Friday, June 4, 2010

On Raising Money

As many of you know, I am an attorney. What many of you may not know is that I started my career in software development during the first internet boom of the mid-to-late-90s. None of this legal advice, nor am I even commenting on the legality of the models put forth. It's just a summary of many conversations I've been having over the past few months. Today and Monday we'll look at some rather unique models for encouraging startups in the brewing industry based on some models that the software industry uses.

What I always find interesting is the similarities between the software and brewing industries. You typically have a small group of very knowledgeable people with little capital but a huge amount of talent trying to get a company off the ground. Initial, proof-of-concept, costs are fairly low. But soon the marketing and production costs begin to skyrocket.

Technology folks talk about the start-up cycle as consisting of a few elements: 1) idea, 2) proof-of-concept, 3) marketability (sub-divided into salability and profitability), 4) scalability, 5) sale. So, 1 and 2 typically are handled by one or two people. It is late part-two or part three that seed funding begins. Is the idea marketable, will people, anyone, use the product and can the product be profitable? At this point, a third person, a marketing-specific person, might be brought in. This is typically a first-round of seed funding that covers the cost of bringing the third person and some marketing efforts and to finish rough development.

The second step, early-stage funding, typically focuses on seeing if the idea scales. This is where more developers are hired and a CEO might be appointed from a Venture Capital firm to oversee costs and product development to make sure scalability can happen in a profitable manner.

Finally, the product is sold off to a company interested in the technology, brand, or whatever. The difference in how much the investors put in, and how much the company/brand sells for, is where angels and VCs make their money.

In the brewing industry, however, instead of labor costs - initial start-up capital is almost entirely equipment-based. But interestingly, the numbers are fairly similar to a start-up technology company. Where a technology startup might need to raise $500K in a three-year cycle, a brewery needs to raise $500K now, but it will last for three (or more years - and bonus, you can sell it at the end unlike sunk labor costs for hiring a $100K developer and bunch of computers that will obsolete in three years; we can talk some other time about the technology industry's developments to reduce equipment costs, though)

Yet breweries have a harder time finding start-up capital than technology companies. There is an entire investment structure around funding technology companies.

What I propose is that breweries could be funded by similar "angel"-style investment along the model of software development. It would require thinking about brewing in a new way and would look at brewers, breweries, and brands in a more commodified manner from an investment standpoint (even if not from a consumer-facing standpoint). So, what brewers need to think about, and what they've never thought about before, but what angels will ask as one of the first questions is: what is your exit strategy? Are you looking to hold? Or are you looking to sell off brands? The latter is more attractive, but represents a rather large shift in the brewing model.

But think about a brewer like Mikkeller. It owns no brewery, no stainless. Mikkel basically shops his services around and contract brews everyting. It's an interesting model. A professional brewer, with his own recipes, but no stainless. He takes his recipes and brews them under his label at various breweries around the world.

But, what if he licensed his recipes to breweries? He'd have even lower costs with returns based on sales generated by other companies. He could tap into their success to sell his brands. The brewery licensing his recipes would get "Mikkeller" recipes to market which carry a premium on the market.

You have a product with very low costs to get to market, but the equipment itself has very high costs. So, basically dividing up the brands produced on the equipment could be one way to split up the cost.

For example, an investment group is looking for 10% return. So, on a $1,000,000 investment they want to get $1,100,000 back. In software, the way it works is that the angels give the company $1,000,000 in return for stock, then when the company is sold to someone who wants the technology, the angel, in theory, gets something more than $1,000,000 in return. But, breweries don't really work like that. You don't really ever "sell-off" a brewery in the same course, or meaning, as you "sell-off" a software company. But you can, or could, "sell off" brands.

So, say, again, you have a brewer like Mikkeller. Mikkeller could "sell off" let's say "Jackie Brown", a wonderful, hoppy, brown ale. A brewery like, say, Sierra Nevada, without a brown ale but a rather sizable distribution network, could purchase (or license) Jackie Brown from Mikkeller. While, of course, the beer would be brewed by Sierra Nevada, not Mikkeller, the recipe would be the same and there is some portion of the goodwill that would transfer - there is plenty built-up in the marketplace - and it would, of course, be necessary during the change-over to insist on some amount of quality control. But at the end of day, there would be "Sierra Nevada Jackie Brown by Mikkeller" not "Mikkeller Jackie Brown". As certain brewers get known for these kinds of transactions, a greater portion of the goodwill will transfer as the marketplace begins to recognize "start-up" or "recipe" brands.

But, in this way, shortening the sale cycle from, essentially, never to approximately 1-3 years for a brand to build a reputation in the market is much more in-line with the software life-cycle. So, a brewer would need to sell 11 brands at $100,000 each to recoup the investors' money. Thinking about the life-cycle and proliferation of brands, this is extremely possible. Separating out the brewery equipment entirely to create a "brewing incubator" would also be possible - a pure alternate proprietorship where investors could make money on the equipment itself, not just the brands that it spins off.

Finally, these models provide more immediate, quantifiable, returns and more exit points for investors who aren't necessarily interested in owning a brewery, but want to make money off of the brewing industry. An investor could quantify, and valuate, what specific brands developed by a particular brewer are worth and there would be competition in an investment marketplace for brewers, not just brands.

I'm not saying that this model is for everyone. Though in reality, with the sale of distribution networks to and among distributors, there is already some of this in the second-tier. I'm really just proposing the second-tier sale to the first-tier. But, it is an option that brewers who are trying to figure out how to raise money could look into.


  1. This is really interesting. It's very clever but makes me feel uncomfortable at the same time, but I'm not sure why. A relevant parallel discussion would be about how brand (or brewery) credibilities change as these transactions occur, and whether or not it screws people in the end. Like underground bands signing to major record labels, if that sort of thing even happens any more, I'm sure there are good and bad ways to do it.

  2. I'm not sure it would work to try selling the brand to another craft brewery. Craft breweries have brewers proud of their signature brands and styles and I think it would be a tough sell. Your real market for selling craft brands is the big breweries. They're losing market share (ok, it's small, but it's there) already to craft beers and are desperately seeking to emulate craft beer styles with their specialty brews and their "unbranded" labels. I think a line of specialty brews that could trade on the cache and name recognition of a poular craft brewer isn't too far fetched. Michelob presents Mikkeller Jackie Brown.

  3. Joe - that's a very good point that I intentionally ignored. I think a lot of that debate will change as the marketplace gets used the idea; much like public perception of contract brewing is changing. It is also highly dependent on quality control both by the seller and buyer of the brand. But, just like any other brand in the brewing industry, certain brands would be recognized for "selling" or providing a high-quality experience and some brands would be recognized as providing not such a high-level of brand control.

    Brett: I don't envision it as necessarily REPLACING the craft brewery's own creations - there's no reason, say, New Glarus couldn't buy Mikkeller Jackie Brown and market it as "New Glarus Jackie Brown" along side it's own creation of "Fat Squirrel" - to the extent the two cannibalize each other, as long as the final result is "more money" who really cares?

  4. To expand on the market idea: it seems to me that this opens up a whole market in breweries selling brands to each other. If a brand, to stay with our example of "Jackie Brown", doesn't work for Sierra Nevada, they could either sell it back to Mikkeller or, possibly, sell it on to another brewery, for example New Glarus or something which then could take a stab at making it marketable under their own label. In fact, it would open up a whole world of interest among craft consumers to compare and contrast different breweries brewing the exact same brand.

  5. Well, that's the thing, though. What does New Glarus (to use your example) gain from New Glarus Jackie Brown? To use the Mikkeller name says, "we think this is better than what Dan can come up with on his own," (I liked it so much, I bought the company!) but to not use it, you lose it's marketing cache, which is what you're paying for - unless Mikkeller's beer is just so astounding on it's own merits that it sells itself, regardless of what it's called. Personally, I think it'll be a hard sell to a truly "auteur" craft brewery like New Glarus. And, I think most professional, successful brewers would rather brew their own beer, under their own brands with their own recipes. Sierra Nevada is certainly open to some fun experimentation, as seen with the recent Master Brewer series (or whatever they're called), but I'd hardly expect them to add another brewer's beer to their flagship brands.

    Also, I have serious doubts that any craft brewery would be able or willing to pay anything like $100K for a recipe, but I don't know the financial side. As much as they claimed a $2/bbl tax hike would put brewers out of business...

    I think if this idea has any chance of success, it's with the big boys. After all, it's the Googles and the Apples who gobble up the start-ups, not other, slightly more successful start-ups.


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