June 2009 Issue of Wines & Vines

Finding Construction Financing

Lenders say it's available to well-qualified small wineries

by Paul Franson
Winery Contruction
Custom crush facility Bin to Bottle arranged an SBA loan with Napa Community Bank to build a new 25,000 square-foot barrel storage building.

  • Banks still have money to lend, but they prefer to part with it for businesses that already are established and successful.
  • Many wannabe entrepreneurs who previously secured financing from friends are now consulting banks, having found that individuals can't follow through on personal loan promises.
  • Lower fees offered by the Small Business Administration are encouraging more businesspeople to borrow from the SBA.

It's an old joke that it's easy to borrow money if you don't need it, and that adage is certainly true for winery construction and expansion. But money is available, though it's generally more difficult to qualify than in the past. In addition, better terms for loans through the Small Business Administration might provide an attractive alternative to wineries that hadn't previously considered them.

It's hardly surprising that money for wineries is tight--it's tight for everyone, as every day's newspaper testifies. One indication is that some normally forthcoming contacts were reluctant even to discuss the matter--either because they were busy dealing with other issues, or they were simply not anxious to talk.

Fortunately, we found many bankers and others who told us they had money available, but made it clear that it's most obtainable by the well-qualified. "There is money available for somebody," notes Rob McMillan, founder of the wine division of Silicon Valley Bank. "What has changed is that bankers are more interested in how it will be paid back. Someone predicting revenue from a 20% growth rate will find skepticism."

He says that in recent polls of top bankers, 80% indicate that they're tightening credit, not loosening it.

A view from Silicon Valley

Silicon Valley Bank is a major lender to boutique wineries, and McMillan notes there's plenty of money available for small, family-owned wineries. "The market is reasonably competitive," he adds.

He says bigger deals are more at risk. "It's getting harder to score loans over $30 million," which typically require a syndicate of banks. "It's tough to get the banks together on terms."

However, he adds, "I can always find someone to work with me."

McMillan has seen a number of wineries seeking money that originally didn't need any debt financing. "They were starting a brand before the crash, and had lined up money from friends and other investors. Now, those people have seen their wealth shrink, and the deal needs money." He adds that, to his knowledge, most of those proposed wineries didn't happen.

It's also important to have a brand name and revenues. The unknown effort will have trouble raising money. "The well-run wineries with established brands are probably doing okay. The average winery is still doing fine, but the average winery is hard to find." He says the fine wine business has generally enjoyed a 20% growth rate, quite a high level compared to most businesses.

All this has led to a fair number of wineries transitioning at bargain prices, McMillan notes. "It's done quietly, at prices well below those of two years ago. Capitalistic Darwinism will take over."

He's also seen various proposals for custom crush wineries fall through, pointing out that someone could instead pick up a facility like Kirkland in southern Napa Valley, which is in the wrong place for tourists, but a generally modern facility. But it's worth less than its original value. "Custom crush facilities help wineries when they're growing and need additional capacity. They grow in a stair-step manner, stretching and using custom crush until they reach the level to expand. During a period of flat growth like the present, this capability isn't as necessary."

Wells mostly concurs

One of the few large banks that seem to be doing well is Wells Fargo, which posted a $3.05 billion profit for Q1 2009, and its regional vice president, Michael A. Sullivan, was happy to talk. "Our lending is at almost-record levels," he says. A lot is in homes, but he says, "There's no lack of capital for good projects."

He adds, naturally, "It's easier for some than others." Among those who will find it challenging are new wineries. "Start-ups are tough unless they have adequate outside support," he says. On the other hand, there's plenty of money available for a successful existing winery looking to expand or build out. "Of course, they have to be doing well to want to expand."

Winery Contruction
The final phase of Trinchero Family Estates' construction project--the tasting and retail sales center--is expected to wrap up this year.

Sullivan notes two common scenarios for new wineries. One is the wealthy individual who wants to get into the wine business. The other is someone in the industry--either in sales and marketing or winemaking--who starts dabbling in what is a virtual winery, then goes full time and eventually needs a sense of place for his winery.

"We will lend to either, but I prefer the project built by an insider. They may not have wealth, but they have industry knowledge."

Sullivan says that announcements of new custom crush facilities have partly been fueled by the difficulty of creating new processing facilities including the requirements for water and especially wastewater disposal. "Using a custom crusher is less expensive up to a certain size, then it helps to have your own facility."

Wells Fargo's Sullivan observes that rates are very good. They're typically based on the 10-year Treasury index plus a spread, and the index is about 2.5 right now, a historic low. Even though spreads are expanding, rates are very favorable.

Community banks serve local wineries

Dennis Pedisich, president of Napa Community Bank, says, "If a company wants to borrow, it needs continuing profitability, good cash flow and strong collateral." He adds, "There's not much new activity now. Most wineries seem to be hunkering down to weather the storm." He adds, "Most people aren't trying to increase production. They should be concentrating on sales and marketing."

"We still are lending," says senior relationship manager Jason Hinde of Mechanics Bank in St. Helena. "But anyone looking has higher hurdles than in the past."

He says his bank, like most, is focused much more on liquidity and net worth of the borrower, on cash flow and collateral. How does he know he can sell his wine in this environment? There's a lot of uncertainty. How else can they pay back the loan?"

He could not overemphasize the need for good liquidity, since no one is sure how long the downturn will last. "There's a huge potential for trade wars." He also feels inflation will be returning. "It's even more important now to be well capitalized. If you're thinking of getting into the industry, make sure you've very well capitalized."

Hinde says that Mechanics Bank is very strong and well capitalized. "We want to take care of the clients we have, but we're happy to talk to potential new customers. We're pretty busy right now."

Senior vice president Adam Beak of Bank of the West says his bank has money available, but the transactions being done are appropriately and conservatively structured, and the loan margins are higher. "We like to see a strong history and multiple sources of repayment."

Farm credit has money

One unique source of cash for wineries is farm credit, which lends only to agricultural enterprises. Lindsay Wurlitzer, senior vice president of American AgCredit, says his organization continues to have money available, though he admits that finding a long-term, fixed-rate loan can be difficult, and expensive. "Loans for expansion and infrastructure are made to those people with strong credit--and they need a strong balance sheet and good cash flow, too."

He finds few wineries looking to expand now, however. "We talk to the makers of tanks, architects, contractors. There's not a lot of activity. Financing is not the problem. Business for higher-priced wineries is slow."

Yet the industry has still been generally showing positive growth rates, and wine remains stronger than many industries.

Help from the government

Another source of money has recently become more attractive to small wineries. In the past, Small Business Administration loans had relatively high fees, but the Obama administration has reduced them significantly to spur businesses. Custom crush facility Bin to Bottle, for example, arranged an SBA loan with Napa Community Bank to build its new barrel storage building.

"SBA loans recently became more attractive," says Dennis Pedisich president of the bank. His chief credit officer, Douglas Haigh, notes that two SBA programs are of most interest to small wineries. One is the 7A program, a bank loan guaranteed by the SBA.

The 504 program is inciting even more interest. It allows borrowers to secure a loan with only 10% down instead of the typical 30%. Loans consist of a 50% secured first mortgage from a bank, with a 40% second loan from the SBA.

Bob Thompson of the Bay Area Development Corp. says his company has done a fair amount of winery lending, perhaps 10 to 15 wineries. He says the SBA rate is quite attractive now at 5.26% for 20 years.

He adds that historically, the fees were high--2.5% plus $2,000 . The SBA has dropped its fees to 0.65%, however. He believes these rates will probably apply until the end of the year.

Napa Community's Haigh says that this size loan is a sweet spot for his bank. The second loan can be up to $2 million. The loans are designed to create jobs in the community, and Haigh notes, "Not much is going on right now."

An alternative source

In addition to traditional sources of capital such as banks, the SBA and farm credit, other money is available--if at a higher price. One is the mezzanine financing offered by Bacchus Capital Management, an investment firm focused on mezzanine and private equity investments in the wine industry. Sam Bronfman, a legend in the fine wine business from his roles in Seagram, Diageo and other companies, is its managing partner. He says, "Bacchus Capital meets needs that can't be met by conventional banks."

Bronfman says that even before the current credit crisis, banks couldn't meet every demand. "Many people turned to equity investors, but that's expensive in the long run. Equity is more expensive than our mezzanine debt, as you take on a partner. Our debt is expensive, but less expensive than equity. Our goal is not to take over your winery."

He points out that his firm is also well connected in wine distribution and marketing, too. "We can give advice as well as money. We're happy to open doors and get priority in distribution.

"If a winery is interested in financing new construction, it's likely to be doing well," Bronfman says. "Those are the clients we want." He also offers money for acquisition or to add new brands. "That's part of what we do. Financing new construction with growth capital is the sweet spot for us." He does look for some size and positive cash flow, and can be flexible about the terms.

The firm typically looks for current payment on interest plus a payment in kind balloon at the end of the term as a success fee. However, it wants cash, not the warrant for equity often expected. "We don't want to be minority partners in someone else's business," he says.

Bacchus typically provides $3 to $15 million, and can arrange more with a syndicate. It's not interested in financing start-ups, just currently successful and growing brands.

Equipment financing sources

Robert Hower of Vintage Capital says one result of the financial meltdown is that many of the traditional sources for winery equipment financing have dried up.

Vintage Capital and Alta Alliance Bank have partnered to offer such equipment financing to wineries. Alta Alliance's Michael Sarscad claims more than $100 million in equipment leasing is entering the market to lend money for buying barrels, presses, tanks and other winery equipment.

Robert Hower of Vintage says the firm recently signed a deal to finance the furnishings, fixtures and equipment of a tasting room for Ken Wilson's Mazzocco Winery in Sonoma County. Hower says his company had earlier helped Wilson finance his acquisitions of wineries, but the equipment financing is new. Alta Alliance is part of Western Alliance Bancorporation; its equipment financing arm is Western Alliance Equipment Finance.

Jerry Guffey of Mission Capital, Santa Rosa, Calif., says that his company has money available. "The banks may be a bit cranky, but we have plenty available for financing equipment." Unfortunately, not many people are looking for funds for vineyard and winery equipment at present, but Guffey says he's seeing a lot of queries from wineries about financing solar energy installations.

Though expansion is the last concern of many wineries in today's economic climate, others may want to take advantage of the slowdown to build and expand. Architects and contractors have the time to help, and suppliers say rates and costs could be at the lowest level for years.

In addition, capital rates are very low--if you can qualify. Banks say they have money available for good projects--but only for wineries with a proven track record, good cash flow, a strong balance sheet-- and often, alternative sources of repayment.

Nine lending questions for a banker

Steve Herron, senior vice president of Exchange Bank, had particularly cogent remarks about the state of winery lending. Exchange Bank is based in Santa Rosa, Calif., and is Sonoma County's oldest and largest community bank. It counts 19 branches in Sonoma County and two in Placer County.

Wines & Vines: Is money available?

Steve Herron: Many if not most banks are still interested in extending new credit to borrowers in many industries, but the underwriting criteria and due diligence now required for businesses to qualify for a loan have appropriately tightened.

W&V: Are financing sources shrinking?

Herron: We are already seeing several banks exit the wine business, but it is fair to say that most, if not all, have tightened their underwriting criteria, particularly for new relationships. Many wine industry lenders are working with existing clients who are challenged by the current economic issues referenced previously.

W&V: Who will be able to find money?

Herron: Established brands that have either designed or altered their business models to adjust to the more recent pressures in on-premise distribution and still manage to generate a profit will find banks, albeit fewer, that will provide the necessary lending capital.

W&V: How about private sources of capital?

Herron: Private money for any wine or vineyard asset is very difficult to obtain at any price. The key is whether the loan cash flows or not. Wineries that cash flow positive under current sales trends will be fine. But many are cash-flow challenged at the moment, and some may not survive this recession.

W&V: What wineries are most affected by the slowdown?

Herron: We are finding that some younger wine brand entrants to this industry over the last several years, and who were in full expansion mode, were not well prepared to weather a sustained slowdown in sales and pressures on price/margins. Many of those are unfortunately far too heavily reliant on bank debt.

W&V: Should wineries be expanding now?

Herron: Understanding the capital needed to operate a wine business, and eventually to own the fixed assets of a winery or vineyard, most small, young winery brands should focus their capital on cost-effective consumer marketing and defer or phase fixed asset purchases or significant investment.

W&V: Are there any new opportunities?

Herron: Ultimately, the situation will create new opportunities for new wine brand entrants who waited on the sidelines before expanding and now find that their capital will go much farther than in recent years past, in terms of purchasing power for distressed operators and motivated sellers.

W&V: How about acquisition?

Herron: The boom in new winery assets (vineyards and winery buildings) for smaller, less-capitalized operators will likely create opportunities to buy distressed assets from new investors (and banks). We see the outlook for wine and vineyard real estate to follow in some correlation with the trend of other forms of real estate assets in the United States: flat to declining for the next several years.

W&V: Any advice to prospective vintners?

Herron: The stock market fluctuations have negatively impacted enough wealthy wine business owners, and they are now reluctant to invest in new brands at the higher price-points. From this perspective, the boutique, high-end artisan winemaker or salesperson who dreamed of starting his own brand may need to be patient and wait out this economic storm until the sales trends turn favorable, grape prices decline and investor capital is once again available to support expansion.

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