06/10/2011

The Perfect Angel Investment Opportunity

By Modwenna Rees-Mogg, AngelNews

If you were to mull over what the perfect angel investment opportunity might look like, do you think it could be a business which, when mature, would have a utility industry model of reliable cash generative profitability and with strong green credentials to boot? Or would you think it should be a business which has travelled from £0 to £20m turnover in three years and is profitable?

How about a business which has only needed half a dozen key contractual relationships in the first instance to garner this revenue, but which is converting each contract into thousands of direct customers each paying up front by monthly direct debit and pre-pay or in arrears on receipt of a bill, for an essential domestic service? Perhaps it would be a company which, even at £20m turnover, had only captured 0.003% of its target market and that is in the UK alone? Could it be a company that already stands shoulder to shoulder in its sector with some of the largest companies in the world, but still offers value and quality of service on a par with the best in the industry? Oh yes, and could it be that there are considerable barriers to entry for anyone else trying to get in on the act!

Impossible you may think, but there are over 100 angel investors already invested in a company with all of these characteristics. If you are one of these people you will know which company I am writing about, if not, let me end the suspense right now and tell you that the company is called Spark Energy, based in Selkirk in Scotland and run by founder CEO PJ Darling.

PJ has one of those charming entrepreneurial stories to tell. A Canadian who had worked for other entrepreneurs, by the mid 2000s he decided that it was time to set up his own business in his adopted homeland of the UK. He took himself and his family off to Scotland and spent some months deciding what sort of business he should set up and how he should go about it. The result was Spark Energy – what has become the UK’s brightest new utilities company, offering a fully-fledged energy service to the UK’s residential tenants and property agents.

You might think that becoming a new independent provider of domestic energy in the UK would be a near impossible task, even if the rewards are exceptionally attractive (see below). But PJ is not alone in having tried. A number of organisations with large domestic customer bases have tried to steal a march on the big six utilities companies and try to sell energy direct to their audience. Broadly speaking, they have failed. Why they did so is a discussion for another day; what matters is that PJ and his team have succeeded; and to such an extent that today the business is established, profitable and growing rapidly on its current customer base of 25,000 homes today.

What PJ did differently was not just to think about where to target a mass customer base, but to think how to incentivise the people/organisations who could give him access to those people. Thereafter, he reasoned, the trick would be to keep the customers happy by offering them better prices and service levels than the big boys and balancing the risks of wholesale and retail energy prices. Some pretty intensive software would be needed to manage the business at high volumes, but that would in itself protect the business once it was up and running and in itself it would add value as it would give superior controls over energy management “within the home” thus meeting many a consumer business’s dream scenario of getting to their customer behind their own front door!

Another key to Spark’s model was to identify the size of the rented market in the UK. Around 3m are privately rented with another 4.5m in the social housing sector.

A further examination of the market showed PJ and his team that the private rented sector had peculiar characteristics in the context of energy supply – a high turnover of tenants combined with managing agents who simply do not want to have to deal with managing switchover of the energy supply in the properties they manage, when tenants change. The opportunity emerged. Offer the landlords and their agents a complete energy management service in return for the opportunity to transfer the energy supply to Spark. Tie them in long term with the offer of annual commission based on the number of properties being supplied.

What really swung it for the strategy was that there are around 9,000 property management companies in the UK who manage the vast majority of private rented properties. Win a small proportion of them and you would have a significant customer base. And heading down this marketing channel would reduce the cost of acquisition of a new customer by about half the cost of online switching engines.

But there were ancillary advantages of going after this market too, not least the fact that tenants are comforted by a Price Promise guaranteeing they pay less than the average of the Big 6 standard tariffs so they tend not to switch, and the big energy companies are not set up to serve a market where there is a rapid turnover of occupiers in a property, so in practice direct competition as such did not really exist.

With each home spending c£1,000+ a year on energy, the private rented sector represented a £3-5bn market per annum. It was too good an opportunity to miss.

So PJ and his team set to work. Three years and 90 employees later, Spark has proved what it set out to do.

There were teething problems of course; it took the company a while to get its service model and systems right. But PJ tells me that the model is now sorted (albeit with work still to do!) and the company can take on as many new customers its property management partners can throw at it. It already has 25,000 customers and is adding more at the rate of 2-3,000 per month and turnover is set to hit £20m this year and £30m next. And Spark’s existing partners alone still have over 100,000 properties waiting to switch to Spark.

Spark is also a good example of how to turn market trends to its advantage – for example 100% of the electricity it buys is from municipal waste incineration sites – still a niche market in global energy terms but big enough for Spark. This gives it not only notional, but also real green credentials.

Meanwhile as one of only 14 fully regulated and licensed domestic energy suppliers, it can, if it so chooses and when the price/volume matrix is right, buy from other renewable or even conventional sources, so there is no question that it cannot offer a service to as many customers who want to buy.

Thanks in part to investing in technology, Spark is currently achieving gross margins of around 40% against the 25% odd that the big six suppliers are achieving. On the one hand that is likely to make it an attractive morsel for an nPower or the like to gobble up one day (and given the growth of the company it would not surprise me that when that sale comes it will be a 10 bagger); on the other hand it has more fat on its bones, if wholesale energy prices move the wrong way. And in the meantime it gives it some firepower financially to entice high quality middle and senior management into the firm from the big six utility providers. “Once they get here they soon discover they like the better way of life, too!” PJ told me.

One of the interesting characteristics of Spark is that it has run itself like a quoted business since day one. PJ spoke of the value having a wise board, who have helped him manage the business professionally from day one. “Our Chairman, Sir Tim Noble, has been particularly helpful in showing us how to manage our investor relations properly” he told me. “We report formally to shareholders on a regular basis, for example.”

As an entrepreneur once told me, the challenges for entrepreneurs do not change – however big their companies might grow – the only thing that changes is the number of noughts on the end of the challenge! With the business now running smoothly at an operational and board level, PJ is dealing with his last big growth challenge – building up the balance sheet to reflect the size of the operational business.

Investment to date has been spent on getting to profitable growth and with the majority of Spark customers paying monthly by direct debit or in advance, cash flows are relatively predictable. The balance of customers, while paying a premium, typically pay up to two months in arrears, whilst Spark has to pay for the energy it buys on their behalf on average 20 days after its used. This is fine in the summer, but with UK winters increasingly unpredictable, PJ has recognised that it would be helpful to have a war chest ready in case there is a sudden surge in demand for energy, at which point they will find themselves writing bigger cheques than they might otherwise have had to do.

PJ tells me that his existing investors are committing to fund a large chunk of the current £2m round. Indeed, Spark’s NEDs have already put up 1/3rd of the money, but there will be room for a few new investors if they are interested. The company is offering both equity shares and also 2 year 5% Energy Bonds: the latter come with £2,000 free energy too! PJ does not think that VCs would be suitable investors for this round but isn’t ruling it out in future – for now he likes his angel shareholder base. And if I was them I would like him too – after all how many angels are invested in a business which has already had such exponential revenue growth and the potential for so much more?


If you are interested in finding out more about Spark Energy’s fundraising please visit www.sparkenergy.co.uk

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