Recently, a winemaker friend approached me with a “private placement” offer. He had decided that the time had come to increase the size of both his tasting room and his production. He wanted to do this without adding new debt. His offer – stock in exchange for investment money – was tempting and made me consider the alternatives that wineries have to raise new funds.
There are a number of reasons wineries want to raise additional money. My friend had several of the most common reasons. Other vintners are ready to take money out of the company for retirement or to build new lines of production. This post discusses a few alternatives commonly used. Of course, blogs are very general in nature and the terms and conditions of any of the methods below vary based on a winemaker’s particular situation.
The old fashioned way - borrowing from the Bank
Part of the money that my winemaker friend wanted to raise was intended to pay back some of the outstanding bank financing he incurred when starting his company. Bank financing is usually the first way entrepreneurs obtain financing. Some wineries start with a secured line of credit, granting the lender certain rights to receivables and inventory in exchange for a maximum amount of money that can be drawn upon.
The rates wineries pay for lines of credit usually are based on adding a percentage to the Prime rate. The Prime rate may differ by bank, but it is usually based on the bank's cost of money, not a true market. The percentage above Prime to be paid, if any, depends on creditworthiness of the winery.
In the last few years, lines of credit have become increasingly scrutinized as banks have gone through some difficult times. Additionally, banks are increasing their focus on monitoring receivables and inventory to insure that the amount of debt amassed each month matches what the business can bear. The larger the company, the more a bank will look at cash flow.
Most bank credit lines have no prepayment penalties. If borrowers hit harder times, these bank agreements are relatively flexible, due to the short-term nature of the debt.
Larger wineries and private placements
It is easier for a larger wine companies to obtain longer term financing called private placements of loans. Private placements are debt placements with institutions like insurance companies and pension funds, and are typically for a term of from 3 up to 30 years. Private placements are exempt from registration with the SEC and do not require any public disclosure or public filing of financial statements.
Interest rates for private placements are often tied to U.S. treasury rates, with a premium. A winery's premium depends on its credit strength. Prices may be based on ratings of groups like the National Association of Insurance Commissioners (NAIC).
Most private placements are senior notes – that is, credit that gets the lender a leg up on other creditors if all goes badly. Senior notes get a priority over the wine company's other outstanding debt.
Bonds issued for large companies – High yield bonds
High yield bonds are reserved for companies that need over $150 million in loans. High yield debt ranks, in seniority, below the banks and the senior note holders, but above stockholders.
One reason that these bonds are only used for large loans is that these bonds are registered securities that require the submission of a prospectus to the SEC and carry reporting obligations to the SEC.
High yield bonds are rated by rating agencies. The bonds often cannot be called (re-paid) in the first few years. The typical investors are primarily insurance companies, mutual funds and money managers.
For smaller companies, “mezzanine debt” fits between senior debt and equity. It ranks as less secure than senior debt, but over the rights of a shareholder. The maturity level is usually a little shorter than senior debt.
Private equity – making friends your co-owners
Private equity refers to selling shares of stock in a company to private investors. This is used largely when a company has limited ability to get bank loans or will pay a high interest rate for those loans. This process has the advantage of bringing in funds, without having to pay interest. The principal disadvantage is that you lose some control of the company, and, if the number of stock issued or number of investors reach a target number, you must follow review procedures of the Securities and Exchange Commission.
My winemaker friend is proposing this, so we will devote a later blog to what he (and I) need to consider.