Traditional liquidity transactions are rare in the craft beer industry, leaving many founders and early investors with illiquid holdings notwithstanding high intrinsic value based on positive cash flow. This article discusses the options for breweries to provide cash for stockholders, including the recent Employee Stock Ownership Plan (“ESOP”) trend, and explores transaction limitations unique to craft beer. Due to these limitations, particularly the industry’s resistance to traditional M&A, craft brewery owners creatively pursuing liquidity will likely increasingly embrace ESOPs, although they should also consider certain hybrid transaction structures and other forms of debt-financed stock repurchase as well.
IPOs: Expensive and Not “Local”
Today there are only three publicly traded craft breweries, Boston Beer Company, Mendocino Brewing Company and Appalachian Mountain Brewery (although Craft Brewers Alliance, which doesn’t meet the Brewers Association definition of a craft brewery, is also publicly traded), and there are not likely to be many others in the near future. The high cost of becoming and staying public makes an IPO ill-suited as a liquidity tool for most breweries given their size, particularly since less expensive capital sources are available. Even larger breweries that may afford the compliance costs avoid going public because an IPO sends a mass-market signal at odds with the goal of maintaining a local image.
Sale of Control: Take Your Money and Run
The most common buyers of craft breweries are larger breweries, including high profile companies like Anheuser-Busch InBev and MillerCoors (through Tenth & Blake) and others like Craft Brew Alliance and Duvel Moortgat. These buyout transactions are often disapproved of by industry insiders and enthusiasts, whom criticize them for tarnishing a brand’s local credibility, imposing “big corporate” culture, and leading to sacrificed quality. This sentiment, combined with seemingly endless industry growth, has made transactions rare, with less than ten deals in the past four years. The appetite by large breweries on the buy side will likely continue, however, as the market share of breweries outside of craft declines and growth appears possible only by taking equity in craft.
In addition to large breweries, many financial buyers, especially private equity funds, are very eager to invest in craft beer. Transactions involving financial buyers have been less criticized than acquisitions by large breweries. The industry at-large seems more receptive to these deals – or at least willing to turn a blind eye – because founders generally retain equity and maintain a management role and there is no association with non-financial advantages from being one of the largest breweries in the world. Even these transactions carry risk, however, as private equity funds often require a sale of control, leaving founders unable to prevent future sales of control and no recourse should new owners push short term growth at the expense of the brewery’s culture and long term health. These tradeoffs can also bring negative publicity for a craft brewery, as was the case with Magic Hat Brewing Co.
There is no doubt that the short list of willing sellers has boosted valuations and created a seller-favorable market. For those seeking to maximize the share price, a buyout, whether by a brewery or financial buyer, may be the best path. As time goes on, this strategy may also carry fewer tradeoffs, since the list of potential buyers will grow to include craft breweries that have risen through the ranks to become buyers themselves.
Minority Sales: Find the Right Buyer
While a complete sale may arguably yield the best share price, another alternative is a minority sale transaction with the founders maintaining control. With this structure, a brewery is better positioned to maintain its culture and existing ownership will continue to control its destiny. Also, if a brewery is willing to sell a minority position, deals with other brewers become more palatable, as a brewery can sell up to 25% to a large brewery and still continue to be a “craft” brand under the Brewers Association guidelines.
There remain trade-offs for minority sale transactions, however. For example, while some buyers may be willing to consider minority transactions to break into craft beer, there are fewer interested buyers, as most private equity firms require control as part of their investment criteria. This limited buyer pool likely lowers the share price, unless a very unique buyer is identified. On the other hand, the desire of “macro” breweries to participate in the craft brewing wave at any level may make these buyers less sensitive to the risk associated with being a minority shareholder, although these deals may still subject a seller to “sell-out” accusations even though there is no change-of-control. The continued stigma of being associated with non-craft breweries or private equity funds remains an obstacle to minority investments.
Minority sales may sharply rise in frequency as the pool of buyers that craft breweries find suitable grows to include other craft breweries. Boston Beer Company, for example, has publicly expressed interest in minority acquisitions. Collaborative transactions have also been completed by Stone Brewing (with Maui Brewing), Breckenridge Brewing (with Wynkoop), and Long Trail Brewing (with Otter Creek Brewing). These intra-craft transactions, however, have generally been oriented more for strategic growth rather than for liquidity. The rising tide of craft beer may soon produce collaborations among craft breweries akin to an equity based alliance – a natural progression based on the industry’s current interest in brewing collaborations.
ESOPs: An Emerging Liquidity Resource
Whether to create an Employee Stock Ownership Plan (“ESOP”) has emerged as a hot topic in craft beer and ESOPs are on the brink of exploding with popularity. Using an ESOP, a trust managed by a third party for the benefit of employees borrows money and serves as the investor, providing cash to current stockholders in exchange for stock. The company repays the trust obligation with future profits and the shares purchased by the trust are given to employees through an incentive stock option arrangement. An ESOP can be structured with the employees receiving the stock as a bonus, as a profit sharing arrangement, or in exchange for a cash contribution.
An ESOP is a flexible structure that can be used as a form of liquidity transaction. Full Sail Brewing and New Belgium Brewing have used ESOPs to transfer 100% of their stock from existing owners to employees and have received positive publicity for these transactions. Breweries such as Deschutes Brewery and most recently Harpoon Brewing, on the other hand, have used ESOPs to transfer a portion of their stock to employees – providing an exit for shareholders who opted to participate. ESOPs provide an opportunity for investors seeking to sell off (or those that believe craft beer valuations have peaked) an option to sell at a price that has been independently determined, while allowing other investors to maintain ownership.
Many of the traditional advantages of an ESOP are tax-oriented and these aspects should always be evaluated by legal and financial counsel. With appropriate structuring, these benefits can include reducing or even eliminating federal taxation in an S-Corporation or deferring the sellers’ capital gains tax for a C-Corporation.
The principle reasons for a craft beer ESOP, however, are not tax driven. ESOPs have been lauded as egalitarian transactions that bring employees into the brewery’s family and protect the brewery’s long-term status as a local business. The status of “employee owned” has also become an asset in itself – as some breweries are labeling themselves as “employee owned” in marketing materials. The ESOP financing method not only avoids the stigma of selling out but results in positive publicity in the craft beer community.
As ESOPs become more popular, the offer of equity may become necessary for a larger craft brewery to recruit the best talent for positions where traditionally equity would not otherwise be offered. For example, large Colorado craft breweries may soon be pressured to follow New Belgium’s ESOP in order to remain competitive in hiring assistant brewers and retaining other key personnel. While the author admits that breweries may opt to transfer value in other ways (such as higher salaries), the allure of having equity in the brewery can be a strong draw.
ESOPs are not all sunshine and berlinerweiss, however. ESOPs are not available to certain breweries (LLCs for example) and there are risks and tradeoffs for those who do qualify. For example, owners have to be willing to part with sufficient equity to avoid anti-abuse penalties and have sufficient ongoing revenue to justify the upfront and ongoing transactions costs of the ESOP. Further, an ESOP is often structured as a leveraged buyout of existing stockholders (note that the lending feature elevates the transaction costs) which elevates the debt of the company to pay off the existing stockholders. Also, doing an ESOP usually delays the seller’s liquidity event, since most banks are unwilling to completely finance an ESOP and the selling stockholders finance a portion (or even all) of the transaction by taking a subordinated note instead of cash consideration. This delays the receipt of cash while subjecting the seller to risks inherent to losing control and being subordinated in the capital structure.
Moreover, an ESOP is not the best structure if the primary consideration is obtaining the best possible price, as an ESOP also does not involve multiple potential buyers vying for a purchase and bidding against each other. Rather, the purchase price is set at fair market value as determined by an independent appraiser, and the professional fiduciary representing the ESOP is likely to be conservative in its assumptions regarding fair market value. In contrast, a strategic buyer may be willing to use a higher value based on perceived synergies or an optimistic opinion regarding growth potential.
An ESOP is also not a transaction that will allow a founder to sell and check-out. Most banks financing an ESOP will require management and other founders involved in the business to stay involved. In most instances, this requirement is welcomed, although it makes an ESOP less appropriate for those seeking to transition entirely out of their business.
ESOPs in other industries illustrate the risks of undertaking a liquidity transaction without a traditional third party buyer. If revenue dramatically declines after an ESOP, public opinion (and employees) may perceive the transaction as one in which insiders took advantage of employees through an unrealistic valuation. While the author is not aware of any mispricing allegations for ESOPs in craft beer, there is a cottage industry for litigation surrounding ESOPs which will undoubtedly spill over into craft beer as they become more popular. In fact, the Department of Labor has been devoting additional resources to reviewing ESOP transactions to curb stock mispricing and mismanagement. Due to these concerns, it is critical to obtain professional review of an ESOP transaction by independent counsel for both the trust and the brewery, in addition to the third party financial valuation.
Combining ESOPs with Other Transactions: The New Frontier for Craft Beer
While many financial investors think of ESOPs as competitive transactions, an ESOP does not have to be mutually exclusive with a sale to a financial or strategic buyer. For example, while a portion of the stock could be purchased by a third party buyer, the remaining portion of the purchase could be set up through a parallel ESOP – either with the third party or the ESOP trust obtaining the controlling stake. This combination takes financial pressure off the buyer and may bring the total deal price low enough to attract a wide buyer pool. This structure also provides immediate cash to sellers that would not be available in a pure ESOP transaction. Further, if an acquirer is a large brewery, this combined transaction may minimize the “sell out” stigma and help retain the brewery’s good standing with employees notwithstanding the change in control.
An ESOP combination transaction structure has not been used in the craft beer industry yet, although the potential for added value compared to traditional transactions or pure ESOPs should make craft breweries consider it as an alternative as well.
Debt Financed Liquidity
Craft breweries are capital intensive businesses and commercial debt is generally more available to breweries than other business, because brewing equipment provides significant security. So long as the company and equipment assets are not already over leveraged and the company has sufficient cash flow to service the debt, commercial debt can be a cost effective way to fund a liquidity transaction without using cash needed for operational purposes.
Breweries using this liquidity structure have obstacles to navigate as well. For example, they should be careful to (i) negotiate for appropriate covenant language that will permit the contemplated stock repurchase transaction, (ii) verify that the transaction is permissible under the company’s corporate governance documents, including any shareholder agreements, (iii) ensure that the debt financed stock buyback will not cause a default under any other existing contracts and (iv) address any applicable tender offer rules, depending on the buyback’s structure.
Final Thoughts on Untapping Liquidity
While a traditional corporate finance and M&A menu remains theoretically available for craft brewery owners seeking liquidity – and pure sales should remain the primary option for those seeking to maximize the liquidity event – these transactions remain uncommon due to the craft beer community’s distaste for most active institutional buyers. It is also the author’s perception that the relative low supply of sellers is due to a sense among current brewery owners that their revenue will continue growing – and who wants to bail just as business is getting good?
In light of these unique limitations, ESOPs present an option with advantages for the brewing industry, as do minority sale transactions with larger craft breweries and debt financed stock buybacks. Further, the possibility of combining an ESOP with a third party sale is an untapped structure for craft beer liquidity with the potential to accelerate the cash event for sellers and make traditional sales more palatable to the industry by ensuring local ownership and protecting craft beer’s culture.
Kyle Leingang is an associate in the Southern California office of Dorsey & Whitney, LLP. Kyle’s law practice includes representing craft breweries and investors in M&A and financing transactions, including ESOPs. Kyle is also a certified BJCP judge and avid homebrewer. Kyle can be reached at leingang.kyle@dorsey.com.