Boutique Vintners Turn to Private Equity for Help

When Ed Sbragia started Sbragia Family Vineyards, it was an accomplishment that was nearly a century in the making.

His grandfather moved from Italy to California in 1904 to work in the wineries just north of San Francisco. In the 1940s, Mr. Sbragia’s father bought property in the Dry Creek Valley near Healdsburg and planted zinfandel grapes, which he sold to local winemakers and used for his own home wine.

Mr. Sbragia, 64, got his start in the wine business at Beringer Vineyards, one of Napa Valley’s oldest, and worked his way up to become one of the most decorated winemakers in the region.

He teamed up with his son Adam in 2002 to make limited lots of wine sourced primarily from the family property. When a small vineyard and facility 10 miles up the road went on the market in 2006, it was an opportunity he could not pass up.

“All of a sudden a little project became a bigger project,” said Mr. Sbragia, who stepped down from his full-time position at Beringer in 2008.

After the recession, however, Mr. Sbragia was at an impasse. His wine had been well received â€" selling out quickly in fact â€" but he faced a laundry list of expenses and few good options for financing them. He needed to buy more grapes, revamp his tasting room and replace his aging French oak barrels, at a cost of $1,000 each.

Meanwhile, Mr. Sbragia needed help with various aspects of the business. Finance, distribution, marketing and sales “are not my expertise,” he said. “I make wine.”

In 2011, he found an unlikely partner in Bacchus Capital Management, a private equity group co-founded by Sam Bronfman II, the grandson of Seagram’s founder. The firm, which has offices in New York and San Francisco, invests exclusively in wineries and wine-related businesses.

In 2007, it raised $40 million for its first fund, which is now nearly fully invested with $2 million to $7 million stakes in more than half a dozen West Coast wineries, including the racecar driver Mario Andretti’s Andretti Winery in Napa Valley and Wine by Joe in the Willamette Valley in Oregon. The firm is contemplating another fund, this time in the $100 million to $200 million range.

For many people, private equity conjures the image of ruthless financiers with a singular focus on profit. Bacchus Capital’s two other founding partners, Peter S. Kaufman and Henry F. Owsley, have done their share of hard-nosed restructuring deals through their boutique investment bank, the Gordian Group. The wine fund takes a much kinder approach.

“We’re big on the concept of partnering with talented entrepreneurial winemakers, who are faced with ‘how do I get my wines sold,’ ” said Mr. Bronfman, who was previously chairman of Diageo Global Wines and president of Seagram Chateau and Estate Wines. “We free up these incredibly talented winemakers to do what they do best.”

The idea for a private equity wine fund was born when Mr. Bronfman, 59, left Diageo in 2003 and set out to create his own portfolio of premium wineries. For help, he turned to Mr. Kaufman, an expert in mergers and acquisitions and a friend since childhood.

“He can go in and get a feel for these winemakers from a totally different perspective than someone from the wine business,” Mr. Bronfman said.

It was Mr. Kaufman’s partner, Mr. Owsley, who suggested they start a wine fund that would offer debt financing in addition to private equity.

The fund initially got off to a slow start on the equity side. Before the financial crisis, valuations for premier wineries “were more than we could stomach,” Mr. Kaufman said. Wineries were selling for the equivalent of 12 to 15 times trailing Ebida (earnings before interest, depreciation and amortization). Today, valuations have fallen, while there is still a dearth of capital.

“Unless you’re a Mondavi with huge enterprise brand value, banks are primarily lending on a formula,” Mr. Kaufman said. “If you’re not in their box, there’s no money.”

Yet for high-quality producers with the right distribution model, the fundamentals are sound, he said. Wine consumption in the United States has been steadily increasing for the last couple of decades, according to the Wine Market Council, and remained robust during the recession.

Bacchus Capital partners think there is still plenty of potential for growth, particularly when it comes to premium wines. Meanwhile, wineries that can improve their direct-to-consumer distribution through wine clubs and tasting room sales also have tremendous potential, Mr. Bronfman said. Although traditional distribution channels, like restaurants and retailers, are still critical, they can reduce margins by as much as a third, he noted.

“People laugh when they first hear we have a fund that invests in wineries,” Mr. Kaufman said. “A well-run high-end winery should have gross margins in the 60 percent range and Ebida margins in the 20 percent to 25 percent range.” To put that in perspective, he said, in traditional manufacturing “you’re lucky if you get Ebida margins of 10 percent.”

Convincing artisan vintners â€" wary of losing control â€" of the benefits of a private equity investment was initially a challenge. In addition to concerns about how the operation would change with outside investors, there was the question of exit strategy. “Each of these wineries is special; these are not widget factories,” Mr. Kaufman said. “There will be no one formula for exit.”

Joe Dobbes counted himself among the skeptics of private equity. Mr. Dobbes founded Wine by Joe in 2002 with $50,000 and managed to expand his winery in Dundee, Ore., into one of the largest in the state, producing 130,000 cases last year.

Meeting one of Bacchus’s managing directors at an industry event caused him to revise his impression of private equity. In 2011, he tested the waters with debt financing and then closed on an equity deal earlier this year.

“I felt I had taken the company as far as I personally could,” said Mr. Dobbes, who is, among other things, looking to expand his brand outside the Pacific Northwest and improve his direct-to-consumer sales.

While the infusion of capital certainly helps, perhaps a bigger factor was the reputation and expertise that come with the partnership. “I got with this a team of coaches who have been in the industry for years,” Mr. Dobbes said.

Less than two years after teaming up with Bacchus Capital, Mr. Sbragia is satisfied with the results. The partnership allowed him to bring in a general manager, industry veteran Steve Cousins, invest in new equipment and improve direct-to-consumer sales by 20 percent last year. He and his son are spending more time thinking about making wine and less time worrying about long-term budgets and marketing plans.

For Mr. Sbragia, sharing a stake in the winery was no easy decision.

“One thing I felt very strong about was that I had a group of people working for me and I needed to protect them,” said Mr. Sbragia, who spoke with more than a dozen individuals or entities about investing in the winery before teaming up with Bacchus.

“There were people who wanted 100 percent of the company and I would be a hired hand.”

While he would like to grow â€" last year he produced 16,000 cases and would like to increase that to 24,000 in the next couple of years â€" he doesn’t want to do so at the expense of the quality of the wine or his family’s legacy.

“We’re a family-owned Dry Creek winery and want to stay there,” he said.