NorthBay biz asks three wine law experts about the top issues facing the industry today: online purchasing, succession planning and mergers and acquisitions.
The advisory ended with a stern admonition that must have left a very bad taste on the palates of many Wine Country businesspeople: “In evaluating any proposal involving third-party service providers, licensees should consider the entirety of the program and the respective roles of the various participants. Violation of the statutory provisions may subject a licensee to discipline, even if all prohibited activities are conducted by the third-party service provider.”
“These types of notices are an indication that ABC is preparing to take enforcement action. The issue is, what can be done now to avert those kinds of actions in the future?” says Michael Mann, a consultant with the Santa Rosa- and Napa-based Dickenson, Peatman & Fogarty (DPF) who has more than 20 years of experience in alcohol-related regulatory issues in California. Previously with the state ABC, Mann was an enforcer of sorts; a former badge-wearing field investigator who wasn’t likely to kick down the door of your tasting room but could put you in hot water with the state if your licenses were a few clauses short of compliance.
As a district administrator for ABC, Mann often served as the conduit between the law firms representing the wine industry and the department. Now he’s switched sides, consulting with counsel at DPF in the interpretation of the statutes and helping navigate the new and ever-evolving legal issues.
Bringing buyers and sellers together online
From ABC’s perspective, licensees may only sell to consumers wine they actually own at the time the orders are received; otherwise, they’re engaging in consignment sales they’re not licensed to conduct. Sound cumbersome? Remember, those are the companies that actually have licenses and are trying to comply with the law. The biggest part of the June ABC advisory was directed toward unlicensed companies that are bringing wineries and consumers together in the unbuffered climes of cyberspace.
“Obviously, there’s a fee that these unlicensed providers get, usually from the seller, and that’s where ABC is stepping in,” Mann says. “From its point of view, these providers and their websites are providing all the functions of a licensee but without the regulation or the oversight.”
It would be a mistake to paint all these third-party providers with the same broad brush of impropriety, he stresses. “For the most part, these are legitimate businesses marketing wine. They’re very well-run companies, and they’re not trying to hide their processes.”
Right now, Mann explains, they’re conducting business in a gray zone that has no specific statutory requirements; if ABC pushes through a legislative remedy, it would most likely grandfather their business, with the proper licensing, into the new regulatory structure. “My sense is they’re as eager for relief as companies that already have licenses and are utilizing their services,” he says.
Brave new world
A decade ago, ABC attempted to create an Internet license for sales and marketing of wine online, but the initiative couldn’t gain traction or political sympathy…and then the Internet exploded. The resulting big bang created a brave new world of unfettered commerce the department was wholly unprepared to manage or regulate.
One of the biggest concerns is that licensed companies could be put in jeopardy by using unlicensed providers to market their products. “In essence, they’re brokering,” Mann points out. “There’s a wine broker’s license you can acquire, but you can only broker between specific licensees, not directly to the consumer as many of the unlicensed third-party providers are doing on the Internet.”
Mann believes a legislative remedy is inevitable. “ABC is taking the line that these providers are outside of statute and should have a license. At the same time, ABC is smart enough to realize it can’t stop Internet sales to the consumer—that engine has left the station—the only way to do that is to create an Internet license that would minimize the liability of existing licensees and provide a legal platform to providers who are already selling online.”
The million-dollar question
“Of course the million-dollar question is: If you create a statute like that, who’s going to oppose it? Those already licensed to market wines direct to the consumer could step up and say it’s going to impede their business. On the other hand, for those unlicensed service providers, ABC has no administrative authority over them precisely because they don’t have a license. That’s why the focus is on the existing licensees using these services. ABC could try to take on these providers criminally, but that would be a huge undertaking. Every district attorney’s office in the counties where these providers are operating would have to agree there are grounds for a misdemeanor filing—and be willing to file it if ABC went the criminal route.”
Mann’s gut tells him that eventually, this kind of legislation will succeed. “Everybody’s on board with pursuing a license-type arrangement or amending an existing statute to cover the issue: vintners associations, industry trade groups, lobbyists in the assembly and ABC itself. They’re all willing to come to the table. It’s not going to happen tomorrow. It’ll take six months just for all the parties to meet and outline the possible legislative remedies. I’d anticipate, if this takes off, it could become an ‘urgency’ bill in mid-2010, which would let it take effect immediately…but ‘immediately’ is relative. Everyone has to agree, hearings have to be held, the opposition has to be heard. All those factors make it hard to nail down.”
Not surprisingly, the pace of mergers and acquisitions in the wine industry has slowed considerably. It’s not that the industry is suffering more than any other, but sales have softened and dealmakers are having a difficult time finding financing. As wineries continue to struggle with the soft economy, it creates more challenges for sellers and, at the same time, greater risks from an acquirer’s perspective.
“There are certain issues that have to be carefully considered before taking part in any merger or acquisition activity today,” says Wyman Smith, an attorney with Napa’s Gaw Van Male (GVM). “First, sellers must realize valuations are lower, so the price of your winery is going to be less than what it would have been two years ago. Also, we’ve seen cases recently in which transactions fell apart due to financial issues.” The cancellation of the sale of Chateau Montelena is a prime example. In July 2008, the owners of the esteemed Calistoga winery, whose Chardonnay beat out its French counterparts in a celebrated comparative tasting in Paris in 1976 [See “A Matter of Taste,” Special Wine Issue 2007], announced they had sold the operation to the Bordeaux wine estate of Chateau Cos d’Estournel. In November of the same year, Montelena pulled the plug on the deal, saying the buyer had been “unable to meet its obligations under its contract,” according to “The Pour” blog in the New York Times.
Smith doesn’t mind getting his hands dirty; he grows grapes himself on 12 acres of hillside Cabernet Sauvignon on Mt. Veeder and serves on the Napa Valley Grapegrowers issues committee. “This is an agricultural industry and not, with obvious exceptions, a corporate world,” he insists. “Wineries expect practical solutions to their legal issues and sensitivity to the relationships between growers, producers and farming traditions.”
Founded in the early 1970s, GVM is divided into three principal practice areas—business and real estate; estate planning, trust administration and probate; and litigation—but one of the largest interdisciplinary groups focuses on the wine industry. Smith heads the GVM business and real estate group and is a member of the firm’s wine law group. GVM experts tackle issues specific to the industry, such as land use and entitlement, trademarks and brand protection, employment, and agricultural contracts such as grape purchase agreements and vineyard leases, while simultaneously counseling clients on corporate matters that pertain to business in general and succession planning.
Buyers hungry for strong brands
“It’s not the best time to be thinking about selling immediately,” Smith says. Another risk mergers and acquisitions present stems from buyers not having the wherewithal to actually complete the transaction due to the unavailability of credit. “It’s very important for the seller to be cautious about qualifying anyone who approaches them, so they don’t start down the sale path only to discover later that their buyer lacks the financing. That’s been happening with some regularity over the last two years, which puts sellers in a compromising situation: Their employees find out, their customers find out and, if the deal falls through, they’re suddenly faced with all kinds of problems.
“For those desperate to sell, the current economy is obviously going to adversely affect the value of their company. That’s not a good place to be. If your only exit strategy is a merger-acquisition-type transaction, you’re likely to find it difficult to realize your valuation expectations.” On the other hand, buyers who are bulletproof to the economic slump are hungry for strong brands and attractive estates. But even buyers flush with cash had better beware, according to Smith.
“From the buyer’s perspective, there are greater risks now not only because of the economy but also because any seller that’s in a distressed situation creates potential creditor problems that the buyer may have to deal with,” he cautions. “That’s one of the biggest differences between mergers and acquisitions now and transactions we saw two years ago. For example, if you’re dealing with a seller that’s not in good standing with the bank or is struggling to keep up with its loan, the bank could become involved in the transaction as a third party. That could kill the deal from the buyer’s point of view—and if you’re the seller in that kind of situation, you could be pressured to do a deal with somebody who isn’t your first choice just to satisfy the loan.”
Get the pros involved early
In a perfect world, Smith and his colleagues are engaged by clients motivated to buy or sell before a deal is on the table. “We like to be involved as early as possible, to do our own due diligence, to help clients so they’re in a position to realize the greatest value whether they’re buying or selling. Cleaning up relatively simple legal matters can have a huge impact on the price a buyer will pay—and a buyer’s willingness to enter into the transaction at all. That opportunity isn’t always presented. It’s often the next stage, when someone has shown up on their doorstep and made them an offer, that they finally consult their lawyer. But it’s important to get the professionals involved early, so we can identify problems before they become major issues.
“From the seller’s perspective, one of the biggest considerations is making sure the proper nondisclosure agreement (NDA) is in place to protect the confidentiality of the seller’s information, such as its customer list and other proprietary data. We also want to protect its key employees by prohibiting the buyer from soliciting them. In some cases, if a prospective buyer knows it can’t pull off a deal, it can recruit some of the best employees of the seller to capture some value that way. We can make sure that doesn’t happen.”
Legal issues can rear their ugly heads even after all the parties have agreed in principle and letters of intent are on the table waiting to be signed. “At that stage, generally the deal is laid out—even though it’s couched in non-binding language. Because of its legal implications, a letter of intent can be a trap for the unwary if it’s not consistent with the final objectives and agreement. Moreover, it’s the first material step in putting the deal together; clients who fail to take that document seriously and who don’t completely understand its legal implications often sign it with the assumption that it can be changed during the deal process. What often happens then is, in working through the dynamics of a deal, a seller realizes it committed to something that’s not in its best interest and wants to renegotiate the letter of intent or ignore certain provisions. The buyer may look at your decision and think you’re trying to renege on the transaction. When that occurs, it disrupts the momentum of the process and makes it more difficult to get the deal done.”
An opportune time to get started
Many people confuse the terms “merger” and “acquisition,” assuming they’re synonymous, but Smith hastens to point out that’s not the case. A merger is a corporate and tax concept that involves one company succeeding to only all the assets of another but also its liabilities (known and unknown), making it a much more risky venture. In certain acquisitions, on the other hand, a buyer has the option to select the liabilities it wants to assume and refuse those it doesn’t, ensuring there won’t be any surprises for the buyer on the balance sheet. “It can be an asset-based transaction,” Smith says. “A buyer will purchase another’s inventory, its brand, its equipment and so on—but not the entity that holds those assets, which also has related liabilities.”
Despite the economic downturn and the fact that most wineries and vineyard owners are aggressively trying to cut their expenses, now is still an opportune time to think about starting the process if you’re inclined to buy or sell to make sure you’re positioned well when the market does turn around. Also, if a seller is considering a transfer to family members as opposed to a third party, this is an excellent time to explore this option, due to today’s low valuations.
“You don’t have to jump in with both feet,” Smith says, “but if you can start talking about it now, you can put yourself in a better position in two years when the economy begins to grow again. A lot of clients focus on the deal itself. But there are other steps to help further their financial objectives that can be done now, such as ridding yourself of inventory that’s not moving, that aren’t just legal issues but can improve your business operations and produce a greater valuation for your winery.”
In the tight-knit, closely-held community of the California wine industry, few issues are more emotionally tinged or potentially volatile than succession planning. Any family-owned business has to deal with questions of continuity and disposal of assets when the patriarch or matriarch passes away—and, when children are involved, whether they’re active participants in the daily operations of the company or not, the pressure on the parents to make fair, equitable decisions can be extraordinary.
“Succession planning isn’t just a business decision. There’s an emotional side to it as well,” says Mark Gladden, a partner in Passalacqua, Mazzoni, Gladden, Lopez & Maraviglia (PMG), based in Healdsburg. “The question is: What do the parents really want to do? Do they want all the kids to have an equal share? Do they want one kid to have control of the business? Do they want one to have 51 percent and the others to split the rest? We try to tailor a program to whatever the parents desire and to help them make decisions that are in the best interests of their family and the business in the long term.”
Founded in 1936, PMG has built a tradition of providing expertise in estate planning, real estate, business law, trusts and probate, litigation and family law, as well as a full range of services for the wine industry. A roster of the firm’s clients is filled with long-term customers, including children—and even grandchildren—of those served by PMG’s founders. “Our clientele comes from a wide range of businesses, but many of our core clients have been wineries and vineyard owners,” Gladden says. “All the original partners are from families who are or have been in the wine business. Both the Passalacquas and the Mazzonis have wineries and ran vineyards.”
The baby boom exodus
Gladden, who was born in Marin County and moved to Sonoma County with his family when he was 7 years old, has noticed a subtle shift in the dynamics of succession planning. “In the last 50 years, the baby boomers have gone to college and followed their interests elsewhere, often moving away from the family winery to become engineers, marketing professionals or financiers. In the past, most of those children would have stayed and worked in the family business. Even if they went away to school, they’d study ag business, viticulture or oenology and eventually come back. That’s not necessarily the case any longer.”
And that’s where things get complicated, requiring tact, legal chops and creativity from the attorneys who specialize in this area. “Let’s say a family has three kids,” Gladden says. “Jack stays on the farm, Bill develops his own business and Jill gets married and becomes a stay-at-home mom, a doctor or a real estate agent. Now you have three different children with three different interests. For the sake of argument, let’s say Jack brings his energy and business acumen to the winery and—primarily through his efforts—converts it from a jug wine operation to a premium wine producer with one or two highly valued varietals. The value of the winery is increased and, in some cases, the family might not even have the winery if it hadn’t been for Jack’s efforts in the business, but the parents want to be fair to Bill and Jill.
“Some of the main factors to be considered are the value of the assets, control over those assets and fair compensation. One option for the parents would be to recognize Jack’s efforts and desire to stay in the business and take ownership of it. So they might give the winery to Jack and then split up other assets, so everything is distributed as equally as possible on the basis of value while retaining the integrity of the business. This would recognize the business’s built-up value due to Jack’s efforts and give him control of the business going forward, and it would also provide the other children with assets and income generated from—but not necessarily based on—the business’s income. However, this option isn’t always the best fit for a family.
“There are cases in which the other kids are interested in being involved in the ownership and operation of the winery, even though they’ve shown no interest in it previously, and where the parents want all of the children to share what they consider the ‘family business.’ The challenge is to meet the parents’ desires without the children fighting over the dispensation of assets and thus undermining family unity.”
Gladden continues, “One of the issues that often clouds decision making is compensation. We’ve seen cases where a child who works in the family business is paid what he or she considers a lower compensation, with the idea that he or she is building value in the business that they’ll inherit, only to find out the increase in value is going to be shared among all siblings. At the same time, the siblings might think, since the one working in the winery receives a vehicle, fuel and, possibly, a residence in connection with the job for which they don’t pay, that they’re getting too much compensation.”
A chance to control their destiny
Aside from value control and compensation, there are other issues to consider when passing an estate from generation to generation. “If more than one child is going to be involved in the family business and there’s an issue over how that involvement is going to sort out, we try to work with the parents to assess each child’s strengths and weaknesses to allocate business assets and responsibilities,” Gladden emphasizes.
“We want everyone to feel they have control over their own destiny and, if they’re involved in the family business, that they’re making a valuable contribution and have real participation in business decisions. Depending on the circumstances, it may be advisable for parents to provide their children with assistance to get them ready to take control of the winery if they don’t yet have the experience to do so.”
Experience and education, as with most matters, are usually the key factors. “Making education available to the children to provide them with the tools to make better business decisions is always important,” says Gladden. “In addition, most transition plans are going to be best-served when parents start to delegate duties between children and provide them with access to—and involvement in—the business’s financial resources and decision making before they hand over the reins. That way, the children can become involved in the process while the parents are still around to provide guidance.
“If more than one child is going to be involved in the family business, we also help determine the type of business entity that will best address concerns over control, compensation and liability, such as whether to use a limited liability company [LLC] with designated managers or a corporation with a family board and specified officers running the day-to-day business.”
“If there’s to be co-ownership of a business or real property, there’s also the concern of what happens when a child dies: Will his or her interest get fractionalized and distributed to people who might not have the same interest and may not be compatible with the other co-owners? Another issue is, what happens if one or more of the children become disenchanted with the investment or co-ownership? If this is a business the parents want to maintain in family ownership, we also look at buy-sell agreements and the retention of assets in an irrevocable trust, which would provide centralized management and prevent a beneficiary from being able to sell it for a period of time.”
But it really comes down to the individuals involved. “Every situation is different. Developing the right plan requires an understanding of the family, its assets and what the parents want to achieve, then applying the available business and estate planning tools to achieve the best results,” Gladden says.
Planning, counseling, peacemaking
In most cases, the parents strive to do what’s best without hurting anybody’s feelings. But as Gladden points out, that’s not always possible. “It usually doesn’t happen with the child who’s been in the business before inheriting it, because he or she has been close to the parents for a long time, has an idea of what’s going to happen, understands the industry and how it operates, and knows his or her parents appreciated the contribution. It’s the children who aren’t in the business who may sometimes become upset when they find out they’re not getting an equal share—or that they’re not going to be in a position to control their destiny in the way they’d assumed. You can get hard feelings and, depending on how things are handled, it may be unavoidable.
“There are occasions where we’ll do a plan for the parents, but the children collectively will be of a different mind. They may say, ‘You know, we should all have an equal share. We understand what our parents were trying to accomplish, but this is what we’d like to see happen.’ For the most part, it ends up working out,” Gladden says. “Depending on family dynamics, we usually encourage the parents to get all the children involved in the process early on. You don’t want them to be surprised or caught off-guard by a decision.”
Gladden says he rarely has to play peacemaker; the more important role is ascertaining what his clients want, shaping a plan that meets those needs and raising legal issues they may not have considered. “It’s more of a planning function than counseling, but inter-familial counseling does play a part in it,” he concedes. “Most of the issues that arise can be dealt with by the attorney, but when a situation calls for it, we may recommend a family counselor who specializes in these types of issues. No matter how large the pot of assets is, the best situation is when everyone feels they’ve been treated fairly and that they control their own destiny.”
While these three issues are commanding the top shelf in the minds of North Bay attorneys, they’re not the only legal issues that the wine industry is contending with. From environmental regulations to organic labeling, from vineyard financing to land use permits—all have a bearing on the business of winemaking.
As Michael Mann says, “Few industries are more regulated—and change as constantly—as the wine industry. It’s just part of the territory.” His advice? Try to stay on top of what’s happening in the Sacramento legislative arena, in the court system and in the boardrooms of wine industry itself. And if all else fails? “Seek counsel experienced specifically in the wine industry.”
