May 10, 2021
CORTADO VENTURES
Venture Capital is the New Oil and Gas in Oklahoma
In the home of the Land Run, venture capital is becoming where wildcatters seek outsized returns
A version of this first appears on the Oklahoma Venture Resource Council page. Thank you to the OVRC for advancing the cause of innovation in Oklahoma!
Oklahoma is an oil and gas powerhouse, home to some of the most prolific fields in the nation, and home to a wildly disproportionate share of industry innovators — Aubrey, T. Boone, Larry, Harold, and many other luminaries on a first-name basis in our folklore. I am a third-generation oil and gas entrepreneur. My grandfather, great uncle, uncle, dad, and two brothers have all run their own businesses in Oklahoma and Texas. My nephew’s initials are the molecular formula for natural gas. The earliest advice I remember from my grandfather wasn’t about cars, sports, relationships or life — it was “always collect pre-payments on AFEs”, referring to managing partner contributions when drilling wells. Oil and gas is in my blood, as it is for many throughout Oklahoma for the past 100 years.
So I come from a place of understanding when translating what we’re now doing in venture capital.
My partners and I founded Cortado Ventures last year, believing there is a generational opportunity to invest in the companies and sectors which will define the next 100 years. In the middle of a pandemic, we raised $20 million in only nine months — twice our goal in half the time. We tapped into a nascent belief in the future of Oklahoma, extending our state’s legacy beyond oil and gas, while leveraging what makes us great.
The process of raising money means you speak to nearly 10 people for each one who consummates an investment. Because of this, I’ve been doing a lot of explaining, and have become “bilingual” across O&G and tech. There are some similarities — more than many expect — but also some key differences. What follows are my key observations and what could amount to a “cheat sheet” for anyone wanting to take the leap with us.
Fund = drilling program
In venture capital, we raise a closed-end fund. We raise the amount of capital we need to execute our plan to invest in dozens of startup tech companies. By investing in many companies, we spread out our exposure and risk. This is analogous to raising money for a drilling program, where the plan is to drill many to dozens of wells. The key difference: in O&G, well results are largely related to each other (e.g. same geologic formation); in tech, the startups are uncorrelated to each other, meaning that the failure of one is totally unrelated to the chance of success of the others.
Capital calls = pre-paying AFEs
In venture capital, we call capital over a period of many quarters or years for investors to fulfill their capital commitment so we can make investments. This provides predictability for our investors, and means that not all capital is tied up at once for the active period of our investments. This is analogous to investors in a drilling program making pre-payments on AFEs (authority for expenditure, or drilling budget) over time as wells are planned. The key difference: in O&G, wells are never right on budget, and usually over budget, so investors need to pay some unknown amount more at a later date, or default; in tech, there is no chance of going over budget, because we only invest what we have.
Cap table = Working interest partners
In venture capital, it is standard to co-invest along other venture capital firms. These owners are captured on the “cap table” (as in capitalization). This is a source of strength for the company, as different firms bring different strengths and resources for the benefit of the company. Some firms are sector agnostic but really know a geography or stage, others are sector specialists, and still others may have built-in customers and strategic partners that the company can leverage. This is analogous to having multiple working interest partners participating in an oil and gas well, where multiple owners have fractional ownership of the well. These owners are captured on the “interest deck”. The key difference: in O&G, other owners are almost totally passive and add no value to the endeavor. Whereas in venture capital the multiple owners often add value in different ways.
Variability of results
Any O&G investor knows there is risk of loss and variability of results. In O&G, the results follow a lognormal distribution, which is a skewed normal “bell” curve, meaning that some wells are total or near total losses, most are clustered around acceptable returns, and very few are much better. In tech, the results follow an extreme version of the lognormal distribution in something called the “power law”. Besides sounding cool, this means that a large number — even the majority — of startups are total or near total losses, several return capital or slightly better, a few return multiples on capital, and a few are wildly successful, returning 10s, 100s or even 1000s multiple on capital. This doesn’t happen in O&G. Outside of a few stories from my grandfather’s time, you never have wells return 10s or 100s of multiple, let alone 1000s. This appeals to the wildcatter in me and should to others. The more we develop venture capital and startups in Oklahoma, the greater the chance we’ll have some massive 1000x return which will positively impact our community in ways hard to imagine now.
Valuation
Investors in Oklahoma know how to value an O&G deal. So many have been involved in these opportunities that familiarity begets confidence. There is no shortage of bonafide and armchair experts in O&G valuation that just about everybody in Oklahoma knows somebody they can ask for advice. Not so in tech. Valuing a tech company seems mysterious and unbelievable. But just like there are metrics in O&G, there are metrics in tech. This can be a multiple on revenue (sliding scale for software to hardware), or comps on similar tech, sectors, and/or stage of company. When it comes to very early-stage tech investing, we at Cortado use a common instrument called a convertible note, which is debt that converts to equity whenever there is an agreed-upon valuation. The advantage here is that we get a premium on our investment for being early, and that equity is calculated when it becomes more apparently calculable. This is a feature not available for O&G investors speculating on a drilling prospect.
Liquidity and transferability
O&G investors often like the liquidity that can come from owning a working interest in a well, or owning acreage that yields royalties. In venture capital, liquidity comes whenever a portfolio company has a liquidity event: sale, IPO, recapitalization, calling a note, or secondary sale. Liquidity is less predictable and “chunkier” than cash flow from producing wells, but still happens. In fact, liquidity can start to happen before the capital calls are done (see above). As for transferability, whether you invest in a drilling program or in a venture capital fund through an LLC, you may sell your interest to a willing party.
Control
No matter where you invest, things will go wrong. For both drilling programs and venture capital funds, investors are relying on the fund manager to do the work, make the decisions, and have some amount of control on behalf of investors. O&G investors like that an operator can remediate (or workover) a well that is underperforming. There is no guarantee that the workover will succeed, but the option is there. In venture capital, funds invest a material amount into startups. It is standard that this is a minority investment, but significant enough to have a board seat, board observer rights, or at least an inside track with the startup. When things go wrong with tech startups, VC investment managers can exert influence to improve the outcome, including changing the direction of the company or (in extreme cases) change the company leadership.
Taxes
Many investors who deploy capital in oil and gas take advantage of IDC (intangible drilling costs). IDCs are the service cost component of drilling a well, and are tax deductible. This is where O&G investing has an advantage over venture capital. But this is changing. With Oklahoma Senate Bill 915, investors in venture capital funds may deduct up to 60% of their investment. Contact your legislator with your support for this measure. Doing so will level the playing field on where capital is allocated in Oklahoma, directing more to companies and sectors that are growing the next generation economy for our state. Investors may also use their IRA to invest in venture capital, and some firms are looking at using Opportunity Zones to further enhance tax efficiency for venture investment.
