Bella Carrara Vino

Winery owners who are nearing retirement and wanting to pull out of their day-to-day schedules might be asking themselves: "Is my family business ready for a transition?"

The American economy depends heavily on the continuity and success of family businesses. It is alarming that such a vital force has such a poor survival rate.

Although it's hard to predict, the California wine industry may just beat the odds. Scion Advisor's 2005 Succession Survey shows that 270 family wine businesses may make it. In addition:

• 66 percent of family wine business owners expect to transfer their legacy to the next generation.

• 31 percent of wine business owners have not actually started planning their succession.

• 33 percent are at risk of future failure or sale to another entity, despite plans for continued family ownership.

Successful wineries adopt practices that greatly decrease the risk and improve the sustainability and value of their businesses, even during transition. Although more research is needed to better understand the viability of the family wine business, the results from the 2005 study substantiate primary observations: Preparedness is at the core of family businesses that are beating the odds.

Achieving Succession in Your Family Business

The tragedy of the family business is that it frequently becomes the battleground for family disputes rather than the means by which the next generation is able to realize their dreams. David Gaw, estate attorney with Gaw Van Male, states this clearly. "The dynamics of these types of situations are extremely complex, and the team of advisors that forms around the family to help them achieve their goals has to operate with enormous sensitivity."

These dynamics, combined with the following four factors, typically contribute to family business demise: (1) the business is simply not viable, (2) there is a lack of planning or adherence to a plan, (3) the owner lacks desire or commitment to transfer the firm, and (4) the offspring are reluctant to join the firm.

On the other hand, successful families manage their businesses against written, long-term strategic and financial plans and usually have well-defined exit plans. As depicted in the table on page 64 ("Successful wine business succession practices"), these owners tend to make better use of a combination of advisors and outside board members, and express above-average satisfaction with business performance. These families also feel better prepared for family business succession.

Preparing for Succession

Three major initiatives typically coincide for successful transition: (1) a succession plan to ease first-generation business owner (G1) concerns about transferring the firm; (2) a family continuity plan to maintain a healthy, viable business by establishing a framework for family roles in the business, and (3) a strategic business plan to define a framework and roadmap for the future business.

The process is emotionally intense, complex and strewn with roadblocks. Most families facing this process are unprepared.

Consider beginning the transition process by conducting a G1 and G2 (second-generation business owner) preparedness audit (See the following two Quick Audits, next page). G1s organizing for transition should first define a clear exit strategy. Options can include: retain ownership but hire outside management; retain family ownership and management control; sell to an outsider or employee; or close the doors.

Successful G2 entry into the family business is delicate and multidimensional in nature. Business owners who opt for retaining family ownership and management control need to consider a reasonable timeline for G2 leadership and management readiness. This concept is often overlooked, resulting in utter frustration on both sides. Since many G2s have not had the opportunity to develop skills and confidence by building the business, it can be difficult for them to take risks once they are at the helm of their parents' business. Many G2s find it equally hard to become motivated by their parents' vision for the business.

Quick Audit for first-generation business owners:
What needs to exist for a strong G1 exit?
(1) Personal financial security: Are you secure in that you will have the funds to live your envisioned future?
(2) Psychological security: Do you have a feeling of positive, defined expectancy about your future and a readiness to move toward it?
(3) Business security: Do you have confidence in the business structure and competence of individuals in place?
(4) Family security: Will you still be respected by and be an influential part of your Family?

If you answered "Yes" to fewer than 2 questions, succession preparedness should become a top priority (especially if you are within 10 years of an exit). If you answered "Yes" to questions 1 and 3, you have substantially achieved preparedness, but may be stuck emotionally. If you answered "Yes" to questions 2 and 4, you are emotionally committed to designing your exit; seek outside expertise to execute questions 1 and 3.

Quick Audit for second-generation business owners:
What supports successful G2 entry?
(1) Management readiness: Are you working in an environment that nurtures and supports G2 developmental needs?
(2) Strategic vision: Is there a business model large and compelling enough for G2s who want to participate?
(3) Governance: Is there a structure that is helpful in evolving G2 communications and a decision-making style that fits them?
(4) Lifestyle: Does the company culture and structure support your needs and desires?
(5) Power of diversity: Are you in an industry and community that rewards and recognizes the benefits of empowered, successful male and female leaders?

If you answered "Yes" to fewer than 2 questions, succession preparedness should become a top priority (especially if G1s are within 10 years of an exit). If you answered "Yes" to questions 1, 2 and 3, you have substantially achieved preparedness, but may be stuck emotionally. If you answered "Yes" to questions 4 and 5, you are emotionally committed to entering; seek outside expertise to execute questions 1, 2 and 3.

How to Build a Business That Beats the Odds

Your objective is to maximize the value of your business, whether you seek to sell your winery to an outsider, your employees or your children, or remain in your business for the next 10 years. Your business worth has an impact on such things as your ability to raise growth financing and equity, your income as the owner, your success in establishing and growing important distribution relationships and, ultimately, the sale price of your business. As such, winery owners who are successful in developing businesses that carry significant value generally do a good job managing the fundamentals.

Fundamental #1: Be prepared for the unforeseen. You should run your business as if you plan to sell it within 10 years. "This philosophy focuses wineries on improving performance by applying more effective, common sense business practices," asserted Hank Salvo, Scion Advisors board member and retired Robert Mondavi Winery CFO.

Propelled by a key investor or key family member's illness or death, you may have to face unexpected financing needs or a sudden decision to sell, finding yourself in "garage sale" mode: selling at a huge discount, being unable to sell in time for bank foreclosure or being unable to realize a proper return on investment. You will find it difficult to make the necessary changes in your business to suit the needs of a viable buyer. Turnarounds in some industries can take 12 to 18 months, but due to the asset-intensive nature and market constraints, this can take three to five years in the wine industry.

And if you are committed to preparing for the unforeseen by building more business strength, Vicky Farrow, a partner with Scion Advisors, recommends observing four critical steps in transitioning your business: (1) stop and take stock, (2) define success, (3) develop a reality-based plan and (4) execute through people. "When winery owners apply these steps, we observe direct ties between their speed and ability to achieve business objectives, their thoroughness and commitment to a long-term plan, and the strength of their leadership team," said Farrow. The process is surgical in nature: You have to strike a balance between the needs of your business and your family culture and values. You need to involve internal and external stakeholders, including owners, employees, wholesale and trade relationships, and consumers. You have to objectively assess the health of your brand, pricing strategy, product portfolio, value proposition and channel strategies.

Stop and take stock. Before you determine how to maximize your business' value, it is essential to gain a realistic perspective on the current state of your business. Chris Indelicato (CEO, Delicato Family Vineyards) said, "We take this as seriously as a medical diagnostic. It should include rigorous market and customer-focused research, focus groups, as well as a thorough evaluation of your operations."

By conducting periodic assessments of both internal and external forces impacting your business' health, you learn to measure the strength of your company's operations, product and position in your marketplace, and seek to understand the essential building blocks of your business: What is the perceived style and quality of your wines, and what is the potential for product improvement, at what cost? What is the strength of your brand and its value proposition to each customer tier; and how should this change in the future? What are your points of differentiation and how can these be more effective?

Self-examination allows you to build your business from a realistic understanding of your strengths and to focus on improving weaknesses. "Business Scorecarding" below details how to take stock through Business Scorecarding processes.

Business Scorecarding

You may choose to seek help from qualified business advisors who can provide an objective perspective. Through this process, you will identify important initiatives that can enhance the value of your business. These typically emphasize financial, strategic, market and brand-focused, organizational or succession-related activities needed to improve business performance and provide a platform for sustained profitability.

Business Value Analysis: This tool assesses your appetite for risk/growth based on two axes of the business in relationship to each other: business value and brand attractiveness. Understanding your risk profile provides a framework for thinking about growth strategy. Should you consider building new competencies, refining your operations or divesting?

Gap Assessment: This tool assesses business strength by measuring how you stack up against best practices in your industry, across a number of business disciplines (all critical to the long-term health of your business). Through this objective assessment, you are able to flag specific areas of your business that need immediate attention.

Operations Benchmark: This analytical tool assesses the health of your business operations through key financial performance indicators (such as gross profits as a percentage of wine sales, cost of wine sold per case and revenues per case by channel) and compares these to similar businesses in your region. This is best done through a reputable industry CPA firm that has compiled a database of their wine business clients for this purpose. A comparison yields a snapshot of where you might be underperforming (or overperforming) within your operations as well as an interesting analysis of how a shift in your strategy could yield stronger performance.

Define success. This step involves the family. Business owners who define clear goals end up with businesses that more specifically support their personal needs. The process of scrutinizing goals is particularly important for families in transition: principally, when a new generation decides to participate in the family business. Family goals can include your explicit need to take profit out of the business to fund education, to pay down the purchase of the business from elders; or your assessed investment requirements for funding future growth in shareholder value. The wisdom behind goal setting is simple: If you aim for the tree, there is a good chance you will hit the tree. But did you really want to aim for the tree? A well-defined set of goals gives your strategic plan integrity and is the basis for evaluating performance and making decisions about the future.

For example, the new-generation business leader of a North Coast winery felt highly unmotivated and burnt out after only several years into assuming leadership of his family business. When queried by a family advisor, he learned that he was operating without a clear set of family goals and was likely running a business that did not support his future needs or interests. After many months of working with his spouse, they succeeded in clearly articulating and quantifying family goals and responsibilities to the business. These were then developed into a family continuity plan, and a Family Council was set up with the mission to hold the business accountable to many of these goals.

Develop a reality-based plan. This step involves an interactive dialogue among key family members and your leadership team. The plan you develop must be actionable and geared towards achieving your stated family and business goals. At a minimum, your plan should stress strategic goals against a timeline and address the key ingredients that are necessary to achieve these. This process ensures that family resources (assets, finances and people) are focused efficiently and effectively on achieving success. Consider answers to these essential questions: What can you leverage from your past to achieve your goals? What existing core strengths can you leverage into a competitive position in the future? How will you compete in your target market? What are your cornerstone strategies for developing the future business?

For example, the North Coast family leader in the previous example developed a strategic and financial plan to support his family goals, and within 24 months became re-invigorated, felt he was running a company that was exciting, and had the potential to successfully support his family's future dreams.

Execute through people. Before you are ready to move out with your plan, you will need to consider your enterprise's ability to support its execution and to identify important organizational gaps. Companies that under-assume leadership, organization and process/system readiness are frequently dramatically off from plan projections by years and by millions of dollars in revenues and expenses. A gap analysis conducted at three levels helps you assess the cost and timing of implementing proper delivery infrastructure: leadership talent; organization strategy and structure; and an appropriate underpinning of reporting, planning and employee development processes and systems. By characterizing enterprise readiness to execute the plan, you increase your probability of achieving your profit goals on time.

For example, the 38-year-old business leader of a second-generation Sonoma County family winery explicitly acknowledged, "It has taken me nine long years to move this business back to profitability. I am convinced we would have been smarter as a family and would have achieved this painful process in half the time had we hired an experienced, mature general manager to lead this process with us."

Fundamental #2: Optimize the use of your wine business assets. A prospective buyer or bank will take points away from your winery's value if you are poorly utilizing assets. "If you learn to see your business through the eyes of a buyer, you become more aware of the steps you need to take to improve both short-term profitability and long-term equity," said one wine business leader who almost sold his family business in 2005.

Asset turnover, which measures how effectively your assets are generating returns, is one of the main (often overlooked) contributors to return on equity. Many factors lead to decreased asset turnover: vineyards yielding less than average returns; under-utilized production capacity and expensive tasting rooms generating less than adequate sales proceeds. You can significantly enhance business worth and performance by separating out each asset on your balance sheet and honestly evaluating each based on its own merits and returns.

The key to improving asset performance is to honestly examine your assets in the context of how they support your long-term plan; when assets are under-performing or not providing an adequate return on invested capital, and are not necessary for the long-term success of the company, a "carve-out" may be necessary to keep those under-performing assets from dragging down the value of the business.

For example, when re-assessing your assets, other things should be factored in as well. Said wine business owner, Ron Lanza, "We were tired of bleeding and were evaluating whether to keep a piece of vineyard property by comparing average growth in land value to the average return on grape and wine sales over time. As painful as it was for our family, we opted for the strategic sale of non-performing land, allowing us to reduce the direct cash flow impact of debt and prioritize our investment on land yielding higher returns."

Fundamental #3: Define unambiguous family policies for family business participants. Family continuity planning is a practice adopted by many successful family businesses and culminates in specific guidelines that address family participation in the business. It involves ongoing family dialogue around issues critical to a family's future, and helps family members communicate, refine, and understand their legacy and vision of the future. This planning activity also benefits families that need to formalize how business owners and business participants work together around the business; reduces conflict on issues that become personalized and polarizing; defines how the family governs prized assets; and smoothes the progress of transitioning G1s out and G2s into the business.

For example, one large vineyard-owning family was concerned with keeping all their assets within the family. They developed a family policy requiring all spouses of future generations to sign prenuptial agreements, protecting these assets in the event of divorce. They sidestepped a potential crisis when the family's advisors also recommended they adopt this policy while their children were young. Otherwise, this new policy would quickly become polarizing if instituted suddenly when the family's first child faced marriage.

Fundamental #4: Establish effective governance practices. The time to add outside perspective to your team is now as you commit to succession. At best, the process of succession is a chaotic time, making it very hard for business insiders to focus clearly. As such, family wineries are increasingly embracing advisory boards, progressively hiring outside directors. The most successful wine families uphold long-term relationships with trusted advisors and maintain professional governance practices.

For example, a mid-sized North Coast producer with major real estate holdings was preparing for the family's third-generation succession. Their profits had been lagging on both sides of their business (grape farming and wine sales), and they realized they had a gap in family leadership. The second generation was ready to exit, and the third generation was still developing professional skills outside the family business. The board of directors voted in several new outside members and then recommended hiring a professional CEO to transform the business by executing a five-year growth plan. The board was instrumental in helping the family and the CEO achieve their stated goals, and then facilitated the successful "transitioning in" of the third generation. The board had a key role in five important aspects of this family's transition:

• Keeping the business on track by encouraging accountability in management and monitoring implementation.

• Acting as a sounding board for balanced decision-making and helping the professional CEO be fully effective by providing confidential and empathetic counsel.

• Ensuring family participants' readiness through coaching and development.

• Providing a broader perspective on compensation, performance, strategy and critical decision-making.

• Acting as an arbitrator during crises, ensuring survival during the final "transitioning-in" period of next generation family business leaders.

It Comes Down to Execution

The culture of other industries makes it easier for businesses, such as high technology, to shift focus overnight. Steeped in history, tradition and tied to highly leveraged land assets, the wine industry and its players are slow to respond to opportunity and challenge. By looking hard at their people, business, financial and market practices, some wine businesses are changing at a faster pace than before. These wineries are learning to reposition their businesses.

Whether the goal is succession, top-line revenue growth or bottom-line growth in profits, these wine businesses are devoting discipline, time and resources to executing objectives more successfully than in the past, attempting to beat the odds by building business strength. wbm