Part 1 of this series discussed state licensing for establishing a brewery. Part 2 discussed municipal and county regulations for a new brewery. Part 3 discussed the process to receive federal permits, labeling requirements, and brewer’s bonds. Part 4 will discuss selecting a brewery’s business entity and distribution methodology.
On of the first steps in any business is to determine what type of business it will be structurally. There are four basic forms of business entities from which to choose.
The first entity is a sole proprietorship. This form of business is separate from the owner in name only. This entity can only exist where there is a single owner of the company. The government does not regulate how the business is managed (other than legal requirements imposed on any brewery), which gives the owner the highest level of managerial control and allows for income to only be taxed once, but also leaves the owner personally liable for anything the business does. Therefore, if a brewery employee does something that leaves the brewery liable in a lawsuit, then the owner can also be sued for his personal assets on that basis. (However, such liability exposure can be significantly minimized with the appropriate insurance).
The next form of entity is a partnership. This entity requires there to be more than one owner. A formalized partnership agreement is not required in order to form a partnership, though it is recommended to prepare a written agreement to avoid problems in the future. A partnership provides the same benefits and drawbacks as a sole proprietorship, only with partners.
A corporation is another form of business entity. A corporation’s primary benefit is that it limits personal liability, meaning that an owner ordinarily cannot be sued personally for something the corporate brewery did. In reality, the liability protection is not nearly so perfect. There are several types of liability for which personal liability cannot be shielded by the corporate form. Additionally, there are several claims that attorneys and creditors make to try and circumvent the corporate liability shield. Finally, many creditors require a personal guarantee when a small or new corporation is involved.
There are two main issues in forming a corporation, however. The first is that there is a greater degree of regulation regarding management. Second, paperwork (called articles of incorporation) must be filed in order for a corporation to exist (without the articles, the business will either be a sole proprietorship or a partnership). From there, there are a series of regulations, including the requirement for a board of directors, dividing the company into shares, and many more. This creates more formalities and procedures that must be followed, requiring time and expense, and reducing flexibility. The other problem with corporate entities is that income is the potential for double taxation: once when it is corporate income, and another time when it is paid to shareholders. With proper tax planning, such double taxation can be minimized with offsetting expenses, including distribution of profits via payroll rather than dividends. Additionally, many smaller closely held corporations qualify for a Sub-chapter “S” election, allowing for “pass through” of income treatment similar to partnerships.
The last form of business entity is actually two separate ones that operate similarly. They are known as limited liability companies (LLCs) or limited liability partnerships (LLPs). These forms of entity are relatively new, and each state imposes a different degree of duty on each. Essentially, these forms of entity seek to blend the limited liability of corporations with the tax benefits and loosened regulations of a sole proprietorship or partnership. Again, either of these entities begins by filing paperwork at the state level, and the business will be treated as either a sole proprietorship or partnership without the paperwork. The requirements and benefits can vary greatly depending on the state, so the specifics should be investigated.
Each form of business entity has unique attributes but a “C” corporation tends to be the most popular for breweries because it has significant advantages for raising business capital from investors. Additionally, corporations tend to have some fine grain advantages with respect to things such as deductibility of health insurance, eligibility to sponsor certain types of retirement plans, and so on. However, other entities have advantages that may work better for the particular business. Thus, the decision between choice of entity is best made with the advice of an experienced business attorney and a CPA. It should be noted that a business does not necessarily need to file in the state it is located, and so that decision may be made strategically as well (however, this choice is not without limits. For example, any entity that is “doing business” in California must file an annual tax return and pay a minimum $800 annual tax “for the privilege of doing business in this state.”) Regardless of the ultimate decision, sometime should be dedicated to deciding the form which the brewery’s business will take.
Breweries must distribute product. Only a few breweries with primarily a restaurant focus, i.e., brewpubs, will be satisfied by selling only directly to consumers. These are limited to certain brewery license types or to brewery “tasting rooms.”
Although a brewery can take it upon itself to sell directly to retailers, such as bars or stores, most breweries choose to use of a distributor. Distributors typically have an extensive retail customer base, which would be impossible for the brewery to duplicate. Contracting with a distributor can leave the brewery more time and resources to focus on creating and brewing. The manner in which the brewery pays the distributor is entirely between the brewery and the distributor. The distributor could make commission, purchase the alcohol up front and keep all profits, simply be paid to be a salesperson, or any other method the two parties agree upon. Furthermore, the parties can include different rights or restrictions on the distributor, such as giving it exclusive distribution rights or only giving it rights to distribute in a certain region.
Distributors have relationships with a number of alcoholic beverage manufacturers and thus are typically well versed in the finer points of distributorship agreements. They have a tested set of contracts that they use. On the other hand, breweries have only had a few, if any, prior distributor relationships. Thus, generally speaking, the distributor has the upper hand in negotiating contracts. Breweries commonly find themselves unable to extract themselves from undesirable distributorship contracts, at least not without a large pay out to the distributor. In particular, breweries must be wary of exclusivity and ensure they have sufficient termination rights. There are a number of important and technical terms in distributorship contracts. However, an over-arching consideration is the ease or difficulty of getting out of a contract that is not working for the brewery, or alternatively, ensuring that the contract contains enough detail and process to ensure a fruitful relationship.