E&P start-ups don't have the luxury of drilling $8-million wells, making a mistake with a major hire or hesitating when it's time to hit the throttle on a project. They are operating close to the bone and there is little room for error.

And, perhaps most important, they must have an exit plan. To that end, start-up executives must craft a strategy to develop, execute and get out of the business when the time is right, according to experts speaking at Oil and Gas Investor's Energy Capital Conference held in Houston in June.

“Always make sure your business plan (includes) plans for an exit,” said Jordan Marye, managing director for private-equity provider Denham Capital, Houston, a sponsor of the workshop titled “Starting an E&P Company," which preceded the conference. While assets should be worth holding and sustaining through economic cycles, E&P companies are still in the business of building to sell, he said.

The business landscape for E&P start-ups has changed. Founding and building E&Ps in the past four, five or even eight years relied on a model of leasing, drilling a few locations and selling fairly quickly. In the past six to 12 months, that's changed dramatically, Marye said.

“I think today you need to be prepared to lease, drill and even develop and hold assets for the long term,” he said.

“We've seen independents of all sizes sell noncore assets to fund (operations on) their core assets. We probably see more for sale today than we have seen, certainly in the last six or eight years, and all of this is a function of technology in our business and the supply impacts that has had on our business.”

To acquire capital, executives should realize that investors' money goes to superb teams, not individuals, no matter how experienced and talented.

“The pricing and understanding of technical risk is what determines value in our industry,” he said. “That is obviously shepherded and led by people. People are absolutely the most important things that we trade in, and those good people's pricing and understanding of technical risk make the difference.”

The speakers, a mix of private-equity funders and recipients of that financing, drew on their experiences to offer a guide to building an E&P and making it pay off.

Mike Oestmann, chief executive officer of Tall City Exploration LLC, Houston and Midland, Texas, agreed that the team is all important, more so even than the business model or plan. In May 2012, his company received $200 million in funding from Denham. Tall City now has 22,000 net acres in the Midland area.

“If the team is bad, you know what kind of results you're going to have,” Oestmann said. “The rewards we all see will be directly proportional to the quality and performance of the team.”

Oestmann said a good team is experienced enough to set individual egos aside and work toward a common purpose: making money.

Competing with bigger players

In a competitive market such as Midland, attracting talent can be a challenge. Oestmann said some companies there have left because they don't believe they can find enough people to be successful.

“We've been successful in assembling our team, but the question becomes, how do you compete with great companies like Apache?” Such companies offer big salaries, benefits and award bonuses, and stock options.

Oestmann believes reputation plays an important role in attracting and retaining talent. Many of his employees are people with whom he or other managers have had past business relationships. Further, the company's salaries are competitive, in contrast to the late 1990s, when moving to a private-equity-backed E&P firm meant taking a pay cut.

And beyond the attraction of having equity in a successful company, there's the appeal of ownership in building a business.

Recruiting someone with two or three decades of industry experience comes down to “finding people in a stage of their careers who want to have responsibility, and they want respect for their decisions,” he said. “We bring them in, give them the tools they need, and get out of their way. That's a work environment a lot of people seek.”

Oestmann said his first key hire was a controller who could provide accurate numbers, so partners would have no concerns about the books when it comes time to sell. Another important piece was hiring legal counsel who could sift through contracts with a keen eye, instead of Oestmann having to try to parse such documents himself.

Tall City also outsources many other functions, such as payroll, taxes and computing. Despite the costs, the benefits outweigh the headaches of handling the tasks in-house. “They can just eat you up,” he said.

And operational staff should be in place as early as possible, since so many regulatory hurdles must be crossed. Tall City won't spud its first well in August, as it had originally planned to do, primarily because of such entanglements.

No capital formula

Acquiring the money for ventures cannot be broken down into a formula, said John Donovan Jr., founder of Donovan Capital. “There's no silver bullet.”

When seeking capital, he advised entrepreneurs to keep presentations short, be ready to answer questions not outlined on paper and understand that from the moment they sit down, their team is being studied and judged. “They're learning how you deduce success and information, learning how you present it, how you analyze returns, and they're watching you work.”

Donovan said accessing money requires entrepreneurs to be specific and remember that often, they may be talking to a less technical audience.

On the other side of the table, Ken Friedman, a director at Denham, said that deciding on the right capital partner can be crucial. “My advice that I always give to people is to put all your cards on the table and ask the sponsor to put all their cards on the table,” he said.

Investment partners range from absentee governors to day-to-day overseers. Denham prefers the middle ground, he said.

He also warned of another danger: A firm may provide sizeable financial backing on paper but disappear when the business goes south. “My advice would be not just seeking best terms or the largest equity commitment, but finding a partner that can actually follow through on that,” he said.

The private-equity company will consider funding young teams that are willing to work with more seasoned leaders. Young management teams have advantages, such as familiarity with new technologies.

“We do look to leverage that type of emerging leadership,” Friedman said.

Marye said Denham's criteria are simple but key to separating the successful from the unsuccessful. For one, teams should be technically excellent at whatever it is they do.

“If you're hired to build a financial model, it better be the best financial model that there is. If you're a geophysicist, you better be a onepercenter in the geophysical world.”

Initiative and an ambition for entrepreneurship are vital to create something from nothing, work outside of protocol and turn a blank page into something great.

And Denham likes people with honesty, integrity and “the no-jerk factor.”

“Life is too short to work with people you hate,” Marye said. “And we will not.”

To get to the point of asking for funding, Bakken player Matt Steele, president and chief executive officer of Ursa Resources Group II, Houston, said it's important to recognize when you need the money.

Steele said companies should consider asking for funding when:

  • Opportunity is available, but it's more than the company can tackle,
  • The company needs to accelerate operations,
  • An opportunity arises to align with a great partner,
  • When growth is the obvious next step.

“When there's more opportunity than you can harvest on your own, it's the perfect time to go out and grow,” he said. Acquiring acreage rapidly and accelerating development require money.

For instance, Ursa was able to hold 1,280-acre units in the Bakken, but it was also important to work the leases during the primary term, Steele said. “We all know this business is PV (present value) driven, so there comes a point where it makes sense to put rigs on something, drill it up and pull that value forward.”

But before going after the dollars, pull your story together, he advised.

Dudley Viles, president and chief executive officer of Bright Horizon Resources, Tulsa, operating about six months, said the transition from being an executive vice president for Samson Resources Co. to heading a start-up brought with it a series of challenges.

His team was formed through meetings at hotels and coffee shops. It won financing and fought through day-to-day chores, opening a new shop with IT, legal and accounting in place.

Most important, Viles said, the company worked hard to form a strategy and refined it again and again.

“I think sometimes there's a tendency to want to wrap up things and go talk to people,” he said. “I think that's a mistake. I think you need to think long and hard about what goes into the components of your strategy.”

That strategy must fit the background and expertise of the start-up's key players. The process becomes a foundation for what the company does going forward and is “what the private-equity companies are going to judge your performance against, at least in the short term.”

As Marye puts it, company leaders should know their edge; that advantage is the most important part of their business strategy.

“If you can't write down what your edge is in one sentence on the back of your business card, you don't have one,” he said.