Wine Businesses, Lenders, and Difficult Conversations
The COVID-19 pandemic and public health efforts to combat it will impact different wine businesses in different ways. Those that depend on 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 hard hit 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, at least for the moment. 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.
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 that borrower is able to answer the typical lender questions we describe later in this article.
The wine industry—and 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 those assets. 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, on the other hand, particularly traditional industry participants with large exposures to the wine business, are confronting a situation where many of both their borrowers (generally without fault of their own) and potential buyers of winery assets are uncertain and under financial stress, making it unproductive or even self-defeating to reflexively declare defaults and exercise remedies. With both wineries and lenders subject to the downturn and uncertainty from the pandemic, we can expect many well positioned wine businesses to be in serious workout discussions with their lenders in the near future.
Which borrowers are likely to do well in these negotiations?
First, as discussed below, we expect that some lenders will be more receptive to reasonable workout adjustments than others.
Second, those lenders that are amenable to such restructurings presumably will be focused on the same factors that they typically assess when considering the feasibility of loan modifications or waivers, including:
- 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? Do they appear to have a good grasp on the business in this changed environment? Is their reporting generally accurate and timely?
- Is the borrower realistic about its situation and about its plans for overcoming its challenges, or does it seem to be in denial? Has management stressed-tested their plans? Is the borrower thoughtful and creative about new ways of driving sales volume and reducing expenses? 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? For example, how reliant is the borrower on tasting room visits and its wine club and what are the conversion rates on to, and roll off rates from, the wine club? Or are most of the borrower’s sales ultimately through off premises retail establishments?
- How can the borrower manage and how well is it doing in managing its costs: For example, a borrower that relies heavily on grapes or juice sourced from other parties might be well positioned to take advantage of the current over supply situation. Does the borrower have a realistic staffing plan in place and is it aware of and prepared for the costs and regulatory requirements involved in executing those plans?
These are just sample considerations. Above all, what a lender wants to know before agreeing to a modification plans is whether the business is viable if the lender agrees to reasonable accommodations and whether the borrower is more likely to be a solution to the problem, rather than making it worse.
The lender’s position in the industry is also important. Lenders that have an extensive exposure to the wine industry and value their reputation for reliability (such as many of the traditional bank, insurance company, and farm credit lenders) will be most willing to work with their borrowers. On the other hand, less traditional, lenders, with relatively small exposure to the wine business (including investment funds, private equity lenders, “one-off,” and hard money lenders) may be less flexible in their approach due to their different business models and less experience with previous industry downturns.
Most lenders have a lot on their plate at the moment. We do not expect them to have systematically determined their approach to the coronavirus-altered landscape, so it is difficult to predict what to expect.
In any event, there are two things we do 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, our experience from past downturns is that time is not a borrower’s friend. The worst possible attitude is one of denial and delay until there is no realistic hope for recovery. 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 what the company’s plan is to deal with that situation. Knowing your business, objectively analyzing the current challenges, and having a realistic plan to deal with those challenges will help your lenders see you as the most important part of the solution.