Few craft brew entrepreneurs contemplate

Transcription

1 By Marc Sorini and Tom Conaghan Buying and Selling a Craft Brewery Few craft brew entrepreneurs contemplate selling their business when they first get started. Unlike, for example, the typical entrepreneur in the software industry, the craft brewers we know were inspired by the love of great beer, a spirit of adventure, and the romance of creating a small manufacturing business. But the life cycle of most businesses eventually requires at least the consideration of a sale or other transaction designed to both recoup the entrepreneur s lifelong investment and transition the company to the next generation. From the buy side, the craft beer business has never been hotter, with market share now approaching 8 percent by volume in the U.S. and margins that have gotten the attention of both big brewers and non-u.s. brewers alike. This article will explore at a high level some of the issues involved with buying and selling a craft brewery. The Current Climate Over the next decade, we can expect a growing number of mergers and acquisitions (M&A) and other deals in the craft beer business, based on several unavoidable facts. First, the age of the first generation of craft beer founders and owners will force them to consider succession planning. In some cases, one or more family members present the most attractive option moving forward. But inevitably, many of today s owners will find themselves without interested or qualified family members ready to take over the business. For such businesses, a sale presents a compelling option. Second, even if a founder wishes to stay in the game either by himself or herself or through a family member, smaller and/or passive investors may want or need to monetize their investment after years of patience. Given the growing maturity of the industry, more and more breweries will find themselves in these situations. In some cases a founding owner can easily buy out other investors, but this may prove impossible if the value of the other investor s equity exceeds what the founding owner can afford and borrow. Remember, too, that allocating all the primary owner s capital in an internal buyout can leave the business undercapitalized and therefore vulnerable in an increasingly competitive market. Third, increasing growth may require additional capital beyond the reach of the original owners. Today s torrid craft beer growth rates will not likely last forever, so making substantial investments now in production capacity and other competitive tools (more marketing, a bigger sales force, etc.) may ultimately drive an owner toward a sale or other partnership. Fourth, for at least a few, the resources a strategic buyer can bring to a brand (for example, the distribution muscle of a big brewer) can provide sufficient motivation for a craft brewery owner to give up some equity in order to partner with a bigger champion. Cultural barriers might prevent such a move some in the industry would describe this as selling out. Also, the purchase can have real-world consequences (e.g., losing eligibility for the federal small brewer tax rate a $660,000 annual tax disadvantage for a good-sized craft brewery). But the access to a big brewer s distribution network, technical resources, back office support (e.g., legal, administrative), and other factors may outweigh such barriers. All of the above will likely fuel unprecedented transactions in the craft brewing industry. Structuring the Transaction The choices for an exiting owner generally fall into two categories: a sale of the stock Photo Thinkstock/Feverpitched 26 The New Brewer January/February 2015 BrewersAssociation.org

2 or other equity interests in the company to a buyer, or the sale of all of the assets of the business. As a general rule in M&A, sellers prefer stock deals and buyers prefer asset deals. In a stock deal, all of the assets and liabilities (including legacy liabilities) of the business convey to the buyer by operation of law. Putting aside any indemnification obligations that the seller may have to the buyer in the purchase agreement, a stock deal allows the seller to walk away from the business and legally leave behind all obligations and liabilities. Similarly, from the buyer s perspective, a stock deal is the best way to ensure that the buyer gets all of the assets of the business, including all contract rights (but make sure you check for any change in control clauses in the contracts during due diligence), because when the buyer purchases the seller s stock, the buyer legally steps into the seller s shoes. But a stock deal also means that the buyer inherits all liabilities of the business, even the ones he or she didn t know about. In contrast, an asset deal is mechanically more onerous for the parties. In an asset deal, the assets of the business (real estate, vehicles, contracts) must be specifically conveyed or assigned (again, watch out for anti-assignment and change in control clauses in those contracts) to the buyer. Buyers have to be sure that they obtain all of the assets required to run the business, including intellectual property (trademarks, copyrights, recipes, etc.) and key employees. On the flip side, in an asset deal, a buyer usually will only walk away with liabilities that he or she expressly assumes, so a buyer of a brewery business with a spotty environmental record can structure the deal to avoid inheriting any legacy liabilities, while a buyer in a stock deal, in most cases, cannot. The primary driver in choosing an acquisition structure, however, is tax. Generally speaking, a stock deal is advantageous to the seller because he or she can benefit from lower capital gains tax rates. On the other hand, from a buyer s perspective, an asset deal is advantageous because the buyer gets a step-up in the tax basis of the acquired assets. This allows for future tax savings through depreciation and amortization deductions, as well as lower gain on the sale of such assets. A complete sale may not be the only option available. Selling partial interest in a company to a strategic investor, perhaps as the first step in a complete sale, is another alternative that both sellers and buyers may consider. From the seller s standpoint, it is a way to raise much needed capital (assuming it is not distributed out to the owners) to fund expansion and growth. As everyone knows, however, the money received will come with some substantial strings attached. Buyers will negotiate for significant control rights, including seats on the company s board, and many owners who have run their business for a long time are not willing to share power. These days, one of the primary competitors to the traditional sale of a craft brewery is an ESOP transaction sale to the brewery s own employees. In 2012, the owner of Colorado-based New Belgium Brewing, Kim Jordan, sold her controlling stake in the company to its employees. Today, 100 percent of New Belgium Brewing is employee-owned. Breweries tend to be good candidates for ESOP transactions since they have strong cash flow, little debt, a history of increasing sales and profits, and loyal employees who are eager to invest in the company. Sales to ESOPs traditionally require the company to borrow money BrewersAssociation.org The New Brewer January/February

3 from an outside lender and loan that money to the ESOP, which then turns around and purchases the shares from the founder. While taking on debt will be a burden, it is somewhat mitigated by the fact that contributions that the company makes to the ESOP to repay the internal loan are tax deductible, subject to certain limitations. A properly-structured ESOP transaction also provides the founder with the opportunity to defer, or even eliminate, capital gains taxes. Going forward, the company can deduct the value of the shares it contributes to the ESOP and the dividends paid on shares held by the ESOP. Regulatory Considerations A secondary but important factor in planning and executing the purchase or sale of a craft brewery arises from the maze of alcohol beverage regulatory requirements imposed on the industry. These factors can substantially influence deal structuring and in some cases can put up an insurmountable roadblock to a proposed transaction. As a first step, the alcohol regulatory system requires an element of due diligence of the buyer(s). As every craft brewer knows, this business involves myriad permits, licenses, and other approvals from both the federal government (mostly the Alcohol & Tobacco Tax & Trade Bureau, or TTB) and from almost every state in which the brewer conducts business. Alcohol regulatory authorities will be reluctant to issue a license to any owner, officer, or director with a criminal record or some other significant background flaw (e.g., an ongoing tax dispute with the IRS). A buyer should conduct its own internal due diligence to identify any potential licensing obstacles prior to embarking on an acquisition. A more common problem arises from the tied-house rules separating (albeit unevenly) the various tiers of the industry. Most of these laws and regulations contain broad language prohibiting direct or indirect ownership interests between tiers particularly between the retail tier and either of the upper two tiers of the industry. Moreover, few of the laws contain broadly-applicable exceptions, and those that exist are often very particular and require careful evaluation to determine if they might apply. The existence of tied-house rules presents a formidable obstacle to many institutional investors, who have vast holdings across the country or the world that, quite often, will include hotels, restaurants, grocery stores, or other businesses licensed to sell alcohol beverages at retail. We have found that today, experienced alcohol counsel is essential to the early evaluation of almost any acquisition by a significant institutional investor in order to detect and, if necessary, evaluate and resolve any potential tied-house issues raised by the transaction. Moreover, even if no tied-house issue exists at the time of the craft brewery investment, an institutional investor would be wise to recognize and understand how ownership of a brewery may impact future potential investments in the retail or wholesale sphere. Transactional planning must also take into account the maze of permits and licenses held by the typical craft brewer. Every brewery will hold at least one TTB-issued Brewer s Notice and a license in the state in which it operates. Craft brewers that distribute in many states or have multiple locations (e.g., a brewpub chain) will hold many more licenses and permits. As these government approvals are necessary to legally operate the business, transaction planning must ensure that the proposed change does not result in a gap in licensing, at least not in materially important jurisdictions. 28 The New Brewer January/February 2015 BrewersAssociation.org

4 A host of factors influences the license transition process, and the licensing process itself may influence transaction structuring generally. For example, the license transition process for an ownership change by way of a stock/equity sale is much easier to accomplish in most jurisdictions than a change achieved through an asset sale. While only one consideration among many, then, alcohol licensing considerations standing alone generally favor stock sales over asset sales in the alcohol beverage space. Other considerations abound. For craft brewers, another important consideration, noted briefly above, involves the availability of the small brewer tax rate and, perhaps, other special benefits that a potential buyer may not qualify to receive. Virtually all craft brewers today qualify for the federal small brewer excise tax rate on their first 60,000 barrels of production. But acquisition by a brewery producing more than 2 million barrels (regardless of where) would make the craft brewer ineligible to receive this benefit if the larger brewer s investment puts both brewers within the same controlled group. Moreover, even a sale to or merger with another small brewer can have a significant excise tax consequence, as each controlled group is entitled to just one 60,000 barrel amount at the lower excise tax rate. Distribution Considerations Distribution presents another area for unique due diligence in the alcohol beverage space. This factor usually does not come into play, of course, if the craft brewer in question is a brewpub. Moreover, an institutional investor with no distribution network of its own will not likely do much to change existing distribution channels. But in the case of a strategic buyer or any transaction involving multiple packaging breweries, distribution synergies (or the lack thereof) loom large. By conventional wisdom at least, consolidated distribution of multiple brands represents the best option in most jurisdictions, most of the time. In the typical transaction, then, an acquirer of a business wants to quickly consolidate distribution networks, achieving considerable synergies in the process. But the beer franchise laws enacted by many states do not permit easy consolidation, even when the new owner only purchases the assets BrewersAssociation.org The New Brewer January/February

5 of a craft brewery and specifically does not purchase or assume the contracts of the craft brewery changing hands. Due to the operations of these franchise laws, a potential buyer cannot expect the same quick synergies buyers in other industries might enjoy. Instead, while consolidation may be relatively easy in some jurisdictions, in many others the process will require either negotiating a voluntary transfer of the brand or proceedings to determine the fair market value owed to the distributor losing the brand due to the change in brand ownership. The details will vary substantially from state to state, so conducting due diligence on this aspect of a transaction early will avoid surprises and maximize the ability to achieve at least some consolidation in the wake of closing. The business of craft brewing continues to grow and evolve. That growth will likely continue to attract investments both from inside and outside the brewing industry. And as the first-generation owners seek to monetize their hard work, a reasonably large number of transactions will likely occur in the next decade. Marc E. Sorini is a partner in the law firm of McDermott Will & Emery LLP, based in the firm s Washington, D.C. office. He is the leader of the firm s Alcohol Regulatory & Distribution Group. Recognized as one of the leading lawyers in his field by Best Lawyers and the Chambers USA directory, he advises breweries, distilleries, wineries, and importers on regulatory, litigation, licensing, distribution, advertising product formulation, and taxation issues. Tom Conaghan is a partner in the law firm of McDermott Will & Emery and is based in the firm s Washington, D.C., office. Conaghan represents both publicly held and closely held businesses, underwriters, and other sources of capital, corporate boards and board committees, and corporate executives. He represents buyers and sellers in merger and acquisition transactions, including cross-border business combinations, going private transactions, stock sales and purchases, and asset sales and purchases. Conaghan has led several M&A transactions for alcohol beverage clients. n 30 The New Brewer January/February 2015 BrewersAssociation.org