Over the past decade, we have witnessed the meteoric rise of craft breweries across the country. Now the craft brewery industry has evolved toward a steady, mature growth pattern with more solid competition than we’ve seen in the past. In this crowded new environment, what do breweries need to consider when exploring craft brewery expansion and capital options? In short, you should master your business, determine your brewery’s trajectory and explore your funding choices. Also, keep in mind that raising capital is time-intensive and requires considerable organization.
The state of things in the craft brewery world is very different than they were five years ago. While it’s challenging to sum up the complete story of craft, we’ve seen phrases like “guarded growth” and “mature market” used to describe where the industry currently stands. In its annual growth report, the Brewers Association stated 7,346 craft breweries were operating in 2018 compared to just 3,814 in 2014. Of those breweries in 2018, 4,521 were microbreweries, 2,594 were brewpubs, and were 231 regional craft breweries. Throughout the year, there were 1,049 new brewery openings and 219 closings—a closing rate of 3 percent. Overall, craft beer growth for 2018 was four percent by volume, which increased craft beer’s total beer market share by volume to 13.2 percent.
“The beer landscape is facing new realities with category competition, societal shifts and other variables in play. There are still pockets of opportunity both in terms of geography and business model, but brewers need to be vigilant about quality, differentiation and customer service,” says Bart Watson, chief economist with the Brewers Association.
Back in 2015, Entrepreneur Magazine made the bold statement that craft breweries were fail-proof, but we know now that’s not the case. We’re seeing tenured breweries closing due to financial stress. Be honest about the financial health of your business. “If there is stress, immediately recognize that and create a forward-thinking plan for success,” emphasizes Matthew McLaughlin, Southeastern based attorney specializing in craft breweries and the alcoholic beverage industry.
Consumers are more educated, they are seeking community and they are diversifying. Even if you’re not considering a craft brewery expansion, you should always ask yourself two questions: How is my brand different, and how can I deliver an experience my customers want?
Lifestyle or High-Growth Business?
Growth doesn’t necessarily need to be aggressive and expensive. Being honest about whether you prefer a lifestyle or a high-growth business is important. Many owners are not interested in being a state-wide or regional player. However, breweries within 3,000 to 10,000 barrels are growing the fastest, so many are choosing growth over lifestyle.
Craft breweries typically expand within the first three years due to capacity restraints. Before expanding, you must project future growth on current and real demand. Analyze your taproom, self-distribution and needs of local accounts first. Always expand where the margin is the healthiest and the return on investment is quick. Focus on distribution outside of your local demographic by understanding your competition, how well your brand will translate to non-local markets and how profitable each new market will be. Are there non-profitable markets or sales channels that are stealing capacity or resources from a more lucrative opportunity? If you have not mastered your business as it is today, then you are not ready for expansion.
In a more mature business, your expansion might be larger by scope and budget. You may be considering additional locations or a much larger production facility. Understand the strengths of your business operations today and project profitability of adding additional sales channels. Where are the inefficiencies in your business model and how can you cut costs? How strong is the relationship with your distributor and their ability to sell additional volume? Do you see consolidation in their future? Is there a strategic merger, acquisition or distribution opportunity with a different business other than your brewery? How large do you need to expand without overbuilding?
The ideas above are barely scraping the surface of what to ask yourself when expanding. Starting with a deep dive into your current business model and financials can help you understand how the business will be more efficient and profitable for a craft brewery expansion. Simply put, master your business.
Often brewery owners will discuss an expansion without a real plan. They justify an expansion based off selling out taps or because their distributor encouraged it, but knowing the “why” of the expansion is the most important question. You should consider the profitability of the expansion and work through a detailed business plan and projections. Consider discussing your expansion with a specialized lender or business consultant to point out ideas to consider in your plan.
“If you want to establish a lifestyle business i.e. one that supports your staff, employees and family, you need to own your market domain and remain small. If you want to regionalize, you better be able to scale because you will be looking for outside debt and equity capital to execute the plan,” says McLaughlin.
It’s important to understand why you want to expand and make sure it’s for the right reason. Now more than ever, we see tenured breweries close their doors or file for bankruptcy. Their finances may not have been healthy enough to expand, but they chose to do so because it seemed like a logical next step. However, many small hyper-local breweries conservatively expand to meet local capacity restraints and are three times more profitable than a larger brewery. If the expansion only leads to top-line growth and stunts or constrains bottom-line growth, then you need to rethink your plan.
Through our team’s extensive experience working with craft breweries, we’ve seen a 3,000-barrel brewery making almost $3 million in revenue while profiting $300,000. Ninety percent of sales come from the taproom. We’ve also seen a 3,000-barrel brewery making almost $3 million in revenue while profiting $50,000. The second brewery was 10% taproom. Both were pushing the same volume, but the margins were night and day.
All money is green, but it’s not all the same.
Breweries are still thriving and growing, and for many, it is time to expand. If you are considering expansion whether the business is two years old or ten years old, an expansion plan and projections are a necessity. Once you have crunched the numbers several times over, then you must understand the capital stack needed to achieve your goals.
Business cash flow, debt, equity and crowdfunding are a few ways to source funds for a craft brewery expansion. Because of the recent big picture shift in the craft industry, you’re going to find a smaller pool of investors, so it’s vital to choose wisely. Of course, there are folks out there who will write you a check with lots of zeros, but you must ask yourself if they bring added value to the business relationship. Also, make sure the investor is willing to back the business in good and bad times.
We’ve seen several messy mistakes when it comes to choosing a quality investor and as a result of these shortsighted decisions, we’ve seen breweries fail. All too frequently, brewery owners are eager to start a business, but possess little financial literacy and promise a crazy and unrealistic rate of return. Additionally, not properly vetting investors is another big issue. “This can lead to violating securities laws if the brewery is relying on an exemption from registration with the SEC, as well as investors that may create federal and state licensing problems due to ownership in other businesses,” McLaughlin adds.
Another common mistake, seemingly rampant in the past few years, is relying on crowdfunding portals. Not only does the hopeful brewery owner make nonviable guarantees to the anonymous backers, but they also run into regulatory issues by accepting money from strangers. You have no way to know if these people shelling out their money have criminal backgrounds, including felonies, which open to the door to a myriad of problems for the business.
When considering a craft brewery expansion, an industry lender can help you assess your capital options and may be able to help you avoid costly mistakes. They will be looking for healthy historical financials and conservative projections. With increased competition and volatility in the market, lenders are unable to lend on projections alone.
With over 100 brewery clients in the Live Oak Bank portfolio, the vast majority are breweries seeking expansion financing. Typically, breweries grow in the triple or high double digits the first four years, but as they mature, growth slows to low double-digit or high single-digit growth. When reviewing a customer’s projections, we gauge how well the client knows the market by the assumptions put into the projected numbers. If a potential customer believes historically high growth will continue forever without concrete facts, then it’s a red flag.
A business needs to have historical positive EBITDA to be bankable. A lender is responsible for proving the applicant can repay the loan. If a business has been losing money year-over-year, then relying on projections to justify repayment is extremely difficult. The historical profitability needs to offset the current debt, plus a portion of the new requested debt.
Per Live Oak Bank’s portfolio of over 100 brewery clients, below are a few metrics of margin in terms of revenue:
- 60-70% gross profit margin
- 25% payroll
- 12% rent payments
- 10-20% net operating income
A craft brewery expansion needs to be carefully thought out and mastering your business as it runs today is a step many owners forget. Before expanding, consider whether your business is lifestyle or high-growth, the plan and budget and how you will raise the capital. What is right for your business may not be right for the brewery around the corner. Even within your business, always be true to yourself.
About the Authors
Kate Lumpkin is Vice President of Live Oak Bank’s Wine and Craft Beverage lending division. Since 2015, Kate has specialized in craft beverage businesses working primarily with breweries, wineries, and distilleries. She understands the unique challenges that owners face and provides a straightforward lending experience to help them avoid costly mistakes and thrive. Kate works from Live Oak’s Headquarters in Wilmington, NC, but travels across the country to meet with craft beverage producers seeking expansion and advising them of their best loan options for their growing business.
Matthew McLaughlin is the founding shareholder of McLaughlin, PC, a boutique corporate, commercial, and transactional legal and advisory firm. He has more than 17 years’ experience representing entrepreneurs and existing industries in highly regulated environments, namely the food and beverage industries. Matthew has worked with more than 250 breweries and distilleries in the United States advising them on a myriad of issues and is regarded as a thought leader on the regulation of alcohol in the United States. He also serves as the executive director of the Mississippi Brewers Guild and received the Brewers Association F.X. Matt Defense of the Industry Award in 2017.