One of the most important, yet challenging, aspects of starting an E&P company is deciding how best to finance it. Plenty of private capital is available this year: 18 capital providers alone are armed with $7.3 billion to invest in the energy industry, they told participants in the fifth annual Private Capital for Energy Forum, co-sponsored by Cosco Capital Management and Oil and Gas Investor in Houston. One sure thing in the oil and gas industry is that volatility leads to opportunity. All this volatility-a turn-off for public investors-is a prime opportunity for private capital providers. "We view the next 18 to 24 months as the Golden Age of private equity," said Greg Beard, principal at New York-based Riverstone Holdings LLC. In April, the Carlyle/Riverstone Global Energy & Power Fund II LP teamed with private-equity firm Madison Dearborn Partners LLC to buy The Williams Cos.' 54.6% interest in the midstream master limited partnership Williams Energy Partners LP. Beard said that today, Riverstone is even interested in participating in auctions to pick up assets, whereas two years ago, the firm had no interest in them. "Today, the auction prices are reasonable," he said. Volatility and the opportunities that come with it haven't changed Natural Gas Partners' behavior or strategy. "These merchant-energy companies are distressed for a reason," noted Billy Quinn, pointing out that opportunity can be wrapped in a liability. Great assets can come with poor management, or poor assets can have great management teams. On the E&P side, high commodity prices have, for the time being, led to an emphasis on drilling and development rather than asset acquisition, according to the private capital providers. Carl Tricoli, president of GeosCapital LLC, a J.M. Huber company, said his firm wants to see companies that aim to do more drilling on existing properties, followed by monetization. A relatively new entrant to the sector, GeosCapital is focused on project equity for E&P companies, preferably in an LLC structure. "We'll provide 100% of the financing if it is project equity, or we'll do mezzanine if there is some equity underneath it. We prefer a significant development component, and look for deals between $25- and $50 million." Holding PDPs over a long period of time is an inefficient use of capital, the firm believes. V. Frank Pottow, managing director of Greenhill Capital Partners LLC, said he is currently seeing the best deal flow he's ever seen. Firms used to buy low and sell high, but now, they are buying as much as they can and locking in high prices, he said. "Whatever you do with deal structure or the properties, the quality of the management outweighs these over time. We want to help companies grow from $50- or $100 million to $500 million." Michael Keener, managing director of Petrobridge Investment Management LLC, said his firm-a recently formed mezzanine lender-has seen a lot of refinancing and drilling deals. "There is a shortage of opportunities for big companies, but no shortage of small prospects for small companies," he said. The formation of Petrobridge itself is a result of energy industry volatility. Keener was with Shell Capital before it was disbanded, and his partner, Rob Lindermanis, was with Mirant Americas Energy Capital. Petrobridge is seeing a lot of opportunities to refinance E&P deals because it will stretch more than most banks will, however, the company will not do deals as risky as those he did at Shell Capital, Keener said. After leaving Shell in February, he briefly thought about forming an E&P company, but decided that lending was more fun than spending. "If I don't like your deal, I get to look at another one in the afternoon," Keener said. "You have to look at your deal all day long." Deal supply While spoken in jest, Keener's remark emphasizes that private capital providers have no shortage of potential investments to review, which makes first impressions highly important. "Put yourselves in our shoes. We see hundreds of deals every year," said S. Wil VanLoh Jr., managing director of Quantum Energy Partners. VanLoh appreciates executives who can give succinct explanations of their deals. "If you can't explain the plan in just a few minutes, maybe there's a reason." Quantum prefers to dissect a track record to find out how management would make money with a constant price deck. Peter Kagan, managing director of Warburg Pincus, said he's not impressed by a flashy package full of color pictures and maps. He simply wants to see a business plan that matches the skill set of the management team. In addition, he does not want to see a management team that is too pushy, repeatedly calling and e-mailing and demanding answers in seven days. Warburg needs at least four to 12 weeks to give investments proper due diligence. On the other side of the spectrum, Gary Milavec, senior vice president of Wells Fargo Energy Capital, likes to see organized packages with maps and third-party engineering reports. He runs a mezzanine portfolio, so he is concerned with evaluating single projects, not entire management teams and company strategies. He said he can sniff out a deal in five minutes, by asking tough questions about the project. He is not interested in financing 100% of a project. "If you come to us and say you have $2 million and need mezzanine to take you to the next level, we like that." Paul Beitel, vice president of ARC Financial Corp., Calgary, wants to consider a company with a strong independent board of directors, not a crony board of management's friends. And, if a management team can't seem to get its own skin in the game, it should seek seed money from family and friends, he suggests. Danny Weingeist, managing director of Kayne Anderson Capital Advisors, wants companies to stay focused on their strategies and not change too radically just to chase money. "I don't want an acquisition company trying to explore because commodity prices are high." As the capital providers ran through their list of do's and don'ts, Kagan reminded the crowd that lenders can make bad decisions, too. He recalled one meeting with a management group that displayed many of the warning signs that capital providers try to avoid: It was run by a promoter with dreams of finding the next 100-million-barrel field, the numbers on the spreadsheet didn't add up, etc. It was the easiest "no" we ever said, Kagan recalled. But sure enough, the company bootstrapped its way into the money and ended up finding that100-million-barrel field, Kagan said ruefully. "And my boss reminds me of it often." The spenders Executives of five start-up E&P companies shared their experiences with raising capital, at the conference. In aggregate, they have sourced $486.2 million from seven sources, mostly for acquisitions and development drilling. Although Tulsan Randy Foutch recently created his third E&P start-up since1991, Latigo Petroleum Inc., raising capital remained a key concern. "The hardest thing was deciding how much money to raise-did we need $20 million, $50- or $100 [million]? And then, projecting where we wanted to be in a few years." Latigo was funded in December 2002 with $300 million of private equity from Warburg Pincus LLC and JP Morgan Partners. After making a small acquisition earlier in 2002, the Midcontinent-focused start-up spudded its first operated well in June. Matching a company's skill set, assets and goals with the right type of capital is crucial, Foutch said. "From the very first day you have to know what your skills are and have the correct financing for them. It's no good trying to fund a blue car if the capital providers want to fund a red car." Each executive stressed that the right relationship with a capital provider is as important as the actual dollars involved, because the relationship will be long and close. All interests should be aligned. All should agree on the business model, goals and exit strategy. "Private equity is very much a form of partnership, more so than other types of capital," said Andy Clifford, executive vice president of Houston-based Aurora Gas LLC. "Each of our partners provides us with skills we don't have" such as information on business contacts, deal flow and financial advice. Formed in 1999, Aurora focuses solely on developing onshore gas reserves in Cook Inlet, Alaska. It raised $25 million in equity from Tulsa-based Kaiser Francis Oil Co. with Cosco's assistance in 2002. "We started with bank debt and later decided equity was the way to go," he said. Arena Energy was formed in July 1999 by three industry veterans, who left their jobs at Newfield Exploration "to drill wells in the big bad Gulf of Mexico," said managing director Mike Minarovic. To date the firm has drilled 22 wells with 20 successful, having spent more than $50 million, net. Along the way, Arena has dined on a complete menu of funding choices from industry partners and bank debt to senior mezzanine debt and cash flow from production. The three founders contributed their own equity at first, but that was quickly eaten up in the first four months by start-up costs for G&A and acquiring seismic data. "Somehow you have to have equity before you get mezzanine, and that can be difficult," Minarovic said. In 2000 and 2001, the company received mezzanine funds from the now-disbanded Shell Capital to supplement cash flow, employees' equity and funds from industry partners. In 2002, Wells Fargo Bank and Hibernia Bank stepped in with senior bank debt and in 2003, Wells Fargo Energy Capital added more mezzanine funding. "In 2000 we came across a phenomenal drilling opportunity so we did something foolish and invested in it ourselves," Minarovic said. "Luckily it was a good well. Then we went to a mezzanine provider and were told 'No, you only have one well. Where is your equity? Come back later.' So we had to drill more wells." The capital providers and E&P executives agreed that when seeking capital, the oil and gas company has to show how it will grow. "Do not approach a capital provider with nothing but a reserve report and a map, saying, 'I just know this will work,'" warned John Rainwater. The chief executive of Carneros Energy Inc. is on his second start-up. Warburg Pincus provided $75 million in equity. "You have to have a complete and detailed business model, superior management, some type of competitive advantage, and a willingness to co-invest. "I am convinced Murphy's Law was invented because Murphy was an oilman." Carneros was formed in May 2001 to focus on California's San Joaquin and Sacramento basins. "It takes patience, patience, patience" to raise capital, Aurora's Clifford said. Even at the start, he had an exit strategy in mind. "The time to exit is when you are big enough to need a human resources department," he quipped. Armed with its business model, Rockford Energy Partners LLC received $15 million from Quantum Energy Partners II LP, with the principals contributing the remaining $900,000 to start in May 2002. The Tulsa-based company operates more than 300 wells and has interests in 500, said Chuck Perrin, chief executive officer. He co-founded Sapient Energy in 1998 and sold it to Chesapeake Energy for $135 million in December 2001. He also emphasized the importance of relationships. "Commercial bankers tell us we have the 'halo effect' because of Quantum. Comerica Bank used the Quantum funding as additional collateral behind our leverage with them, so we got more than we might have otherwise." It is important to be well-organized from the beginning, recognizing that eventually either the assets or the start-up company itself will be sold, so accounting, reserve reports and other details must be well-documented from day one. "Our financial management is quite tight and disciplined, with look-backs to see how we compare to projections," said Rockford's Perrin. "I learned that while working at Apache, which I thought has one of the most disciplined managements I've seen. We do capex budget planning every quarter and track production and cost control."