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Growth Capital: The Big Money

A review of how the Williamsburg Winery has raised more than $6 million through ingenious financing.
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Over the past seven years, the Williamsburg Winery has exhibited financing ingenuity seldom seen in other small private companies -- and raised more than $6 million along the way. Here's how

Few entrepreneurs need to scrounge together as much capital as Patrick Duffeler and his wife, Peggy, have raised over the past seven years: more than $6 million. Nevertheless, the progression of the Duffelers' savvy and comprehensive financing strategy offers a wealth of ideas and techniques to support any fast-growing business.

Financing headaches come with the territory when you're starting and running a new business. And for Patrick Duffeler, the 50-year-old founder and chief executive of the Williamsburg Winery, a $2-million-plus wine producer in Williamsburg, Va., the search for capital has often assumed nightmarish proportions, requiring a level of financing ingenuity seldom seen in small private companies.

Wine producers assume they need to make an initial investment of $2 to $3 in land, grapes, barrels, and laboratory equipment for every $1 worth of revenue they will eventually produce. Few of the standard rules of business management apply: upscale producers, for example, anticipating that their wines will appreciate in value over time, seek to build rather than turn over their inventories. Factor in the impact of unpredictable weather conditions, along with the standard uncertainties related to competition and consumer tastes, and it's little wonder wine making has earned a reputation as a rich man's hobby, as well as a distinctly poor odor among bankers and potential investors.

Duffeler was born in Brussels and came of age in the chaos of post-World War II Europe, with an enthusiasm for the American Bill of Rights and the United States as "a place of optimism and pioneering." He emigrated in 1959, earned a degree in economics and finance from the University of Rochester, and embarked on a career as, in his own wry assessment, an "international industrial mercenary."

Duffeler worked first for Eastman Kodak (where he mastered the company's approach to new-product development and marketing) and then for the international marketing division of Philip Morris (where he learned that there are advantages to a lean, entrepreneurial management style). His own flourishing entrepreneurial instincts eventually led him to join a European investment company, where he lost 45¢ for every dollar he'd invested. But, as he recalls, it was through one of that company's troubled holdings that he learned he "liked the wine industry immediately. It is one of the last unstandardized food products in the world -- with room for tremendous value in the product."

In need of restoring his savings (and credibility), Duffeler returned to the corporate world to run an international privately held fragrance manufacturer. During his five-year stint with Fragrance Selective, he researched a project closer to his heart: the launch of a winery in Virginia's historic Williamsburg. Williamsburg symbolized for him the best of the American spirit, in the midst of "echoes," as Duffeler puts it, "of the American Revolution, of Thomas Jefferson, Patrick Henry, and George Washington."

By 1986 Patrick and Peggy Duffeler had cashed in their retirement accounts and other savings and bought a 300-acre cattle and grain farm in Williamsburg. They'd formed a limited partnership, with $180,000 of capital, as the first stage in converting that farm to an upscale winery. Just about two-thirds of the financing came from their personal savings; the additional $65,000 was raised from friends and business colleagues.

It was typical financing for a start-up, albeit at a pricier level than most. But what distinguishes Duffeler from many company founders is that from the beginning, "I made a clear-cut decision that I would continue to seek participation from outside investors -- and that, while I was doing so, the issue of retaining control would never be an issue for us." He pauses. "I've always believed that if a single-minded individual wanted 100% control of his company, he might be giving himself a lot of freedom, but he would be putting a tremendous burden on his company."

Duffeler had other burdens to consider. That initial $180,000 disappeared faster than, well, a cool glass of chardonnay: 2,500 grape plants, production-equipment rental fees, and a "test crush," or trial production run, quickly swallowed those funds.

The test-crush results were so promising that by mid-1987 Duffeler was ready to raise more money -- much more -- to move the winery beyond the production-test phase. After all, a single wine barrel costs $500, and the purchase of 60 barrels was just the beginning of the winery's shopping list. Duffeler had to plant new fields, buy new fermenting devices, and, perhaps most important of all, hire a viticulturist and a wine maker to supervise the fields and the production process.

Because he was used to working in a corporate environment and appreciated that corporations were more accountable to investors, Duffeler decided to convert to S-corporation status. As a preliminary stage, the limited partnership's asset base was converted into about $170,000 worth of S-corporation shares, valued at $1,000 apiece. At that point Duffeler and his wife controlled about two-thirds of the stock.

In August the Duffelers invested another $160,000 in the business, at that same share price of $1,000. That was an important gesture to their initial investors. Duffeler has always purchased his company's stock at the same prices his investors pay because he values their long-term commitment and involvement as much as his own. "I learned when I lost my personal investment in that European company that you are the custodian of other people's money when they invest in your business," he emphasizes. "You have to respect their rights."

That September the winery sold additional corporate stock, now valued at $1,500 a share, in a private placement that raised a total of $390,000. An outside investment firm handled the deal, collecting $10,000 to $25,000 from professional investors who were no longer just friends of the family. After the dust settled, the original investors owned 46.7% of the stock (the bulk of which, 32.5%, was owned by Duffeler and his wife); 25 new investors owned 43.3%; and the investment firm's attorney and merchant-banking advisers held the rest.

With its new capital structure in place, the Williamsburg Winery geared up for its first period of intensive growth. Duffeler signed contracts for the grape harvests of three outside vineyards whose vines were already mature. He planted nearly 12 new acres of chardonnay, cabernet sauvignon, and other varieties on his own property, and he conducted a miniproduction of 2,000 cases of chardonnay. Construction started on a wine cellar, a laboratory, and a retail store, all of which Duffeler, a talented artist, had designed. Three weeks after shipping its first cases, the winery won the Norfolk Yacht & Country Club gold medal for its Governor White. "That gave us a sense of confidence that we were going in the right direction," Duffeler says.

Unfortunately, the right direction was proving to be costlier than he had ever anticipated. There might have been some bankers around during the high-flying, high-leverage 1980s who wouldn't flinch at the voracious financing needs of a start-up winery, but by 1989, when Duffeler was still building inventory and buying vines, U.S. capital markets were much more interested in predictable, growing sales; profitability; and secure cash flow. The kind of two-to-one debt-to-equity picture that Duffeler envisioned looked like a disaster to gun-shy bankers. He was lucky, back then, to qualify for a nominal credit line.

Meanwhile, with only losses to speak of, there was a limit to how much equity Duffeler could raise. He needed to complete production of the Williamsburg Winery's 27,500-square-foot building, which now houses its administration, distribution, retail, production, and storage facilities. So he came up with a strategy to boost the debt side of his financing picture. During 1988 he worked with his local bank and municipal, county, and state authorities to win approval for an $850,000 tax-exempt industrial revenue bond for economic development.

But Duffeler was still short of cash. He says, "I reached an agreement with a merchant-banking firm to carry out a $2.5-million private placement that would raise the money from a few very large investors. Then the CEO resigned, and his replacement wasn't interested in handling financing deals of less than $5 million -- which we couldn't begin to justify raising."

With production up to about 14,000 cases, Duffeler raised another $1.5 million in late 1989 by persuading his existing investors to purchase an additional 1,000 shares. Still unable to turn a profit, the winery had to hold its stock price to $1,500 a share. Duffeler was on a financing merry-go-round with no end in sight, and later, during the Persian Gulf War, he could arouse little interest in a rather complex deal he'd designed to raise additional capital by selling shares in yet another limited partnership.

Money, money, money. By 1992 it looked as if the Williamsburg Winery was going to post a tiny but noticeable profit, on the sale of more than 27,500 cases, for revenues of about $1.8 million. But it was still gulping capital. Duffeler successfully managed to raise another $1.5 million in another private placement, this time selling 600 shares, with options, priced at $2,500 each.

Duffeler turned to a Richmond, Va., merchant-banking firm, Scott & Stringfellow, which approached new as well as existing investors. "It was the toughest financing I've ever been involved in," S. Buford Scott, chairman of the firm, asserts. "There's such a consensus among investors that you cannot make money in the wine business! When I would show people the Williamsburg Winery's sales results to date, without telling them what business it was in, people would be interested. Then I'd tell them what the company did, and they'd run away."

One person who did not run away was Don Messmer. A faculty member at the nearby College of William and Mary, Messmer is also a marketing and strategic-planning consultant. "What appealed to me was Patrick," he recalls. Messmer had been impressed by Duffeler's ability to market his concept of high-quality, affordable wines to potential investors. "I remember telling him, 'I believe that you can make money for me." Messmer joined the board of directors. From that vantage point, he now confides, "In all candor, I believe we were relatively nave about how much would be required to finance this business. I believe that Patrick has been forced to spend 40% to 50% of his time on financing throughout the years."

Duffeler has done a remarkably good job of keeping his investors behind him. While making it a high priority to understate corporate goals, he's kept shareholders satiated with timely progress reports. "We've had only one investor who needed to sell his holdings, and that was for personal financial reasons," the CEO explains. "The good news is, our existing shareholders bought up that available stock within a week."

But if his investors were relatively happy, Duffeler himself was losing patience with the financing runaround and the valuable time it was taking away from marketing efforts. He blamed his bankers -- the same local group that had provided the initial mortgage for his property back in 1983 -- for failing to understand and support the winery's growth. "If you're dealing with bankers who are used to dealing with car loans, they can't understand the dynamics of growth," he fumes. "We would ask them for a new loan or to approve an extension of our credit line, and six months later we'd still be waiting to hear from them.

"They kept telling us, 'Your plans sound so exciting -- we want to be part of them," he continues. "But the biggest mistake I made was continuing to believe them as they kept stalling on every request I made. On Monday they'd tell me they loved me, on Tuesday they'd hate me, and by Friday they'd love me again, but they were never willing to put anything positive in writing," he notes wryly. "When your bankers keep telling you, 'It's almost approved, but give us this, this, and this,' and you swallow hard but keep giving them more information -- all the while knowing that they don't understand your business and don't really want to give you any more money...." His voice fades away in disgust.

Recognizing that he -- and the winery -- could benefit from all the financing insight he could get, Duffeler reached out to John Jamison, formerly a general partner of Goldman Sachs in New York City, who runs a corporate financial-consulting firm in Williamsburg. Jamison had passed up an investment opportunity during the winery's earlier years. "I'm a doubter," he says. "I didn't think you could make a wine worth a diddly-dong in Virginia."

Now that the Williamsburg Winery had won an impressive list of awards, had begun to attract national interest from wine critics such as Robert Parker, and best of all, had built a small but solid history of sales growth, Jamison was willing to take a second look. "What particularly appealed to me was Patrick's decision to hire Daniel Uzelac, a former plant manager from Anheuser-Busch in Williamsburg. That told me that the Williamsburg Winery was a business, not just a one-man band, and that if something happened to Patrick tomorrow, there would be someone around who would know how to run it."

But Jamison was critical of some of the winery's earlier financial maneuvers, in which Duffeler paid for consultants' services with warrants instead of cash. "If you give away stock -- and warrants basically mean stock -- as though it has little or no value, pretty soon it won't." In Jamison's assessment, "the problem with the winery was that it was still operating in a capital-market area too small to interest the right kind of banker."

If Duffeler did not change gears, Jamison warned, he would handcuff the company's growth by forcing it to rely on a stop-and-start stream of financing capital and on small-time bankers who were afraid to support a true growth strategy. He adds, "What Patrick needed to do was build a sophisticated and large capital base that would include subordinated debt and equity and would ultimately position the company to borrow from the right bank at a comfort level that would appeal to it."

Jamison joined the winery as an investor and board member in 1991 and began working with Duffeler on a two-year process of financial restructuring. Completed last November, the restructuring took place in two stages. First there was yet another private placement of subordinated-debt notes with warrants, priced at $3,000 per share, which raised about $1.5 million. The notes guaranteed purchasers 10% interest over 10 years and options to purchase stock at a later date.

"Because the company was an S corporation and already had 35 investors -- the legal limit -- there wasn't any room to bring new investors in on the equity level," explains Scott, the winery's merchant banker. "This was a viable alternative. Since the winery needed the capital, 10% wasn't too much to pay, considering that it was still a relatively unknown company operating mainly in a local market and selling a product investors didn't understand." That offering brought the company's capital base to more than $6 million, with subordinated debt constituting roughly two-thirds of total financing.

Finally, Duffeler, Jamison, and the rest of the board believed that the winery's financing and growth picture qualified it to appeal to a regional bank with a large national presence. NationsBank was interested and showed proof of that interest by flying California wine-industry analysts to Virginia to evaluate the Williamsburg Winery's internal controls, production systems, and prospects.

"Through it all, our old bankers tried everything they could do to keep us." Duffeler laughs now in retrospect. "They tried to manacle us. They tried promising to be more competitive. But in the end they kept to their record of talking, talking, talking, and never making any decisions or coming up with results."

Even with a thorough corporate analysis, which included environmental surveys, land appraisals, and financial audits, NationsBank went from, in Duffeler's words, "the initial meeting to a policy decision about us in about six months. The bank's people knew what they wanted and were willing to act." The winery's credit line has risen from $300,000 to $1 million, which puts Duffeler in a good position to respond quickly to changing harvest conditions by allowing him to buy grapes on the spot market.

"We are finally positioned to go national," Duffeler exalts. As he has always done, he continues to keep his investors up-to-date. Recently, he notified them, in four-inch-high letters, "Awesome job! At last we can get on with marketing!"

THE WILLIAMSBURG WINERY'S FINANCIAL HISTORY

Date Event Equity % Equity (in thousands)
July 1983 Purchased farm 100
May 1986 Formed limited partnership 63 $180
August 1987 Formed S corporation 160
September-December 1987 Did private placement 32.5 390
July 1988 Sold industrial revenue bond 850
Decembers of 1988, 1989, 1990 Sold 1,000 shares to shareholders 30 1,500
March 1992 Sold 600 shares in second private placement 22 1,500
April 1993 Issued subordinated debt with warrants 1,500
Total: $6,080

GLOSSARY OF THE WILLIAMSBURG WINERY'S FINANCE

Industrial revenue bond: A bond whose interest payments are tax-exempt for purchasers at both the state and the local level because the revenue raised finances an approved development project

Limited partnership: A business structure in which income is taxed at the partner level rather than the partnership level and, for the investors, there are limited personal liabilities. There is no limit to the number of investors, but for interstate operations, the structure may prove awkward

Note: A financing instrument for which the issuer guarantees payment of interest as well as the principal. Purchasers of S-corporation notes are creditors, not owners, and take no part in management

Private placement: Stock, notes, or other investment tools that are sold by a merchant banker or a private agency

S corporation: A corporate structure that avoids the corporate "double" tax on corporate dividends by taxing income on only the shareholders' personal tax returns. Limited to 35 shareholders

Subordinated debt: Principal and interest obligations that take second place behind a company's bank loans

Warrant: An option to purchase stock shares at a specified future date and price

Last updated: Feb 1, 1994




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