Is your winery worth what you think?
Author: Bruce Plaxton
Date: August 2011
Publication: 2011 Summer Issue of Canadian Grapes to Wine
As a proprietor, you likely have a number in your mind that represents what you think your winery is worth, based on your hard work and success. It is probable though, that this number does not accurately represent the true value of your estate winery. There are many situations throughout the lifecycle of your business, whether you are launching, growing or selling, where you will need to know the answer to: What’s it worth?
If you are thinking about selling your winery or are considering an expansion and require financing, you will require a valuation to determine the actual worth of your operations. Even if you are merely curious about the value of your estate, it is good business practice to know the value of your winery today so that you can take steps to maximize future returns.
What Drives the Value of an Estate Winery?
There are four main components of value in a typical estate winery which include real estate, equipment, inventory and goodwill.
Real Estate is divided into land and improvements made to land. The value is driven by what can be done with your land now and in the future, based on best use. Improvements can include permanent plantings such as vines and upgrades or additions to winery manufacturing facilities, tasting rooms and other winery buildings. The key driving factor in determining the value of real estate though is location, location, location. Land value is as much a function of past real estate sales in your winery’s area of operation as it is cash flow that your winery has generated historically. The services of a qualified real estate appraiser with experience in the winery industry can assist in determining the value of your winery’s real estate.
Equipment is typically valued on a “value in use” basis, which is the price a buyer would pay for the winery assets while in operation rather than in liquidation. The “value in use” is higher than the price you would receive in a forced sale scenario, like an auction, but less than the cost to replace your winery’s existing equipment. It should also be noted that the “net book value” of equipment on your winery’s financial statements, which is equal to the original cost less the depreciation taken on the assets, may or may not be close to the “value in use”.
Inventory can be broken down as wine and non-wine inventory. Wine in cooperage is generally valued at the lower of cost or net realizable value while wine in the case is valued based on the distributor’s case price. Non-wine inventory is not usually a big ticket item and generally includes bottles, labels and other wine making supplies.
Goodwill is often the most difficult component of value to calculate. Generally speaking, goodwill is the premium a buyer is willing to pay above the value of the winery’s net tangible assets (hard assets less liabilities). The value of a company is equal to the present value of all future benefits anticipated to accrue from ownership. Accordingly, the existence and magnitude of the goodwill of a company is truly a function of the future cash flow that the company is expected to generate. It is also a function of the amount that a buyer is willing to pay to purchase the expected future cash flow.
What Methods Should be Used to Determine Value?
The rule of thumb method is a general industry standard based on a multiple of revenue or income. For example, in the wine industry, a rule of thumb is that a winery is worth 25% of annual sales. While these methods are easy to apply, the down fall is, due to their simplicity, the resulting value conclusions may not correspond to the true value of the business. If you took two estate wineries that produce $4 million in sales each and applied the industry rule of thumb of 25%, it would appear that the value of each winery should be $1 million. This is likely an erroneous conclusion though, as it does not take into account any of the determining factors above. For example, if only one of these wineries grew their own grapes while the other winery purchased grapes on contract, this could alter the value considerably. Professional business valuators will use the industry rules of thumb as a guideline, but will not rely on it to determine the actual value of the winery.
Business valuators will generally use two approaches to determine the value of an estate winery. The first is an asset based approach which is based on the fair market value of the tangible assets like real estate, equipment and inventory. The value of a winery under an asset based approach will typically be at the lower end of the range as it does not take into account the expected future cash flows generated by the winery. Examples of situations where an asset based approach would be appropriate include when a company is expected to cease operations and the assets will be sold on a piece meal basis. It would also be applied as a measure of downside risk if a winery is expected to continue operations as a going concern. An asset based approach could also be used when operations do not generate a return higher than a reasonable return on the tangible assets.
The second method is an income based approach which will typically value a winery higher than an asset based approach (when the winery is a profitable going concern), as it takes into account the cash flow the winery is expected to generate in the future. There are two distinct income based approaches that can be applied. The first approach is the capitalized cash flow method which is used to determine the value of a winery that is at a mature stage of their business cycle, has stable income and is not in a growth mode. This method uses the historical financial performance of the winery to estimate maintainable future cash flows. The value of the winery is arrived at by capitalizing cash flows at a multiple that reflects the risks and rewards associated with ownership of the winery.
The second income based approach is the discounted cash flow method which is used with wineries that are in a growth phase and accordingly historical cash flows are not indicative of future cash flows. This method projects out the cash flows of the winery generally over a five year period. The projections can incorporate growth plans in terms of revenues, margins, working capital as well as any expected expenditures required for expansions or upgrades. The time value of money is used to determine what the worth or present value of the winery is today. This method is generally the most accurate approach to value a winery, but is dependent on reasonable, management-prepared, cash flow projections.
Can my winery’s value be enhanced?
If you are not planning to sell in the short term but want the option of a profitable sale in the future, you may want to consider an independent business valuation prepared by a Chartered Business Valuator (CBV). They will establish a baseline value for your business, provide you with insights into the strengths and weaknesses of your operation, and can help to identify specific ways to enhance the value of your winery. This could include suggestions on strengthening cash flow, implementing cost controls, reducing debt, building your customer base, improving inventory turn-over and upgrading or adding to your existing operations, real estate and equipment. Doing a valuation of your operations at least five years prior to selling will give you enough time to implement value enhancements and increase the value of your estate winery.
Bruce Plaxton, CA, CBV is a member of BDO’s Winery Services Team. Bruce can be
reached at 250 763 6700 or 1 800 928 3307, or by email at: bplaxton@bdo.ca
