Disengaging 7 | The Mortgage

Disengaging 7 | The Mortgage

by | 'Oct 27, 2017' | Disengaging | 0 comments

Peter Cannon

I’m still rattled by the board meeting and especially by my conversations with Joyce (if you can call them conversations, since they’re mostly one-sided rants by Joyce). And now she’s barely speaking with Matthew, her own son. I don’t know what to do. I’ve always thought my roles in life were: to be a good person, a good husband and father, a good brother and uncle, and a good winemaker, and that if I fulfilled those roles, everything would work out okay. My father’s bluster always bothered me—I’ve always been more like my mother. Mom was calm and strong, balanced, measured. She held us together, like the glue in the family. Even growing up, Joyce was so much like Pete Sr. that I guess it came naturally to try to balance her out and model myself after Mom.

We’re really getting stuck at Cannon Springs Farm.

Joyce is so fixated on how the ownership of the businesses was divided, and how the farm land got mortgaged to start the winery, that she’s neglecting the farm and failing to make decisions she needs to make before the growing season starts. Matthew and Grace can fill in to some extent, but they’re still learning. It takes decades to really understand the process and choices involved in running a successful growing business, and to be successful, you have to think ten or twenty years ahead. I’m worried about what will happen to the business if her downward spiral continues.

Pete Sr.’s decision to start Cannon Bridge Winery by taking on debt at Cannon Springs Farm did create a problem—I can see Joyce’s point. Cannon Springs has a financial obligation that was incurred to start Cannon Bridge Winery, yet because of the ownership structure, Cannon Springs doesn’t get any income from Cannon Bridge Winery to repay that debt. Joyce only gets 20% of the total distributions from Cannon Bridge, and even if she wanted to loan money to Cannon Springs, it’s not enough.

After a couple of weeks of having all this churn in my mind—Chi-Yu told me I was grinding my teeth and thrashing in my sleep—I decided to ask our accountant, Sam, who has worked with us for decades, to explain to me exactly what Pete Sr. did, and why it created this situation. He told me that Pete Sr. had wanted to start a winery back in the 70’s, but was too busy to do much about it. In the early ‘80’s, some land became available in Mendocino County, and Pete Sr. decided he needed to act immediately. One of the local banks was stepping up their mortgage lending on farmland, so even though interest rates were high, Pete Sr. convinced the bankers to do a cash-out mortgage. He wanted to keep the deal secret, both from the other growers and winemakers in the area and from his staff, so instead of having Cannon Springs buy the land, he created a separate entity and had an agent do the purchase. Sam told me that he advised Pete Sr. that it would be best if Cannon Springs owned the entity, but Pete Sr. had strong ideas about how the new winery should be developed and managed, and he wanted it separate. You never could argue with my dad. So, the lawyers figured out how to distribute the shares of Cannon Bridge Winery to Pete Sr. personally, without triggering the loan covenants.

I suppose, given how well the growing business was going then, mortgaging Cannon Springs Farm didn’t seem all that risky—the combined acreage of Cannon Springs Farm dwarfed the acreage of Cannon Bridge Winery. And, the cost of building our stone winery buildings, while not exactly nothing, wasn’t nearly as much as what other winemakers were spending on their facilities.

Pete Sr. was so excited by the winery project. He started spending all his time up here on the ridge in Mendocino County. He was everywhere at once—watching over the guys who were planting the vines, working on the layout of the outbuildings, choosing casks for the aging rooms, fussing with label design. He said Joyce was doing a great job at Cannon Springs, and that she didn’t need his help. I wonder. I think he was just obsessed about the winery, and loved having something entirely new to do, so it was easy to say that Cannon Springs was fine. Whatever. Whatever Pete Sr.’s motivation was, it’s all water under the bridge now.

But things have changed since those days.

The taxes, for one thing. Property taxes keep rising on Cannon Springs’ land, even as revenues are falling. Tastes in wine have changed, too. Cannon Springs isn’t keeping up with diversifying its vine stock—though it’s true, as Joyce always says when Grace and Matthew bring up the topic, that tearing out established and successful varieties to keep up with fashion can be a fool’s errand. And I admit, the back and forth surrounding the Muscat crop won’t help Joyce open up to new growing opportunities. And then this drought. We’ve got enough water that our vines are hanging in there, but if the weather patterns don’t change, we’re going to have to rethink how and what we grow.

I love the winery but not more than I love my family. It’s not worth it to make great wine, but become estranged from my sister and family. Maybe I need to go help Joyce more. Or maybe I need to talk to the bankers about the options for the mortgage. God forbid, but we may need to consider selling some of the land so that we can regroup.

Damn it, though! How am I supposed to help Joyce when she won’t even listen to me?

Family Business Governance Analysis:

Peter Cannon’s world remains in chaos, largely due to his sister Joyce’s overwhelming anger about the financial situation at Cannon Springs Farm—of which Peter owns 30%—and the tongue-lashings she’s been giving to Peter and to her children.  In “The Mortgage,” we are privy to Peter’s inner thoughts as he works to figure out how the actions of his father, Pete Sr., created the situation the Cannons now find themselves in.

It’s becoming clearer to us that Cannon Springs Farm is facing financial difficulty from multiple sources: demand for different varieties of grapes is shifting in ways that hurt Cannon Springs Farm’s business, the loss of crop due to the vine disease crown gall, drought, and high taxes. In this episode, we’ve learned that Cannon Springs Farm has longstanding debt that was put in place by Pete Sr. so that he could purchase the land for Cannon Bridge Winery. Through conversations with the businesses’ long-time accountant, Sam, Peter learns that Pete Sr. was advised to make Cannon Bridge Winery a division of Cannon Springs Farm, but chose instead to distribute the proceeds of the loan out to himself and then create Cannon Bridge Winery as a second, independent entity.

That may sound like dry legal stuff, but Pete Sr.’s choice has had real consequences for the Cannon family businesses. Pete Sr. borrowed money based on one business, then invested it in a separate business.  Pete Sr. borrowed against the future earnings of Cannon Springs Farm, in essence betting that Cannon Springs would have a future income stream sufficient to pay off the debt. He then used those funds as an equity contribution to found Cannon Bridge Winery. Equity, unlike debt, does not need to be repaid, so there was no required stream of payments from Cannon Bridge Winery, as there would have been had Cannon Bridge taken out a mortgage on its own land to fund the purchase and building of the winery. The business Joyce runs (and which she and her children own 50-50 with Peter and Jacob) is paying off the debt incurred to start the business Peter runs (which is owned 80% by Peter and only 20% by Joyce).  We don’t know the magnitude of the debt, but it’s clear that repaying it is a burden for Cannon Springs Farm.

There are two points I’d like to focus on: the challenges of family business ownership over generations, and the concept of Reciprocity.

  • Reciprocity first. Reciprocity is a concept from social science, and it refers to the ways in which a member of a system adjusts his own behavior or scales down his own needs or interests to relieve anxiety within the system. This is one of the adaptation postures we mentioned in the Disengaging episode about Matthew, who was showing us what Triangling looks like. Peter is demonstrating Reciprocity in this situation. We can see Reciprocity when he thinks about what actions he might need to take at Cannon Bridge Winery in order to help deal with the debt problem—and, almost certainly just as important, the family problems—at Cannon Springs Farm. This comment from Peter is very much the voice of reciprocity: “I love the winery but not more than I love my family. It’s not worth it to make great wine but become estranged from my sister and family. Maybe I need to go help Joyce more. Or maybe I need to talk to the bankers about the options for the mortgage. God forbid, but we may need to consider selling some of the land so that we can regroup.” Reciprocity has been identified by many researchers who study family businesses as a real advantage of family business systems, and a significant factor in their longevity. Put simply, because family business owners are concerned about their fellow owners as family members as well as business partners, they are more likely to take actions that will benefit the system as a whole, even at some cost to themselves.

Now, let’s talk a bit about the challenges of family business ownership over generations.

  • The financial relationship between Cannon Springs Farm and Cannon Bridge Winery simply wasn’t a problem when Pete Sr. owned both. So long as he was sole owner, he had considerable flexibility and could shift assets, income, equity and debt between the two businesses with a considerable degree of freedom. It was when he chose to transfer his interests to his children, and especially, when he chose to do so in different percentages, that he created the financial challenges that the Cannons are dealing with now. Our view back in time is hazy at best, and distorted by the Cannon family members’ interpretations of Pete Sr.’s intentions in creating his estate plan, but there are lessons we can glean from this situation:
    • First, it would have been very helpful to everyone had Pete Sr. explained the reasons behind his choices, perhaps in a letter or at a meeting. Perhaps he was in a hurry, or afraid of the outcome, or believed that matters of money were best left unspoken, but it’s likely he didn’t anticipate the negative consequences of his silence.
    • Second, when the ownership and cash flow are mismatched, then estate planning becomes more complex (as here, for example, where debt is incurred in one business to found another, but there is no reciprocal income stream back to the first business to repay the debt).  It is not enough for families and their planners to look at asset value alone in planning transfers of ownership interests. They need to consider how interlocking ownership and obligations might complicate family as well as business life. This is in no way to say that one family-owned business can’t provide the seed funding for another—business owning families have been successfully leveraging existing assets to invest in new entrepreneurial efforts for centuries.   What’s important is to think through how the obligations might play out—in the family as well as the business—over time, and especially after the ownership has been transferred to multiple individuals in the next generation.