There is an old joke that goes, “How do you make a small fortune?” The punch line is, “You take a large fortune and invest it in ______" —racehorses, sailboats, a football team--whichever expensive hobby is the butt of the joke. These days, I hear this joke told a lot in the wine sector, by both landowners with centuries-long ties to their vineyards and industrialists from Italy and farther away who buy a winery for the pleasure of owning it, visiting it occasionally and showing it off to friends. The joke is told tongue-in-cheek—a way to underscore the teller’s lucky situation.
Even though most of these owners do not live off the income from the wine business, none of them wants to lose money. “Cover expenses” is the goal I hear most often, expressed in a tone that suggests that the goal is both modest and easy to achieve.
So why do investors so often fail to meet their goals? To answer that question, I started by taking a look at T-minus-10, the time right before the purchase, and at what similarities exist among winery investments that ultimately disappoint. Here are the five things these transactions had in common.
1. The idea for the investment came from a friend. This is noteworthy; you would think that a few-million-dollar investment would be the kind of plan that emerges over time--logically, organically, a result of a life-long passion for wine or for Italy or for the land. Yet, often, the catalyst for the investment is a friend’s suggestion. “I bought a winery, and I’m running low on cash. Want to buy in for €10 million?” Or: “We bought a winery, it’s hugely profitable and a great way of life, but we’re bored of it so why don’t you buy us out?” Or (this one from the investor’s Italian friend): “There’s a winery for sale here. Great investment opportunity. Come have a look.”
Wineries can be great investments; even in today’s highly competitive wine market, there are real opportunities to make and sell wine at a profit, or to just enjoy owning a wine estate without having to shovel cash into it year after year. I would absolutely encourage wine lovers, Italy-lovers, Tuscany-lovers, country-living lovers or agricultural entrepreneurs to evaluate investing in Tuscan wineries.
At the same time, think twice about your motives. Take some time to understand your interest in wine estates. Clarify what you want out of the investment in terms of returns. Be honest about what you are willing to give to the project in terms of management time and how often you can physically be there. What are you are counting on in terms of side benefits, such as the possibility of vacationing at the estate, hosting friends, participating in wine world events? The very first step toward any investment is clarifying expectations--without it, most projects are doomed.
2. The investors didn't comparison shop. Rarely, if ever, have I seen a potential investor to whom a winery is proposed take the time to evaluate a handful of similar properties. For some reason, the conviction that investing in a winery is a great idea and the conviction that the first winery proposed is the BEST winery to buy seem inextricably linked.
In other business sectors, multi-million-Euro investments would be subject to all kinds of analyses, the first of which is likely to be, what else can we acquire for the same amount of money? There’s a saying in Tuscany, “Everything’s for sale:” Italians taking a dig at their own willingness to part with almost anything at the right price. In truth, partly because of the real estate taxes imposed by the Monti government a decade ago, partly as a result of the 2008 economic downturn and because younger generations do not always want to take over agricultural businesses from their aging parents, there are many properties for sale in Tuscany. Potential investors can quickly get down the learning curve by looking at even a handful of them.
3. The investors didn't know what they didn't know. Potential winery investors are the first ones to admit they “know nothing about running a winery.” They explain that they have made fortunes in other sectors of the economy, industrial sectors often. They own up to total ignorance when it comes to viticulture or winemaking. But behind these confessions are some arrogance and some ignorance, in the form of the assumption that the skills and experience of successful industrial managers overlap with what makes a successful winery manager. Now, this is partly true. Good business acumen and experience in effectively managing production, sales, administration, etc. are transferable to the wine sector without a doubt. But industrial production does not depend on the weather, nor is it constrained for years by the decisions made during one crucial month.
An estate with a north-facing vineyard will have some late-ripening grapes. Is that a plus or a minus vis-à-vis an estate with all south-facing vineyards? How will that affect production processes, wine quality, pricing, marketing and the future value of the estate?
As with any sector, wine businesses have their peculiarities. These should be identified and understood by potential investors, and each estate should be evaluated in terms of whether these peculiarities contribute to minimizing or exaggerating the normal constraints of the sector and how they compare to the particularities of alternative estates.
4. The investors overlooked the personnel question. It is nice when investors have the fate of the winery’s current employees on their lips. But what would really help the current employees (who are surely in a precarious situation, given that wineries for sale are often struggling) would be the arrival of an investor who can make the company profitable.
Employment laws in Italy give employees generous benefits and privileges, and most standard contracts are without a term—a guaranteed job for life. The moment of acquisition is a unique opportunity to evaluate the organizational structure, try to assess employee potential, sign on the top people and get rid of dead weight. Yet, I recently witnessed an acquisition take place over the course of almost a year without anyone questioning whether the huge amount of work that went into taking over all the employees’ contracts on the exact terms of the old ones made any sense, financially, or otherwise. It was not questioned! The team handling the transaction was so focused on pushing the deal through and the owner-to-be so terrified of upsetting anyone that he avoided even an exploration of options.
Personnel is the largest fixed cost for most wine estates, and it is difficult or impossible to reduce it in a short amount of time. Whom to keep and on what terms are essential decisions and deserve careful attention on the part of any potential investor.
5. The investors neglected due diligence. Or worse, they carry out due diligence processes that are set up to conceal problems. Why? In the worst case, the seller provides the due diligence, along the lines of “Who needs lawyers? We’re friends. I’ll just tell you everything.” Or the seller suggests a professional who can carry out the due diligence in exchange for a success fee—a blatant yet often overlooked conflict-of-interest. What sounds better but can actually be worse is that, because she assumes the locals are untrustworthy, the buyer brings a team of her own from Milan, Zurich, London or wherever she lives to carry out the due diligence. This team (also motivated to complete the deal and obtain their success fee) is unfamiliar with most or all of the assets it is evaluating, and with their context. This is worse, because the due diligence is unlikely to provide a realistic assessment, yet the potential investor thoroughly trusts it can. At least with a local team, she may be distrusting and question their conclusions. [Click on the photo to download my Winery Due Diligence Checklist.]
So there you have them, the five mistakes I have most often seen winery investors make. To learn more about how to make a successful wine-sector investment, download my “7-Steps to Value: How to Perform Effective Due Diligence on Wine Estates.”