There has been a recent trend of consolidation within the energy industry, forcing acquirers to innovate their competitive offerings and strategies. In this episode of Mastering Innovation on Sirius XM Channel 111, Business Radio Powered by The Wharton School, guest Thomas Knauff, CEO and Founder of Energy Distribution Partners (EDP), discussed how to differentiate both operationally and financially to become a preferred acquirer.
Acquirers do not have much room for price competition within the energy sector space. Knauff explained how EDP pursues a local “Main Street merchant” operational strategy and leverages a revised private equity model to relieve the time frame pressure for its clients. Through these strategies, EDP developed a reputation as a preferred acquirer that puts the target employers first and allows entrepreneurs to remain embedded in their local communities. Knauff has started applying the unique limited partnership model to related industries, such as heating oil or gasoline and diesel fuel distribution. For other industries, however, he emphasizes the broader need to have both operational and financial skillsets in pursuing any type of innovation.
An excerpt of the interview is transcribed below. Listen to more episodes here.
Harbir Singh: Tell us what Energy Distribution Partners does. How does it differentiate itself?
Thomas Knauff: We acquire, operate, and grow locally owned and operated propane businesses that exist in all 3,300 counties of the United States, both for commercial and industrial purposes in the cities, and for home heating and cooking in rural areas.
We differentiate ourselves in two ways. Operationally, we assume the role of having the look-and-feel of a local Main Street merchant, so we’re the opposite of Walmart. We don’t feel like a chain. We make ourselves easy to do business with. We’re a good local corporate citizen. We sponsor local charities. We are a good local employer. We put our best trucks in the local parades. We strive to be well-thought of as an independent business. As a matter of fact, we maintain the local business trade name, or a trade name that’s very close to it, when we acquire the local businesses.
From a financial standpoint, we’ve innovated. Because this is my third company, we’ve learned to innovate by using the private equity marketplace in a different way so that we don’t have an expiration date on ourselves, you might say. Private equity generally has to exit around five to seven years after their initial investment. In order to avoid that built-in expiration date, we formed our own look-alike private equity fund with only ourselves as a portfolio company.
It’s a variation to the extent of desiring to remain independent beyond the five to seven-year private equity window and to continue to grow. We designed a limited partnership entity that is very similar to the entities that house private equity investors, with a general partnership that the founding investors share a portion of. Investors, for reasons that have nothing to do with our industry or our strategy, may have to exit or liquidate their investment – as many investors did during the financial crisis. For example, even in sound industries, they had to exit their investments in order to provide liquidity. We have 44 investors instead of 1. If we have to provide liquidity for one or more investors, we have the ability to do that without doing a terminal transaction that causes the company to cease to exist.
“If we have to provide liquidity, we have the ability to do that without causing the company to cease to exist.” – Thomas Knauff
Singh: Very interesting. It’s really a way to extend their life by giving people opportunities to exit while still allowing the vehicle to continue. Do you see this in other industries as well? Many industries are consolidating for a variety of reasons. Are you seeing serial acquirers of entrepreneurial companies mirroring some of this process, or is this unique to your industry and company?
Knauff: Frankly, I haven’t seen this miniature private equity fund approach – or non-fund approach, if you will – duplicated elsewhere. I credit a former investment banking partner of mine for having it as his brainchild, and it has worked very well. Other industries tend to build to critical mass, and if they can go public, they go public, or they sell to a strategic investor. Sometimes today, they sell to another private equity fund, depending on the strategic intent of the second successful private equity fund.
In our case, we wanted to get to critical mass and get to the public market, but not have to get to the public market within a certain amount of time or else force an exit. In fact, our portion – the energy portion of the public market, the NLP space – has been in somewhat disarray for the last year or so. It’s not really feasible for us to go public now, so we very much need this structure that we created. We can find and cultivate successor investors to liquidate people who are at their time horizon and need to exit without bringing a company to an end.
Singh: It’s fascinating. I teach a course on mergers and acquisitions, and we talk a lot about these two things. One is being the preferred acquirer, but that really comes from investing in acquisition capability, which you’ve articulated very well.
What’s fascinating about your point, though, is that you’ve also created a vehicle which seems to be in many ways both innovative and unique to your particular setting. Do you think that there are some limits to scale in this? That’s fine, because you can always churn out some units and add others. One doesn’t have to keep growing. It is about maximizing profit or impact. Any thoughts on that?
“We try to discipline ourselves to not get the Midas touch disease, where we think we can do this in other industries.” – Thomas Knauff
Knauff: There are some limits in scale, frankly. In order for us to get to the next level of growth, we will seek infrastructure-related investors that like to put in nine figures, between $100 million and $400 million. Those successor investors would have to be part of a very large single-purpose fund if we were going to continue the multiple investor approach. The next phase of our growth will probably involve such an institution, either buying part of our existing infrastructure, or starting the infrastructure over and starting anew, using us as a platform for the new phase of growth. What we’re doing works up to about the size we are now. It was designed originally to get us to the critical mass needed for the public market. If we’re going to double and triple in size, we’ll need to modify the structure, probably with fewer investors.
Singh: As you look at other industries or other geographies, do you see domains that may be at the right place for such a model to emerge? I know consolidation is taking place in many industries.
Knauff: We try to discipline ourselves to not get the Midas touch disease, where we think we can do this in other industries. However, I will say that the propane gas distribution industry tends to be joined at the hip with the heating oil distribution business, and the gasoline and diesel fuel distribution business in various parts of the country.
Sometimes, it’s not possible to separate the businesses when you acquire them. We’ve acquired in those spaces as well and execute according to the same parameters. What we know we don’t have is the expertise to apply what we’re doing to self-storage projects, Laundromats, or something we don’t know anything about. But, I would think that in any highly-fragmented business where a Main Street style of doing businesses can be effective against the national chains, and where the fragmentation is indefinite, as it is in our industry, some of the same techniques could apply.
About Our Guest
Thomas Knauff is chief executive officer of the start-up Energy Distribution Partners, a retail propane marketer; Tom’s resume includes more than 30 years of executive and financial roles, including 80 mergers or acquisitions. Before launching EDP, his third start-up venture, Knauff was a division manager and marketing director at Ferrellgas where he helped integrate the $400-million leveraged buyout of a rival firm.
Knauff’s financial and operational innovations have helped EDP grow to nearly $140 million in annual revenue and 14 distributors from California to Pennsylvania. Knauff works with business owners to transition their businesses to benefit their employees, communities and themselves. He regularly contributes articles on entrepreneurship to outlets such as Entrepreneur, BusinessInsider.com and The Chicago Tribune.
Mastering Innovation is live on Thursdays at 4:00 p.m. ET. Listen to more episodes here.