CHAPTER 5 AN OVERVIEW OF EQUITY FINANCING—1982

• Jurisdiction: United States

Mineral Financing
(Nov 1982)
CHAPTER 5
AN OVERVIEW OF EQUITY FINANCING—1982
Fritz Meyer
Corporate Finance Department Boettcher & Company
Denver, Colorado

This paper is intended to provide an up-to-date overview of the equity markets as they relate to the oil and gas exploration and production industry.

Our definition of equity is, very simply, capital which does not have to be re-paid, as does debt. Equity constitutes the most permanent form of a company's total capitalization, and it provides the basis for borrowing against assets (long-term), and against inventory and receivables (on a short-term or revolving basis).

I. Description of Forms of Equity Financing.

The business of drilling for and producing oil and gas has, by its nature, spawned a myriad of financing techniques which include equity, debt and hybrid forms. With respect to equity financings we would segment these financing techniques, generally, into balance sheet and off-balance sheet categories, as follows:

A. Balance Sheet Financings.

1. Common Stock (and/or warrants to purchase common stock).

2. Convertible Preferred Stock.

3. Convertible Subordinated Debentures.

4. Exchange offers.

5. Participation in production as an "equity kicker" to a loan.

B. Off-Balance Sheet Financings.

1. Limited Partnerships:

a. Drilling Funds (non-leveraged and leveraged; development, exploratory and balanced).

b. Completion Funds.

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c. Income Funds.

d. Royalty Funds.

e. Acreage Funds.

II. Relative Merits to the Issuer of Various Forms of Equity Financing.

While these forms of financing are generally familiar, it is useful to review the relative merits of each when making a recommendation to a company as its management considers the equity financing alternatives which might be available to it. Our summary of the advantages and disadvantages of each form of financing is contained in the following matrix:

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Advantages/Disadvantages of Various Forms of Equity Financing

Common Stock	Convertible Preferred Stock/Subordinated Debentures	Exchange Offers	Limited Partnerships
Advantages:	1) Permanence;	1) Permanence, assuming conversion;	1) Capture aggregate cash flow of partnerships;	Captive source of risk capital;
2) Use of proceeds entirely discretionary vs. project oriented;	2) Typically less dilutive to to existing shareholders;	2) Creation of substantial borrowing base;	2) Off-balance sheet, thereby limiting financial exposure to the operator;
3) When sold publicly provides continuous access to capital markets;	3) Also may be used as currency if issuer is publicly-held.	3) Means of going public, thereby creating continuous access to capital markets plus an acquisition currency;	3) Non-dilutive to shareholders.
4) Publicly-held shares can be used as acquisition currency.	4) Reduction of overhead from operating partnerships; reduction of complex administrative responsibilities.
Disadvantages:	1) On-going costs of being publicly-held;	1) Debt service requirement for some indefinite period;	1) High transaction costs; no real "going concern" value given; new company, new management;	1) Administratively cumbersome — ongoing accounting and reporting obligations;
2) Dilutive to existing shareholders;	2) May carry certain restrictions as to dividends or coverage ratios.	2) High risk of failure in present market environment; poor market performance;	2) Not flexible — project oriented;
3) Being publicly-held restricts many activities by management which might otherwise be permissable.	3) Exposure to limited partner lawsuits;	3) Unpredictable and undependable as a continuing source of capital;
4) No real overhead reduction in many cases;	4) Currently difficult to sell without successful and extensive performance record.
5) Geographically diverse properties resulting in uncontrolled operating costs.

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While each of these means of financing may be attractive to an issuer for any number of reasons, the issuer is subject to market forces which may or may not allow for a successful financing on terms acceptable to the issuer. Hence, a review of current market conditions vis a vis the various types of equity financing will provide the prospective issuer with an idea of what is likely saleable and what is not.

III. Availability to the Issuer of the Various Forms of Equity Financing.

A. Common Stock — Exhibit 1 provides a listing of every common stock financing successfully completed by domestic oil and gas producers since January 1, 1979. Some...