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E CONOMICS The barrel room of Duckhorn Vineyards, St. Helena, Calif., highlights where an asset-based loan helped bolster the winery's working capital. Barrel Leasing and Cash Flow How to address your fast-depreciating oak inventory through finance By Kerry Kirkham at competitive rates. Fortunately, there are more options than ever in leasing barrels. With the help of longtime wine in- dustry finance veterans, Wines & Vines examined two lease types: capital and operating, along with the potential tax benefits of each. We also explored examples of three different financing options: traditional bank loans, winery-specific leasing and barrel-specific leasing, all with the goal of protecting existing credit lines and freeing up precious winery cash flow. W Leasing demystified In a lease, an equipment owner or lessor agrees to allow a client or lessee to pay to use equipment within a specified time period. Unless there is a buyout option, the lessee may be required to return the equipment to the lessor at the end of the lease period. Even though the lessor owns the equipment, the lessee is required to maintain and insure it as if it were theirs. A lease differs from a loan in many ways. For one, a loan requires an initial down payment, whereas a lease typically requires just the first payment up front. For the same 100% financing advantage that is found in a lease, a loan requires ad- ditional collateral. In a lease the equipment itself is the collateral. A loan is financed according to its balance, and a lease is 32 Wines & Vines sePTeMBeR 201 1 hen it comes to securing loans in our recovering wine industry, lenders concede that though money is difficult to secure, it is still available Highlights • Leasing barrels can preserve existing credit lines and precious winery cash flow. • Barrel-specific leasing companies add another option to traditional loans and industry-specific leases. • Cooperages may be willing to offer a discount when leasing since payment is received upfront rather than the usual net 30 or 60. financed according to a specified time period that the equipment is to be used. When considering a lease versus a loan, Bill Rodda, vice president and branch manager of American AgCredit, Santa Rosa, Calif., advised that the economic life of the asset must be taken into con- sideration. Rodda, who has worked with AgCredit since 1981, said, "Wineries typi- cally do operating leases for barrels for a period of three years. Just like corks and bottles, barrels are a necessary compo- nent—you constantly have to replace them. We're not talking about stainless steel tanks with leases that can sometimes run up to seven years. The answer lies largely in the real-life usefulness of the as- set. Most people buy stainless steel tanks because they last for 20 years or so." Rodda said that barrel leases often have a $1 buyout at the conclusion of the lease contract. Therefore, wineries can take their barrels through their useful life and resell them themselves. American AgCredit, founded in 1916, is a nationwide government-sponsored enterprise that is part of the Farm Credit System. To qualify for financing with American AgCredit, a winery client must grow grapes or have a long-term lease on a vineyard. Farm Credit Leasing services the loan and American AgCredit main- tains the relationship between the client and Farm Credit Leasing. Jerry Guffey, president of Mission Cap- ital, Santa Rosa, Calif., has been lending to the wine industry for 15 years. Mis- sion Capital specializes in financing for wineries that want to acquire equipment. Guffey explained two types of leases: operating leases and capital leases. "With an operating lease, the lessor is the owner of the equipment and is entitled to take the depreciation on the equipment so they get the tax deduction," Guffey said. Since the lessor takes the tax deduction, they require a lower lease payment. Guffey added, "Because we're the owners, it doesn't show up on the client's balance sheet as a debt, since they are essentially renting the equipment. It shows up as an operating expense in what is called off balance sheet financing." Barrels can be sold back to the winery via a fair market clause, which is a form of a buyout in an operating lease. "The good news is the fair market value on barrels is not much, so operating leases DOUGLAS STERLING