When launching an alcohol beverage business, it is crucial to consider your exit strategy from the start. Below are key questions designed to guide founders through preparing their business for a future investment or acquisition:
1.Who Are Your Potential Buyers or Investors?
Understanding the restrictions on potential buyers or investors is central to an effective exit strategy and highlights the complexity of alcohol industry investments. The alcohol industry's regulatory environment limits who can invest in different businesses within the industry. Because of the invasive disclosures required during the licensing process and restrictions on investing across different industry tiers, not all investors are suitable partners.
The end of alcohol Prohibition brought increased scrutiny to and regulation of the alcohol industry. Part of this scrutiny involves state and federal agency investigations into who manages, controls, and operates licensed businesses to prevent organized crime from profiting from the alcohol industry as it did during Prohibition. This means that businesses holding alcohol licenses need to disclose their investors to regulatory agencies, which often look through corporate structuring, and may seek sensitive personal information from larger investors. This is not something that every investor wants to go through, especially private equity and venture capital with passive investors that may want their investments to remain private. This can be especially challenging for founders seeking to replicate Silicon Valley investment models because investors may balk at the required licensing and disclosures.
Additionally, post-prohibition alcohol laws called “tied-house”[1] laws generally prevent investors in alcohol manufacturers and wholesalers from also investing in retailers unless a relevant exception applies. Tied-house laws may make it challenging, if not impossible, for certain investors to get involved in a licensed business if they are involved in a different tier of the industry already. For example, an investor that owns a series of hotels may not be able to acquire the cocktail seltzer startup, or the e-commerce solution for alcohol brands that holds retail licenses might not be able to take on investment from an investor that is also involved in Anheuser-Busch's venture fund.
Thinking through the potential investors that may be interested in your company may also dictate where you set up your business, which licenses you will hold, and what agreements you sign as you get started in the industry.
2. What Are You Selling – Brand or Business?
In the event you want to fully exit the business, it can be helpful to consider whether to sell a brand or the company itself. A brand sale will generally be an asset deal, which may be more appealing to an existing industry member that already has their own licenses, compliance, and distribution relationships, as in the case of a large supplier-tier buyer like Diageo or Gallo. A stock sale of a company that has licenses, real estate, equipment, and an existing customer list may be more appealing to a buyer that does not currently have alcohol beverage holdings or that wants a turnkey business to fit into their other holdings.
In the case of a company positioning for an asset sale, a company may decide to focus on sales and marketing to be asset light, meaning they have little real estate, equipment, or alcohol beverage licenses. They might work with a co-packer or have what is called an alternating proprietorship, where they have their own permits but are operating under a lease that alternates premises between different operators at an existing facility. For an asset sale, the licenses are generally not part of the sale, the buyer would apply for their own licenses or might already have them if they are an existing industry member.
Stock sales, on the other hand, generally involve a more capital-intensive approach, that builds a valuable business that will transfer the ownership of the business itself and frequently the licenses. Stock sales are more common than asset deals in the alcohol beverage industry, especially if a business has multiple locations, licenses in many states, and contracts with other industry members. Stock deals may involve pre-approvals or notices to regulators within a certain period after closing, depending on the state. Understanding the potential type of sale—asset or stock—can influence how you prepare your business for the market.
3. What is your “Route to Market”?
The route to market, or how a particular product will be produced, distributed, and sold in the marketplace, is an important consideration, because it often dictates the license strategy. Every alcohol license carries different privileges—different supplier licenses permit the holder to produce, blend or import alcohol, wholesale licenses permit the warehousing and sale of alcohol to retail sellers, and retail licenses permit the sale of alcohol directly to consumers. Some states permit the same business to hold multiple license types pursuant to exceptions to the tied-house laws, others require a licensee to pick one level of the industry and do not permit holding licenses on multiple tiers of the industry.
As such, it is important for founders to consider how they will get their product to market and discuss how the regulated alcohol industry may affect their stated goals. For example, a distilled spirits brand may have a harder time with a social media-driven direct consumer engagement model because distilled spirits producers and distributors cannot sell directly to consumers—they must go through an independent retailer. And because of the trade practice laws, our spirits brand can’t just partner with a retailer and send all of their customers there, tell a retailer that they will take any product back that they can’t sell, or pay a retailer a kickback to discount the product during a launch; many of these more aggressive sales tactics that might help a new business gain a foothold in the market are illegal in the alcohol industry. It may be necessary for the spirits brand to reconsider its route to market and capabilities given the regulatory restrictions.
For international brands, the route to market may be even more challenging if they do not have a U.S. team in place or U.S. facilities, which can be surprising to brands excited to reach American consumers. Many of the acquisitions in recent years have been driven by international alcohol businesses trying to better reach American consumers by buying production facilities, many of which have tasting rooms or restaurant privileges, in addition to the local production advantages. Imported brands do not have the same privileges that American brands may have, such as tasting rooms or the ability to sell directly to consumers in certain markets, because these privileges are attached to domestic manufacturing facilities. This makes brand awareness and customer engagement more challenging in a crowded market that requires imported brands to go through distributors and retail channels to reach consumers.
4. What have you already agreed to?
During investments and acquisitions, the people considering investing in a business or buying a brand will want to see agreements that the business has entered into to understand what commitments they may be taking on. In the alcohol industry, that will most frequently involve production agreements, distribution agreements, and marketing agreements. Ideally, you have an experienced industry lawyer review agreements before signing them, but in the startup phase, these agreements often get signed before the legal team is brought in and may require untangling before seeking investment or a buyer. Distribution agreements, for example, can be especially thorny to deal with for new brands, because the negotiating position is often very unequal between established distributors and new market entrants, and many state laws will favor distributors in ways that affect the ability to change distributors in a particular market. Investors and buyers will closely scrutinize these agreements, so it is essential to review agreements for the length of the agreement, the termination and change of control provisions, and the state laws that may apply to these relationships, among other terms.
By thoroughly analyzing these questions, founders can strategically navigate the early stages of their business. This preparation not only aids in aligning with legal and market realities but also sets a clear path towards a successful exit. Engaging with an alcohol beverage lawyer early can help mitigate risks and ensure a smoother transition when the time comes for investment or acquisition.
[1] Tied houses were traditionally pubs or saloons that were required by contract or investment to buy from a particular alcohol manufacturer.
This blog is dedicated to occasional (and hopefully interesting) reports of state and national alcoholic beverage regulatory developments that we encounter in our practice. Booze Rules (and any comments below) are intended for informational use only and are not to be construed as legal advice. If you need legal advice please consult with your counsel.