Questions Wineries Need to Answer Before Talking With Lenders About Coronavirus-Caused Financial Woes
The coronavirus pandemic and public health efforts to combat it will impact different wine businesses in different ways.
Those that depend upon on-premise and direct-to-consumer (DTC) sales — such as restaurant, hospitality, and tasting room operations — for a significant part of their revenue have undoubtedly been hit hard already, while other wine businesses are finding that channel and allocation shifting to off-premise and DTC sales to phone and email consumers are making up for some declines.
Meanwhile, virtually all suppliers that sell and ship through the three-tiered system are finding it essentially locked up, with distributors managing inventory in new ways in order to conserve cash. And this is just in the first few weeks of what is likely to be a prolonged period of uncertainty.
Facing difficult banking conversations
We cannot be certain what the ultimate financial and operational impact of the pandemic on wine companies will be and exactly how those impacts will be distributed across the industry. We can be certain that, at some point, many if not most wine operations will face the prospect of difficult conversations with their lenders.
Whether these conversations lead to a good result for a borrower depends on how well that borrower demonstrates that it knows its business, understands the current situation, and has a well-thought-out plan to come out on the other side.
The wine industry — particularly traditional wineries — are heavily invested in very expensive fixed assets and almost universally rely on term loans and lines of credit to acquire, improve, maintain and operate them. Lenders typically rely on steady asset values and predictable cash flows in the industry to service that financing. With coronavirus-linked dips in cash flow leading to loan-repayment problems, and the sudden drop in sales and operating earnings resulting in breaches of financial covenants, many wineries are facing looming loan defaults.
Lenders are confronting a situation where many of their borrowers and potential buyers of winery assets are uncertain and under financial stress, making it unproductive to reflexively declare defaults and exercise remedies. With both wineries and lenders subject to the downturn and uncertainty from the pandemic, we anticipate that many well positioned wine businesses to be in serious workout discussions with their lenders in the near future.
Lenders receptive to negotiations?
We expect that some lenders will be more receptive to reasonable workout adjustments than others. Those lenders that are amenable to such restructurings presumably will be focused on the same factors that they typically assess in determining whether a borrower is likely to succeed if given some breathing space. Here are questions lenders are likely to ask:
- What is the borrower’s performance history? Do the borrower’s operational and financial troubles predate the current situation?
- How strong is the business’s management team? Do they consistently deliver on commitments? Is their reporting reliable?
- Is the borrower realistic about its situation and about its plans for overcoming its challenges, or does it seem to be in denial?
- Is management knowledgeable regarding, and have they appropriately explored potential opportunities in, the recent government stimulus bills?
- How does the borrower ordinarily distribute their product and how open are those channels currently?
- How well is the borrower doing in managing its costs? Is the borrower free to exploit opportunities in the currently oversupplied wine grape market?
- Does the borrower have a realistic staffing plan in place and the knowledge to execute upon it?
- How exposed is the lender?
The lender’s position in the industry is also very important. Lenders that have an extensive exposure to the wine industry and value their reputation for reliability will be most willing to work with their borrowers. On the other hand, lenders with relatively small exposure to the wine business may be less flexible in their approach due to their different business models and minimal experience with previous industry downturns.
In any event, there are two things we think borrowers should be prepared for:
First, even successful workouts will not be without cost. Lenders will be looking for compensation for taking these unexpected, if unavoidable, risks, whether in the form of interest rate increases or additional fees, not to mention recovery of out of pocket expenses. If borrowers are unable to pay these costs up front, they may be able to negotiate paying them sometime before exiting the loan.
Second, time is typically not a borrower’s friend, as denial and delay will continue to erode prospects for restructuring debt. Borrowers are usually well-advised to reach out to their lenders as soon as they have some insight into their situation, and to let the lender know what to expect and the company’s plan for dealing with that situation. Knowing their business, objectively analyzing the current challenges, and having a realistic plan to deal with those challenges will help lenders see borrowers as the key to overcoming them.