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“Niche” financing and the wine industry – interview with Rob Mcmillan, senior VP in charge of Silicon Valley Bank’s Premium Wine Industry Division

“Niche” financing and the wine industry – interview with Rob Mcmillan, senior VP in charge of Silicon Valley Bank’s Premium Wine Industry Division – Interview

Rob McMillan is senior vice president in charge of Silicon Valley Bank’s Premium Wine Industry Division based in St. Helena, Calif. He has the distinction of heading the only bank office in the entire nation devoted exclusively to serving the wine industry, and the division he heads has loaned in excess of $60 million to more than 30 wineries.

Early in his career, with the Bank of America, McMillan was involved with startup financing for Kendall-Jackson. Today, as an acknowledged expert in wine industry financing, McMillan manages an office engaged exclusively in meeting the needs of vineyards and wineries. Following in question and answer form are his observations on current industry trends.

Q Does the present interest shown by banks in the wine industry indicate the banking industry is finally committing to the wine industry?

I think many lenders have remained committed for many years. If you look at the industry five years ago, though, there weren’t the number of banks compared to other industries. That has obviously corrected itself today. I think it’s too early to say if it is a permanent change. I believe some lenders will continue to maintain a long-term interest in the wine industry. Others, however, will opt out when the business cycle changes.

Q You’re referring to the business cycles of wineries?

Yes, in part. In the early ’90s, the wine industry was sitting on excess bulk wine, and demand was off relative to today. Clearly the improvement in demand at the consumer level has bolstered many wineries’ fortunes, and that has made more wineries “bankable” and attracted more debt to the industry. But equally important to note, and perhaps less visible to those in the wine industry, is the cycle in banking. Today banks have more capital to lend than in the early ’90s, primarily due to two factors: (1) California banks have collected the problem real estate loans that plagued them for the past five years, and (2) the hot I.P.O. market of the past two years has paid off bank debt and created additional liquidity on the bank’s balance sheets.

Q How long do you see the present cycle of financing availability lasting?

Just to be clear, I don’t believe it’s an all or nothing proposition. Some lenders will remain committed to the industry throughout the various cycles. However, when the supply and demand of wine supplies hit an equilibrium point, sales at the individual winery level will be impacted, distribution will become a major concern again, promotions will erode margins, and credit will get tighter for lower-margined wineries.

Q When do you see supply and demand meeting?

It probably depends upon the business model. For the super- and ultra-premium producer, it’s probably four to five years out, based on plantings net of removals in the North Coast. For the high volume, low-cost producer, supply and demand might level out in two years based on the planting expected to come on-line in the Central Valley. In truth, though, the supply shortfall is being met today to a large extent with foreign supplies.

Q Speaking of foreign supplies does the increase in sales of foreign wine worry you at all?

Not particularly. U.S. consumers always will purchase with value in mind. In the early ’80s, we saw the French able to export good quality wines at reasonable prices relative to the wines that were made in California. As the quality of California wines improved and the value of the franc strengthened relative to our currency, imports of French wines dropped.

What we see today in some cases is large producers buying foreign wine and marketing it under their labels. That moves some of the worry of a brand being established in a volume segment internally. The dollar also is in a very different position from an exchange standpoint than it was in the early ’80s. That puts us in a better position to defend against lower-cost imports. Furthermore, the quality of wine made in the U.S. is on a par with or better than wine produced in any other part of the world.

Again, when the supply of grapes catches up with demand, and prices of grapes begin to drop, the market will correct itself in the aspect of foreign bulk purchases. The other thing that should be remembered is that the entire premium segment is gaining in volume. Consequently, the market should be able to accommodate some foreign wine while still allowing U.S. production to grow. At the very high end of the ultrapremium segment, winery owners may in some cases be bumping up against an import value point. Their consumers are generally the most sophisticated and are better able to track value in foreign wine.

Q Back to an earlier line of questioning, what attracted Silicon Valley Bank to the wine industry?

Our bank has a history of lending into the start-up technology segment traditionally viewed as a very risky enterprise. We developed a methodology of lending that has proven highly successful.

In the early ’90s, we began to evolve into a “niche” bank. Wine lending, like technology lending, had been perceived as a risky segment by the banking community. We saw this as an opportunity several years ago. We applied the same business skills that helped us in technology lending to developing a methodology of lending to the premium wine industry. We had the benefit of a small base of winery clients that we had in our portfolio since the middle ’80s. We’ve been growing steadily ever since.

Q Does this methodology differ from that of other lenders?

I believe so. However, it would be presumptuous of me to say that it’s “the best.” After all, there are many fine institutions out there. When you boil it all down, we’re all just renting money. I would say it’s best to ask our clients if they view our approach as unique.

Q What type of financing do you provide?

While our focus is on providing working capital for wineries, we also provide a full range of financing options for companies that we feel have strong management and a good plan. We are not afraid to get into a deal early. In fact, our bank has a history of lending into preprofit and occasionally prerevenue companies. We have lent into a prerevenue client in the wine industry already and have had several preprofit companies that have done well.

As for size, we have sufficient capital to handle 99% of the transactions that are in the industry. I would love to make a loan to Gallo, but they probably are a little bit large for us. I would place us between the local banks and the large national banks. A $250,000 borrower would be a little small, and a $15 million borrower would be a little big.

Q Do you focus your efforts in a specific region?

No. Our target market is the premium wine industry. That extends from the Pacific Northwest to the Central Coast and beyond. Even though our offices are in St. Helena, we are used to driving or hopping on a plane to visit clients. We are not an institution that spends a lot of money on facilities. We have found electronic means of banking makes a remote relationship a convenient one.

Q What is your criteria for making loans?

That’s a trade secret that I’ve sworn not to divulge. Actually, it’s really more common sense than anything. We start with the quality of management and include the strength of the applicant’s professional service providers. We work at understanding the business plan and look to collateral just in case the plan doesn’t work as expected. We adjust along the way as needed. Traditional measures of liquidity and leverage have their place, but we aren’t afraid to work with clients showing losses if it’s part of the business plan and the plan makes sense.

Q Do you consider wine good collateral compared to collateral in other industries?

I would have to qualify my answer. Most people might be envious that of the requirements of my job is to sample the collateral. Drinking the wine makes perfect sense, because we have a common sense theory: “If you make good wine, you ought to be able to sell it. If someone will buy it, it has a value, and you should be able to make a loan against it. Conversely, if you make not-so-good wine, when the market shifts again, you might have difficulty selling it.” Consequently, I try the wines of all my clients and am a good customer as well. Compared to technology clients who at times have a 90-day product life cycle before a new release has to be out, I would say wine is much better collateral. If nothing else, it’s certainly more fun.

Q Using your crystal ball, what changes do you foresee in the industry in the next 10 years?

I expect many changes. Wine as a beverage is pretty mature in its life cycle. Wine as a consumer product, though, is going through a rebirth that puts it more in an early stage position. This is attracting capital. With that capital come the high expectations of investors and a greater emphasis on running wineries as profitable businesses with consistent returns.

I see the greatest changes in the business side versus the wine processing side during the next decade. These changes will include:

* A greater focus on functional management;

* Increased use of electronic technology in farming and the office;

* A larger number of wine makers with experience from several wineries creating more varied and consistent quality wines;

* Some limited corporate and equity money flowing in;

* Changes in the three-tiered distribution system;

* More sales directly to the consumer through technological means;

* Greater outsourcing of production;

* Greater use of standard consumer tactics of advertising, which will grow the segment;

* An even more competitive mass market side of the business.

Vineyard and winery owners will develop more strategic partnering to share the cyclical risks. Smaller wineries started in the middle ’80s are going to tee looking at transfer to heirs or outright sales. Regions just coming into their own will begin to develop their own reputations as great wine regions. Tourism and hospitality will play a larger part in many significant premium winegrowing areas, particularly in the North Coast and to a lesser extent the Central Coast of California and parts of the Pacific Northwest. see a continuing modest flow of merger and acquisition activity and an expanded opportunity for strategic partnering with winemakers offshore.

There is only so much land that can produce magnificent wine, and that land will become hard to find and plant. The vineyards that now are producing consistently great vintages will begin to assume a greater brand identity of their own. Foreign wine will gain a greater acceptance in the market place, and there will become a dilution of the varietal designations as more super- and ultrapremium wineries begin to make great blends. We will begin to slowly crack the palates of offshore consumers as we produce and market wines with their tastes in mind.

Q Do you see any threats on the horizon?

Trying to predict consumer tastes is always a trick. I would say the larger threats are: neo-prohibitionism, a strong dollar, high interest rates, prolonged recession, high land costs, wine business owners not looking at the horizon, and the development of vineyard land for other uses.

Some of those threats can be controlled somewhat through the ballot and the work of trade associations. A strong dollar will create half of the equation that hurt the industry in the early ’80s. High interest rates will hurt business investment and industry growth. Any of these would have major impact on the industry. However, I don’t view any of these as looming threats today.

The most likely threat on the horizon is that of significantly reduced prices for wine grapes. This decline will create fallout among many of the people who have leveraged themselves to buy land and plant more acreage, particularly if they have planted a varietal that ends up in excess supply.

It is important to have reasonably-priced land to compete in a world market. If the costs of land continue to be high or increase, it will allow foreign wine greater access to the U.S. market and stifle domestic growth. Wine business owners who don’t keep track of change might be managing a depreciating asset.

Overall, my feeling is that consumer demand is in a long-term growth mode. That is obviously positive for everyone.

Q Do you have any final thoughts?

There is an allure to the wine industry that is hard to describe, but it relates to the land and the vines. Watching the vines go through the changes is a reflection of life itself. In the spring, there is new birth and growth. The summer brings harvest, and the fall brings the spectacular show of crimson and yellow before dormancy. My hope is that we as a community, inclusive of the consumer and developers, will find legislative or other means to protect the rare resource that produces our world-class wines. The future is a challenge, but ought to be fun, especially if you have enough cash. And if you don’t, I know someone who might have a little extra.

(Rob McMillan is the senior vice president in charge of Silicon Valley Bank’s Premium Wine Industry Division. He has been in the banking industry for 15 years and started in winery finance in the early ’80s. He holds a degree in finance and economics and an MBA from Santa Clara University. McMillan can be reached in the Napa Valley at (707) 967-4825.)

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