Why most propane startups fail

This is the first of a two-part series on retail propane startups. I chose this topic because the launching of a new retail propane plant is and always has been a fundamental part of the retail propane industry. In a way, it is the classic American capitalistic story – that of entrepreneurs risking capital and energy to create a new business.

Carl Hughes

Every existing retail plant is initially a “from-scratch” startup business. Startup ventures have a component of glamour to them. They are full of risk-taking and uncertainty and therefore come with enthusiasm and excitement about the possibilities.

Our highly fragmented industry – while showing signs of serious consolidation – has a very active contingent of individuals and companies attempting to start new branches or new propane businesses altogether. This effort has become significantly more challenging than in years past.

Totally unresearched, I selected the title that claims most startup retail companies or startup branches do not succeed. Before we go further, let me define what I consider a business success with respect to startups. Then, from this perspective, you will understand why I say most fail.

I will address both the new propane startups as well as the launching of a new plant by an existing propane company.

What constitutes a successful startup?

I offer three levels of financial success that should be expected from a retail propane startup.

1. Break even on startup costs. The first measure of financial success is when a startup begins to cover the initial annual fixed startup cost of operation. Fixed costs include labor, insurance, rent, utilities, etc.

2. Turning a profit. A profit constitutes the level at which all expenses have been covered. Many may consider this an acceptable level of success. Often this is considered successful because the entrepreneur is gaining a market-based wage that is part of the operating expenses. However, I do not consider this a financial success.

3. Making an acceptable return on invested capital. Beginning with an expected annualized return on invested equity is the most valid way to measure success of any enterprise. It is especially applicable to the retail propane industry.

For example, suppose a new retail propane plant was created with $500,000 of equity capital in costs for a plant and equipment (along with $500,000 of debt for a total capitalization of $1,000,000). Assume that this business created an annual pretax profit of $10,000 for a particular year. This would represent a 2 percent return to the equity before taxes ($10,000/$500,000). Under the definition of No. 2 above, this would be considered a financial success.

However, all of us should agree that investing this $500,000 in risk-free government securities at 4 to 5 percent would be a better investment decision.

What constitutes an acceptable return for this type of risk? Each of us will have our own idea of the acceptable return. However, it must take into account the risk associated with the investment as you arrive at what success means for your new venture.

Why most fail

1. Sales and gross margins were not attained. The market projections were under researched and overstated.

2. Capital runs out before profit is reached. There was not sufficient planning for capital needs beyond the early euphoric years of setting tanks.

3. Success was not defined. Because the success was not defined, disagreement among investors arises.

4. Loss of financial control. Inadequate accounting and financial controls prevent management from knowing where it stands and from making well-informed decisions.

5. Management was not sufficiently prepared for the multifaceted tasks that needed to be accomplished. Some of those areas are attracting, motivating and managing employees; dealing with customer needs; and banking, accounting, insurance, etc.

6. Time horizons were not realistically considered. In the euphoria of gaining new customers and setting tanks, it is easy to lose sight of the time that transpired and where one is in relation to the plan. Expectations of return on capital from both founder equity and debt are based on timelines and checkpoints along the way.

Launching startup correctly

Not to leave the issue on a negative note, in next month’s column I will address the financial fundamentals that must be considered in order to conduct a successful retail propane startup.

Hughes is vice president of business development for Inergy LP. He can be reached at Chughes@InergyServices.com or 816-842-8181.