As with most business transactions, supply and demand dictate the outcome. The same is true when buying or selling wineries and/or vineyards. With 2023 on its way, it is always good to take a step back, look at your business, and plan for the future. This article will help that process by looking at traditional buyers, reviewing pandemic transaction interruptions, inflationary impacts on mergers and acquisitions, and how to differentiate your business.
There are five typical winery/vineyard purchasers. The first is a generational transfer – the founder passing the property or business down to children.
Many owners start and grow a business hoping to pass it to their children – wineries are no different. Second, investment firms, such as venture capital or private equity firms, explore worthy targets to purchase – usually to streamline processes and sell again in 5–7 years. Foreign buyers seeking a foothold in the American market comprise the third group. Larger alcoholic beverage companies (i.e., Gallo, Diageo, Constellation, etc.) aiming to scale and expand their portfolio by purchasing assets is the fourth group. Last is the lifestyle purchaser enamored with the wine business and our beautiful area.
Many of these buyers hit the pause button in March 2020. However, just as many quickly moved forward with deals in the pipeline or already in progress. Investment firms had money set aside and a mandate to acquire more assets, and these firms kept the market active with several acquisitions. Lifestyle purchasers also saw the opportunity to move away from urban centers and purchase a vineyard with a residence. With low-interest rates, borrowing money was inexpensive and viable to finance an acquisition. The combination of these factors made for a strong seller’s market.
Over 2022, we saw interest rates increase with the fear of inflation. Debt financing (borrowing money to fund a purchase) became much more expensive. The availability of capital/cash affected the supply and demand. A seller’s market moved back to a buyer’s market. The ability to borrow money and the expense involved means buyers value property and assets differently. What one million dollars could buy at the beginning of 2022 was much less at the end of the year. Sellers that once thought their assets were worth a certain dollar amount were disappointed when offers were much less.
Most buyers look for a return on their investment. Thus, with higher interest rates and the greater expense to borrow, purchase price offers decreased in value. If debt financing is more expensive, it will likely drive prices down. As inflation fears remain, the cost of business also increases. Add other pandemic-era obstacles, such as supply chain issues, finding competent employees, and local governmental hurdles, and the return on investment shrinks, decreasing a buyer’s asking price.
Of the many potential impacts of this change on the mergers and acquisitions market, two stand out. First, buyers are demanding that a financial contingency is included in purchase and sale agreements. This allows a potential buyer to examine lending and financing possibilities, such as loan terms or investor requirements, during the due diligence period or a separate financing contingency period. If financing does not work out for the buyer, the buyer can terminate the agreement. Such contingencies were not common during the period with low interest rates and high demand for property.
The second is more complicated and involves alternative payment structures for a buyer to pay the purchase price. These structures allow the buyer to pay less cash at the closing and include various means to pay off the purchase price balance over time.
Seller financing, for example, is one common way to accomplish this. The buyer delivers a portion of the purchase price in cash, along with a promissory note for the purchase price balance. The promissory note should be secured by a deed of trust, with the seller as the beneficiary in the event of default under the promissory note.
Other possible alternatives provide for the seller to retain a certain percentage of the company (in the case of an equity rather than an asset sale), the seller keeping some of its land yet providing the buyer with the right to purchase that land at a later date, and the buyer offering a certain percentage of buyer’s company as compensation for the land (rather than cash). In this last scenario, a buyer pays a portion of the purchase price in cash and then grants equity in the buyer’s company to the seller at a value equal to the balance of the purchase price.
Another alternative is an earn out. Under this scenario, a portion of the purchase price is paid at closing, and the balance is estimated based on projected post-closing metrics – typically yields, sales goals, cost margins, and similar items. The balance of the purchase price is then paid to the seller at later dates if/when certain milestones are achieved, or the targeted metrics are realized.
This scenario can cause conflicts between a seller and buyer as the two remain wedded for this post-closing period until the purchase price is paid in full, and disagreements over the milestones and metrics may arise. Very often, accountants and financial advisors are involved in calculating the metrics. The seller may see the buyer’s conduct as detrimental to the seller’s ability to reach those milestones or obtain targeted metrics. The result is not always as initially planned.
Other effects on these transactions, which may occur in a more buyer-friendly market, are longer exclusivity periods, longer due diligence periods, purchase price adjustments, and requirements to amend or terminate existing agreements. These contingencies put pressure on sellers to have their assets, contracts, books and finances, and historical records in proper order before negotiating with a buyer.
A seller with organized documents and business operations can be better positioned. In addition, quality (of location and product) and water remain significant influences on buyers. In the last decade, having an adequate water source has risen to the top of the concerns and needs a buyer seeks. Ensuring legal, permitted, and secure water sources is a necessity for any potential seller. Quality soil, vines, and grapes certainly follow from that, as does wine club membership and a reliable margin on the cost of goods sold.
Despite these hurdles, lifestyle buyers are looking for the right location, and investment firms mandated to spend money. Thus, there remains hope for sellers.
To be successful in this process you must prepare and organize. First, assemble your team. Your attorneys, accountants, bookkeepers, bankers, financial advisors, civil engineers, managers, employees, and others should make up your team. Second, use your team to pull together documents and information on every aspect of your business, such as organization documents, financial records, and land use permit. Clearly segregate information into distinct categories. The asset is not just the land and/or business but everything attached to it – trademarks, wine club lists, existing contracts, easements, water sources, and goodwill. Finally, identify missing pieces and strive to locate, replace, or create what is missing.
Hard work on the front end will lead to a successful transition later. As trusted advisors to winery and vineyard owners, CMPR has assisted hundreds in this process. We aim to provide excellent service to our clients with a collegial, teamwork approach. Please contact Jeremy Little with any questions: jlittle@cmprlaw.com
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