Does an ESOP Make Sense? Craft Beer's Growth and Consolidation

By Damien Vira

The craft beer industry has witnessed explosive growth over the past several years, eschewing its former microbrew moniker. Although craft beer is no longer a niche product—accounting for more than 11 percent of the U.S. beer market according to the Brewer’s Association, and with growth not expected to plateau for several years—it has had its share of growing pains.

The consolidation and sale of some beloved brands to Big Beer has raised eyebrows and piqued new questions about the industry’s identity. As a homebrewer the spirit of the craft resonates with me. I have on occasion waxed poetic about my favorite brews and also felt a sense of loss when learning about some of Big Beer’s acquisitions. The good news is the industry is still expanding with more than 4,000 U.S. craft breweries, over 100 in San Diego alone, and there is an opportunity for employee stock ownership plans (ESOPs) to play a larger role in the industry’s future.

State of the Industry

The craft beer industry is a vibrant business. Changes in consumer taste along with increased deregulation of the three-tier distribution requirements has fueled much of craft’s meteoric growth. Meanwhile, traditional beer brands have stagnated, especially in comparison to the nearly 19 percent year-over-year growth in the craft segment. This dynamic coupled with healthy margins has attracted institutional investors and conglomerates. Valuations for craft brewers have soared, with recent deals being priced in the 20 to 30 times EBITDA range.

Aside from record valuations, what is the impetus behind the uptake in sales and consolidation? One must first understand that most the craft breweries in the U.S. were founded out of a passion for the craft itself. Maximizing profit and absolute return were probably not in the minds of many founders; instead they cherished the creativity, community, and artisanal qualities of the craft. In sum, they just wanted to brew great beer. However, as the industry rapidly expanded over the past decade founders began to face new challenges. Today, many craft brewers are capacity constrained and face significant distribution hurdles. The complexity of larger operations has increased exponentially requiring new skillsets. Smaller craft brewers have limited control over input costs and are increasingly fighting for shelf space. Many founders are also confronting the reality of business succession and that the majority of their wealth is tied-up in one asset. High valuations and these combined pressures have made exits to institutional investors and Big Beer attractive. However, there is still considerable resistance within the industry to the siren’s song. One possible and attractive exit strategy for founders and craft beer shareholders is an ESOP. 

ESOPs

An ESOP can be a compelling finance technique enabling craft beer employees to acquire a large ownership stake in their company. ESOPs are employer sponsored tax-qualified defined contribution retirement plans. ESOPs enjoy substantial tax advantages that offer important benefits to the company and its current owners. Several craft beer founders have successfully exited to ESOPs, with the most prominent sale being that of New Belgium Brewing, which now is 100 percent employee owned. It should be noted that ESOPs are a tactic and certainly not right for every business or craft brewer, but with dedicated management and clear strategic goals they can be a powerful tool that retains the soul in craft beer.

Advantages

ESOPs can offer several advantages to a craft beer selling shareholder. They are a tool for liquidity, enabling the founders to take some chips off the table in a potentially tax advantaged way. The flexibility they offer sellers is really second to none; a seller can choose to sell gradually, liquidating whatever stake they desire, whereas few other buyers will take a minority interest in a closely held private company. Once established, an ESOP also becomes the natural buyer for any future stock sales.

The benefit to the company can also be significant. Contributions to the ESOP are tax-deductible within certain legal limits, and since ESOPs are tax-exempt entities, any earnings attributed to the ESOP are also tax-exempt enabling the firm to reinvest what was formally income tax in growth. Lastly, an ESOP can be a significant employee benefit, creating more wealth with less volatility than a comparable 401(k) plan. With a common vision, autonomy, and an atmosphere of trust and respect, an ESOP can enable employees to share in the growth and success of craft beer. 

Drawbacks

Each craft brewery’s needs are a function of unique circumstances interacting with unique objectives. Just because an ESOP is right for one brewer does not mean it is the correct tactic for another. The tax advantages ESOPs potentially afford brewers come with not insubstantial legal and regulatory requirements. Furthermore, the expertise in marketing, operations, and the distribution network Big Beer offers cannot be replicated in an ESOP. ESOPs are also forbidden from paying more than fair market value for the stock purchased. Although appraisers will take into account the future cash flow of the craft brewer as well as examine recent M&A transactions, an ESOP cannot pay a strategic premium for stock that one of the Big Beer conglomerates is able to do. Lastly, the continued success of an ESOP requires commitment from leadership. Employee ownership creates its own stress areas and continual confirmation of the culture is required for success. 

Conclusion

The high valuations and external market pressures have resulted in numerous craft brewers selling and/or exploring sales to outside investors and conglomerates. Once thought of as “the man,” Big Beer has become a viable liquidity and exit strategy for several of our most beloved brands. However, there is another option for craft brewers worth exploring: employee stock ownership plans. Not only is there a precedence for ESOP success among craft brewers, but the passion craft beer employees have for their work enhances the benefits and probability of success of an ESOP. An ESOP is not the correct fit or a panacea for every craft brewer, but should be seriously explored as a means to create value for all stakeholders.

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