Finding the right private capital provider is like dating. Dating as much as possible before settling down is essential. A prenuptial agreement laying out the rules of the relationship is also necessary. And getting divorced can be terribly expensive. "Don't elope with that first private capital provider who offers you a check," warns John L. Rainwater, chief executive officer of Prime Natural Resources Inc. Speaking at "Accessing Private Capital for the Energy Sector," a conference sponsored by New York-based capital provider Cosco Capital Management LLC and Oil and Gas Investor, the Houston independent producer took a lighthearted approach to advising fellow producers on the capital-winning experience. But his message was quite serious: givers and receivers of private capital enter into highly committed relationships that can turn out tremendously well or exceptionally bad. As part of a panel of producers who built their companies with private capital, Rainwater and his peers doled out valuable advice for those seeking to follow in their footsteps. "Don't short-circuit the process. Negotiate with two or three people," said Richard A. Bachmann, chairman and president of New Orleans-based Energy Partners Ltd. The former president of The Louisiana Land & Exploration Co. (since absorbed by Burlington Resources Inc.) founded Gulf Coast-focused EPL in 1997 with a MasterCard. He focused initially on debt capital, rather than turning too quickly to equity markets. Its initial funding was $25 million from the Energy Income Fund in 1998. In mid-1999, after being successful with 22 out of 23 wells, the EPL executives turned to Bank One for additional drilling and acquisition capital. They received a $50-million credit facility. "Bank One was as supportive a lender as I could talk about," Bachmann said. At the end of 1999, EPL approached Evercore Capital Partners, New York, for more growth financing and to improve its balance sheet in anticipation of eventually taking the company public. Evercore invested $60 million, initially controlling 54% of EPL equity. Under the deal's structure, management can earn 11% of that control back. "We maintained about twice as much ownership in the company by going this way rather than by going to the equity markets up front," Bachmann said. He warned against dancing with only one boy at the ball. "Evercore was the first firm we talked to [for corporate equity capital]. They wanted to short-circuit the process. I would counsel against short-circuiting the process." Deal structuring can get heated. When negotiating with more than one firm, "you can break off with one and get back to them." Sapient Energy Corp. received $15 million of initial common equity from Irving, Texas-based Natural Gas Partners, according to Robert R. Anderson, chief executive of the Tulsa independent whose motto is "Buy or bye-bye." NGP was Anderson's first choice as a capital provider, "and after meeting with them, they are our only choice." To maintain a successful relationship with a private capital provider, producers must be willing to yield controlling interest in the company and to treat other people's money as their own, he said. "If you're the type who wants to work only for yourself, this is not for you," Anderson said. On the other hand, having private capital can open more doors for a small producer, providing recognition and credibility for the company and allowing it to accelerate growth, he added. When considering whether to pursue private capital, there are several things to keep in mind, he said. First of all, do the research. "Find out what they're really looking for [in an investment]. Talk to people who've done business with them before." Be prepared to be scrutinized as well. Also, be honest about your company's assets and liabilities. It would be hard to find a bigger advocate of honesty than Christopher J. Whyte, president of Houston-based Petrosantander Inc. "Cut the crap," Whyte bluntly advised the audience. "If you can't explain this [deal] to my 10-year-old son...there's nothing there anyway." He added, "The truth is, this is a miserable business. It's mature, risky, capital-intensive, highly regulated...If I was 20 again, I would never go into this business...If you want private capital you have to be in the top percentile. If you're not, you'd better be lucky." Some private capital providers want your natural gas-to buy it, transport it, market it, or all of the above. "It's amazing what $4 gas will cure," Richard H. Adams, director, structured transactions, Aquila Energy Capital Corp., Houston, said. Aquila Energy Capital, a mezzanine capital source formed in 1998, did $250 million in business in 1999 and $100 million through May 2000. It is backed by Aquila Energy, the unregulated energy marketing subsidiary of $7.5-billion Kansas City-based UtiliCorp United and one of the largest gas and power marketers in North America. Since inception, AECC has provided capital to 14 producers in more than 25 transactions, with total capital commitments of approximately $350 million. Aquila would be more than happy to market its energy-capital clients' natural gas, Adams said. "We like to at least participate in that." Jeff Goodman, vice president, Houston-based Duke Energy Financial Services LLC, a division of Duke Energy Field Services Corp., also wants to buy clients' natural gas. "We look for [financing] transactions that enhance our midstream assets," he said, which means additional throughput in the DEF system. "Size doesn't matter to us. We're looking for deals that will add value to our assets." "We encourage payment, of course, but we also incentivize prepayment. We're not in it for the long-term financing return," Goodman said. The firm wants to finance gas-focused producing-property acquisition and development programs. "We did a few which I found out afterward [were] exploration deals." The firm also does not seek to take a working interest in the properties or equity in the company. "We are not in competition with our customers. We have done one or two [of these deals]. We didn't plan it that way." Many other capital providers are more traditional. Houston-based EnCap Investments LC is a subsidiary of El Paso Energy Corp. but primarily wants return on financing, not natural gas. Since El Paso purchased the firm in 1999, "there's really been no difference [in mission]," said D. Martin Phillips, EnCap managing director and principal. "I'm frequently asked if we want gas supplies...That's really not the case." "El Paso does try to invest alongside us, where possible...They've been an excellent partner as a source of capital [for deals] we didn't intend to do with the fund." The firm is presently placing capital from its EnCap Energy Capital Fund III-a $480-million chest of which approximately $310 million has been placed. The fund is EnCap's ninth, but its third one that is equity-oriented. Its beneficiaries of corporate-equity capital through early June are Plains Resources Inc., $48.5 million; 3Tec Energy Corp., $41.9 million; Breitburn Energy Co., $30 million; Matrix Energy, $28.6 million; Magellan Petroleum Corp., $26.5 million; Harken Energy Corp., $25 million; First Permian LLC, $16 million; San Juan, $15.6 million; Bargo Energy Co., $15 million; and Cordillera Energy Partners, $10 million. Receiving project equity from the fund are Ceres, $15 million, and MBOE, a Mike Montgomery and Bob Mase startup that has been buying properties in the Permian and Midcontinent, $12.4 million. Receiving mezzanine debt financing are Cheniere Energy Inc., $3.1 million, and Sharpe Resources Corp., $3 million. Receiving a bridge loan is Benz Energy Inc., $18.1 million. EnCap has a stay-the-course strategy. "When we do invest, we want to make sure it's not a Band-aid." Opportunistic exit is part of its strategy. Meanwhile, Shell Capital Inc. is a means for Royal Dutch/Shell Group of Cos. to enjoy returns on assets it doesn't own, says Michael Keener, director of Shell Capital, Houston. "The group has decided there are better ways to [make money] than just by owning every asset we've traditionally owned." The firm does senior, subordinated and/or mezzanine debt and preferred-equity deals. It won't do pure senior debt. "We'll send you to a banker." And it won't do a pure preferred-equity deal. "We did do one. I don't like to admit it." "We're really a science-based lender. We like the deals where you understand the science better than we do," he adds. Deal size should be at least $10 million. "Any smaller [than $10 million], we're going to take all your money." The deep pocket behind the firm can help a project. "Once we buy into a project, we don't want it to run out of money. We won't let that happen." Aquila's Adams had these suggestions for companies seeking equity or debt mezzanine financing. Believe in your development plans. "If you don't believe in it, we won't believe in it. The money won't be there." Implement your own due diligence. "Show me you care more than I care." Show continuous attention to detail. "I don't want to play investor cop and look over your shoulder and show you what you've missed." Rainwater said one advantage of the private-capital marriage is that the producer gets lots of "free" advice. A bad spouse nags, however, costs more than expected, demands too much control, and cheats and lies. "You need a partner that will work with you through changes." One conference participant said, "The mood is not very good for exploration capital." None of the presenters stated interest in backing pure exploration projects. Exploration can be nothing more than trading dollars; it doesn't really create value, says Peter A. Leidel, partner, New York-based Yorktown Partners LLC. It is better to buy reserves, he says. "I'd be hard-pressed to find small companies that have created a lot of value [through pure exploration]." A conference participant asked, then, what entrepreneurs could do to access exploration capital. Toby Neugebauer, principal, Quantum Energy Partners LP, Houston, said, "Most of the exploration deals we've looked at are uneconomic-and because we've done a couple, I think we've now seen every one." Kenneth A. Hersh, managing director, Natural Gas Partners, told Neugebauer, "I'll send all mine to you." He added, "I don't think exploration itself is uneconomic. Exploration and institutional dollars are not a good match." Yorktown has 18 active investments with $680 million, "which is about 10 minutes of Super Bowl ads for e-commerce companies," Leidel said. "Whether we own 5% of a company or 90%, we don't act in a control manner. We are in partnership with management...We don't mess with your grip or your swing. We let you run the show...We don't tell people what well to drill or what acquisition to make but we're there for advice." The firm's four partners were with Dillon Read and have been doing private-equity deals since 1983. U.S. private equity investments in all industries in 1999 totaled $48 billion. "Close to $20 billion of that went to Internet companies," Leidel said. About 1% ($450 million) went to energy companies. "Energy capital [need] is about $3 trillion a year. It dwarfs e-commerce; it's a tenth the size. It's even bigger than healthcare. There's not a lot of capital and there's not a lot of focus on this industry and if you find the right companies, you can get the returns," Leidel said. Yorktown currently has $144 million invested in energy companies, or about 59% of its portfolio. "In the last six months, about 70% of our capital has been non-E&P-oriented [because of higher prices]." He suggests that new producers be capitalized with equity, not debt, because of vulnerability to commodity-price swings. "The companies that have gotten into trouble have been those that got into too much debt. Our strong philosophy is to use equity capital, rather than debt capital [even though bank money is cheaper]." The firm has exited 17 E&P investments, made an average of more than four times cash on cash, and never lost capital on any deal. Providing equity and in a big way are corporate capital funds Chase Capital Partners, Global Energy Partners/DLJ Merchant Banking, Huff Alternative Income Fund LP, SG Capital Partners LLC and Warburg, Pincus Equity Partners "Energy is relatively new to DLJ private equity...and we don't require being a sole investor. We would be happy to invest alongside Chase or whomever," said R. Graham Whaling, managing director, Houston-based Global Energy Partners, a business of DLJ Merchant Banking. The private-equity and mezzanine financing unit consists entirely of Whaling, former chief executive of Monterey Resources, and Steve Webster, founder and former CEO of R&B Falcon Corp. DLJ Merchant Banking has raised three large private equity funds: $1.2 billion in 1992, $3 billion in 1996, and $4 billion this year. A $1.6-billion mezzanine fund was added to the plate in June. Returns on the 1992 fund averaged more than 50%. For the 1996 fund, dollars are just about spent and returns have been very good as well. None of the funds are specific to energy investment. Two other units seek investment in healthcare and technology. The minimum deal size is $30 million. "Because the funds are so big, it doesn't do us well to make investments of $5- to $10 million," Whaling said. Founded in 1994, Morristown, New Jersey-based Huff Alternative Income Fund is a regular energy investor, and does equity or subordinated debt deals of $5- to $60 million, says Chris Rafferty, managing director. The fund managers look for development drilling deals, with a high-quality management team that is co-invested and has experience in the basin in which it is drilling. Assets Huff considers must be onshore or in shallow water offshore, on established acreage, with long-life reserves and multiple or shallow pay zones. "Who wouldn't like this stuff?" he added. Huff will exit upon initial public offering or private sale of the E&P company. "We're reasonably flexible." Doing deals over a wide range of $5- to $500 million is Warburg, Pincus Equity Partners. "We don't have a fixed answer for deal size," said Peter R. Kagan, vice president, New York. It's an issue of time. Only three members of the firm do E&P deals. "Every investment we make has to be meaningful to the fund." The firm has invested in Newfield Exploration (exited in a series of four divestments), Vista Energy ("Not every deal works."), Spinnaker Exploration ("A wonderful success story with a lot more legs to it. The story's got a long way to go."), Lariat (introduced to Warburg by Cosco Capital partner Cameron Smith), Encore Acquisition Partners and EEX Corp. New York-based Chase Capital Partners has $18 billion under management in equity and mezzanine capital to private but mostly public companies. IPOs are not an exit option, said Christopher C. Behrens, partner. "As the [equity] market has become even more volatile, an initial public offering is not an exit strategy...We really look at IPOs as a cheap currency to do deals." He advises that capital-seekers add some "what-if" funds to the total they seek, to have enough capital available before it is a good time to return to the cash well. "When you raise money, you should raise more money than you think you need." And, do due diligence on the potential investor, "not only just making the calls but actually visiting people...to determine what kind of person he or she is," Behrens advised. SG Capital Partners, the New York-based merchant-banking affiliate of Societe Generale, has about $100 million still available in its private equity capital fund of which 10% to 20% is targeted to oil and gas. The firm prefers to invest in E&P companies with managers who have demonstrated extreme competence. And, the firm likes the client to keep that focus. "If we've been with someone successful at buying and selling companies who says we now want to go and explore...that makes us real uncomfortable," said Lawrence Neubauer, vice president. The firm has invested in Archer Resources, Ipec Ltd. and Bargo Energy Co. for their management's acquisitions expertise in their focus areas; Canrise Resources and Tepco Resources Inc. for their exploration expertise; and Addison Energy and Ballard Petroleum LLC for development expertise. "Structure in many ways is one of the least important of the factors...These other things [management, properties and timing] are much more important than structure," said Neubauer. The last speaker of more than 25 during the one-day conference, he added, "All the people you've heard from today are just trying to get their money back at some point...not to fall in love with their assets, with their properties."