to focus more of their effort on promotion than do private operators. It’s a habit Gray loathes. “It attracts too many investors who want to be told stories about how they’re going to make millions of dollars,” he says.
In addition, Davies says, “Private equity is usually more patient capital.” Private equity partners plan to be invested for three to six years typically, and don’t look at quarter-over-quarter growth but instead year-over-year data. “They also usually take a much more active role in running the company and deciding when and how it will be sold.” And regardless of where the money comes from, be prepared to look internationally. “Canada is not a large country, and it can be risk averse,” Davies says.
But no matter how newfangled your idea might be, finding investors starts with some old-fashioned salesmanship. This is especially true if you’re planning to go public, but even at a private company you have to be able and willing to sell. “You have to be able to look them in the eyes, and they have to believe that they’re going to make money off of you,” Davies says. “If you’re going for public money you have to have a public story that’s drill ’em and thrill ’em … because the public markets are looking for that liquidity, looking to get in and out.”
Gray cautions that the thrills had better be based on data rather than just dreams. He compares it to Moneyball, the Michael Lewis book about how the Oakland A’s used advanced data to produce a winning ball club on a shoestring budget. “What I want is someone who’s really willing to dig through that data,” Gray says. “There are guys who prefer to dream up something, [and] they tend to gravitate towards imagining something instead of doing the work to become the best.”
Ties That Blind
Since Gray stepped down as the CEO of Peyto and started serving as its chairman (he also started Gear Energy in 2010), he’s become a more active investor on the side. From that side of the mahogany desk, he urges startups to resist blind pools – large sums of cash to be used at their pleasure – and instead only raise as much money as they need. “If you raise too much money, you start to waste it,” he says. “It’s not until you get to the last third that you start spending it wisely.”
Davies sees those blind pools more favourably. “If you’ve got the chance to get some money, even if it’s not under the conditions you want, you’re best to take it,” she says. “The last thing you want – and this is a very common phenomenon – is to be underfunded.”
Don’t Bank on It
Gray doesn’t think energy sector startups can – or should – rely on the banks for their funding needs. “They won’t loan you money against anything that’s speculative,” he says. But Steve Meston takes issue with that analysis, noting that they’re more than willing to listen to the pitch and provide preliminary support if it’s as solid as the rocks you’re attempting to drill through. “Given the scale and investment required in the Western Canadian Sedimentary Basin today, it is important to be aligned with strong financial partners,” he says, adding that the management team’s track record, its other financial resources and its operational plans will also be considered.
In that respect, it might be best to come to the bank when the company is already big enough to stand on its own or if you’re acquiring wells already in production. Only then, says Davies, might a bank loan you up to 50 per cent to purchase it.
A Taxing Discussion
Ah, royalties. Yes, after all that hard work building and selling your company, you now get the pleasure of paying out a percentage of your income to the government. But the government doesn’t just taketh away. It also gives back, mostly in the form of a flow-through exploration tax credit that incentivizes new drilling activity, allowing investors in exploratory wells with unproven reserves to write off up to $1 million of their expenses. The program has its detractors, from critics who call it a government subsidy to investors and entrepreneurs like Gray who accuse it of encouraging inefficient decision-making in an industry that’s often rife with it. “Most flow-through dollars get spent on wells that should have never been drilled,” he says.
Davies isn’t quite so critical of the flow-through structure but suggests it’s more for up-and-running businesses than those still in the early stages of their development.
If you can’t turn to the public markets, a group of private investors or the banks, you’re probably left with only one other option: friends and family. While that might not seem ideal – mixing business and family can be a toxic recipe – Gray says sometimes you don’t have a choice, especially if you haven’t built up a reputation in the industry yet. “When you’re not known, you have to tap into people that know you: your friends, your family, your business associates.”
He was lucky in that he was (and is) a well-known petroleum engineer, and that he has two engineers for brothers and an oil man for a father. They knew how to speak the language of the industry and how to find flaws in his plan. “Hopefully they’re not just investing in you because of that family relationship,” Gray says. “They’re investing in you because through that family relationship they know the type of person you are [and] that you have that aptitude to be successful.”
Just don’t let the family affair become a family tragedy. When in doubt, Gray says, underplay your hand – and don’t be afraid to tap into your well of skepticism from time to time. “[If you] know the odds better or you’re more disciplined, you will win,” he says. “But if you look at every hand you draw and believe your pair of twos is going to draw into four twos, you’re an idiot and you’re going to lose your money.”