Editor’s Note: Nichole Shustack is a partner in Nutter’s Regulatory Practice and a member of the Alcohol group. Isabelle Cunningham is an associate in Nutter’s Regulatory Practice and a member of the Alcohol group.
After years of rapid growth, warnings that the U.S. craft beer industry was approaching oversaturation have become a reality for brewers. Combined with a new generation of young adults less thirsty for alcohol than their forebears and the impacts of new and increased tariffs, craft brewers are seeing a growing wave of mergers, acquisitions and divestments shake out and transform the industry landscape.
Buyers, sellers and consolidators in this market approach deals with many different motivations. Sellers may be looking for a retirement exit plan or to protect their employees by finding a trusted partner to take over their business, especially those facing the most intense competitive challenges. Buyers may be looking for an opportunity to buy production capacity, intellectual property like protected recipes and valuable trademarks, specific brewmaster know-how, or access to successful brewery-affiliated taprooms and restaurants.
In one high-profile Massachusetts deal that epitomizes a national trend – Jack’s Abby’s acquisition of fellow Bay State craft brewers Wormtown and Night Shift Brewing, creating Hendler Family Brewing – incumbents are seeing great opportunities to expand their corporate portfolios by adding a homegrown brand with a proven track record and consolidating entities with complementary products and markets.
Between the complexity of federal and state regulations under which breweries operate, and the unique cultures and “ways of working” that predominate in the craft beer industry, craft beer M&A participants need to take a thorough approach to compliance, deal structuring and due diligence to navigate a successful merger that satisfies both parties.
Based on our experience counseling participants on both sides of many different kinds of craft beer M&A transactions, here are three best practices we have identified, along with two all-too-common mistakes to avoid.
Do: Understand and Comply with Federal, State and Local Regulations
People inside the industry know – and those looking to get into craft beer often do not fully appreciate – what a complex regulatory regime governs the beer industry.
Throughout any restructuring or M&A transaction, regular and proactive reporting to government agencies is crucial to ensuring successful transaction closing. This includes not just engagement with the Treasury Department’s Alcohol and Tobacco Tax and Trade Bureau (TTB), the main regulator of the industry, but also
(particularly for larger operations), coordinating with the Food & Drug Administration (FDA), Occupational Safety and Health Administration (OSHA) and the Environmental Protection Agency (EPA).
Alcohol is one of the rare examples of a consumer product that is heavily regulated both at the federal and state levels, with each state requiring different reporting and licensing updates in a transaction. For brands with national distribution, that could mean 51 different licensing changes, including a few jurisdictions that may require brands obtain state approval prior to effectuating certain types of transactions. The TTB recently announced it will be stepping up enforcement against companies that do not update their license in a timely or proper manner. Failure to appropriately update or notify TTB brings the potential of production delays, the assessment of fines or can even jeopardize the closing of a deal.
Do: Understand Tied-House and Franchise Laws
Going back to the end of Prohibition, a key goal of the U.S. alcohol regulatory scheme has been maintaining separation among brewers, distributors and retailers to prevent the exertion of undue influence or control over beer retailers. In addition to federal tied-house law, all 50 states have their own versions, most with some unique details and quirks that pose potential compliance risks.
Franchise laws were also born of an attempt to sure up three-tier separation, providing protection for the middle tier, distributors, by leveling the playing field between what was historically categorized as an imbalance of power between large national suppliers and small local beer distribution businesses (the prevalence of local craft brewers and national wholesaler consolidation has greatly changed this dynamic, but franchise laws remain). When it comes to understanding how these bodies of law impact mergers and acquisitions, there are two main issues to consider.First, federal and state tied-house laws generally prohibit entities or individuals from being “interested” in two different tiers. For instance, a director of or investor in a brewery likely cannot also be a director of or an investor in a retailer, such as a hotel or restaurant. For that reason, all organizational individuals and their relationships must be accounted for to prevent the creation of tied house issues during a merger or acquisition.
A famous example of tied house violation involved Mario Batali’s Eataly restaurant and food and wine retailer running afoul of tied-house laws due to Batali’s business partner’s interest in an Italian winery that was deemed to represent an improper cross-tiered ownership between retailer and producer. Investors or acquirers not familiar with the alcohol industry may not even have these prohibitions on their radar when contemplating a transaction.
Secondly, company leadership must understand the existing wholesaler relationships that are impacted by M&A transactions and often difficult or expensive to terminate.
Often, buyers are looking to consolidate distribution footprints, but many contracts include change-of-control clauses that can impact future distribution rights, and state franchise laws often prohibit termination of these relationships solely as a result of a change of brand ownership. It is crucial to determine what options are available under the seller’s distribution agreements, or if consent from or payment to existing distributors is required as a result of a transaction, which often requires careful analysis of state franchise laws and distribution contracts.
Do: Protect Intellectual Property and Brand Identity
Like all products, alcohol brands have trademark protections, familiar branding, customer loyalty and other examples of “goodwill” that must be accounted for during consolidation. Craft beers also come with valuable intellectual property such as recipes and brewing techniques that require protection and proper valuation and transfer during the M&A phase.
Ensuring the confidentiality of recipes and brewing techniques may require carefully crafted non-competes, non-disclosure agreements or other confidentiality agreements from the seller to preserve company secrets and limit future competition. All of these factors must be fully described and accounted for in a transaction to ensure the brand doesn’t lose its competitive edge, customer appreciation and loyalty, and therefore financial value in an M&A deal.
Trademarks like company name, product names and logos must be accurately registered and appropriately transferred as part of a transaction. This may require coordination with the U.S. Patent and Trademark Office to ensure registrations are managed and executed for continued mark validity and protection, and to avoid post-merger legal disputes.
Do Not: Neglect Employee and Stakeholder Considerations
Any transition plans that stem from a merger or acquisition must factor in the legal implications for the involved companies’ workforce, leadership and other stakeholders.
Some of the variables that require negotiation include:
- Calculating pre-merger valuations and pre-existing debts;
- Allocating ownership stakes between the merging companies;
- Creating new equity classes for the post-merger entity;
- And funding buy-outs for departing officers.
The same considerations apply for employee integration from an acquired company: Who will be retained and how they will be integrated among current employees?
Understanding the current retention bonuses, systems and procedures before the acquisition allows the two organizations to establish a timeline for post-transaction policy changes. Getting it right before the deal is key to retaining key talent while maximizing workforce efficiencies and minimizing disruption.In craft brewing particularly, maintaining authenticity starts with the people. When it comes to satisfying and retaining the workforce that’s responsible for creating the product, failing to integrate employees or mismanaging staff transitions can harm operations and company morale and at worst, result in a “brain drain” of the people most important to ensuring the value of the product.
Do Not: Overlook the Fundamentally Different Culture of the Craft Beer Industry
The close-knit, relationship-based culture of the craft brewing industry often sets it apart from other bev-alc operations. In some cases, these relationships span generations or include personal relationships outside the business.
Procurement deals for key items like suppliers for hops and kegs and distribution contracts often originated as handshake agreements – determining how to honor, formalize or amend those agreements are a critical part of any restructuring. An acquirer or consolidator who mismanages workplace culture and customs risks losing employees, industry relationships and customer loyalty.
The Bottom Line
As the once-bubbling growth of the craft brewing industry continues to flatten, the M&A market will continue to evolve.
Consolidation offers tremendous opportunities for sellers to cash out of the business or become co-owners of stronger and more efficient craft brewing operations. It also offers buyers the chance to create stronger, multi-brand breweries taking advantage of acquired companies’ brands, recipes, brewing talent, production capacity and restaurant and taproom sales channels.
Craft beer drinkers will tell you there are few pleasures in life quite like a perfectly poured glass of their favorite brew. Behind that simple pleasure, however, is a uniquely complicated body of law and regulation that requires careful navigation and compliance for M&A participants and investors.
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