The Legal Lowdown on Starting a Brewery or Distillery
In Start Your Own Microbrewery, Distillery, or Cidery, the staff of Entrepreneur Media Inc. and writer Corie Brown with Zester Daily Contributors explain how you can get started in the craft alcoholic beverage industry, whether you want to start your own microbrewery, distillery or cidery. In this edited excerpt, the authors take a look at some of the state laws regulating the craft alcoholic beverage industry.
With the repeal of Prohibition, the federal government got out of the business of regulating alcohol distribution and gave it to the states. Each of the 50 states and the District of Columbia has its own distinct set of rules for each kind of alcoholic beverage. The resulting state-specific regulations means a production facility may meet the requirements of its home state, yet fall short of the requirements necessary to sell products in the state next door. Below, we’ve detailed the ways in which a few states do business to show you how diverse the business environment can be for the craft industry.
“We still had Prohibition marketing laws [in Texas] when we opened in 1994,” says Brock Wagner, founder of Saint Arnold Brewing Company in Houston. “You couldn't have a pre-arranged promotion at a bar or restaurant. You could have a promotion, but you couldn’t tell anyone you were going to have it. It was like throwing a party without inviting anyone,” says Wagner. “If you opened a brewery, you couldn’t sell beer there. Taprooms are critical for a small brewery to survive.
“The legislature was in the pocket of the beer wholesalers. [As head of the state association representing the beer distributors,] Mike McKinney was the most powerful lobbyist in Texas." After he passed away a few years ago, the taproom law was finally changed in 2014.
Ron Extract, founder of Jester King Brewery in Austin, adds, “A lot of work still needs to be done to make Texas competitive with the rest of the country. But it’s gotten better. When we started four years ago, there were only 25 breweries in Texas. Now there are more than 100, and lots more are planned.”
In general, direct sales, brewery tours, brewpubs, microbreweries, excise taxes, packaging, and franchising regulations are more stringent throughout the southern half of the country; progressive states have been more willing to roll back Prohibition-era laws, even when those rollbacks upset the interests of companies reliant on those established regulatory hierarchies. New York State is among the most aggressive states in this regard.
New York State
Undoubtedly, New York is the most craft-friendly state. Each year for the past four years, Governor Andrew Cuomo has taken further steps to support the state’s craft breweries, distilleries, cideries, and wineries. He's made on-site sales of both by-the-glass and packaged goods legal, simplified or eliminated state permitting, enacted tax cuts, abolished bond requirements, and provided grants for marketing support and self-distribution. “They leap-frogged everyone,” says James Rodewald, author of American Spirit: An Exploration of the Craft Distilling Revolution (Sterling Epicure, 2014). “It’s smart. They don’t have an industrial liquor industry, and they elevated their local grain and produce production out of the commodity market.”
“With things like self-distribution, we’ve carved out exemptions to the three-tier system for small producers," says New York State Liquor Authority chairman Dennis Rosen. "Generally, those tiers have to be independent of each other. We can’t extend the exemptions too far without getting sued for violating the commerce clause.” At this point, Rosen says the state has gone as far as it believes it can to support craft producers. The push back from large producers and distributors, he says, has become significant.
New York’s approach to nurturing the craft sector is having an impact. Between 2011 and 2014, the number of New York microbreweries increased 175 percent to 109 breweries; brewpubs increased 230 percent to 33; cider producers increased five-fold to 28; farm distilleries increased from 10 to 51; other small distilleries increased 164 percent to 37. There are 70 new farm breweries since that license was approved in 2012. Rosen points to New York City residents’ new awareness of the rest of the state and support for what’s happening outside the city as a positive result.
This progressive approach to supporting craft is spreading, particularly in the area of self-distribution and direct sales. Small breweries, distilleries, and cider houses in more and more states are able to sell directly to customers, not just in their taprooms, but also by delivering kegs and packaged goods to restaurants and convenience stores.
In California, spirits producers are gearing up to fight for a New York-style regulatory overhaul. Currently, they're limited to selling a thimbleful of a maximum of six different products to distillery visitors. “We need to be able to sell from our distillery tasting room. It's the only way to tell your story to consumers and know they understand what you're doing,” says Cris Steller, executive director of the California Artisanal Distillers Guild and founder of Dry Diggings Distillery in El Dorado, California.
“Distributors are fighting back hard. California is one of the top five markets for spirits in the world, and they think they're going to give up market share if we can sell out of our distilleries. New York, Colorado, Washington, and Oregon all leapfrogged us. California is down at the bottom with Alabama and Kansas,” says Steller, noting that when he lobbied Governor Jerry Brown on the issue, “he didn’t even know about the rules and called it ‘ridiculous.’ We’ll have this in another year.”
State Distribution Laws
States regulate the relationship between alcoholic beverage producers and distributors through franchise laws. You can enter a franchise relationship with a simple verbal agreement to move a single shipment through a distributor. But if your distributor turns out to be a disappointment, you may be stuck in a loveless relationship.
Franchise laws were designed to correct a perceived imbalance in bargaining power between powerful, national brewers, and the smaller state-specific wholesalers who serve them. In reality, consolidation has made both sides of that equation evenly balanced. The mice in the room are craft producers. Cancellations, failures to renew, attempts to modify a distribution agreement are all restricted by franchise laws written to protect the distributor.
Worse, franchise laws vary by state. The BA has created a database of U.S. beer franchise laws governing beer sales in each state. Before entering a contract with a wholesaler, you should learn how specific states regulate this relationship because state laws may trump contract terms. With spirits, there are two types of state regulatory environments. Open states allow alcoholic beverages to be sold through private entities; control states sell through state liquor control boards. State franchise laws trump distribution contracts for spirits in open states just as they do for beer.
Eugene Pak, an attorney with the law firm of Wendel, Rosen, Black & Dean specializing in brewery law, suggests getting professional help before entering any distribution arrangements. Mistakes here are critical. “Set a term for your distribution agreements to expire. Most states prohibit termination without cause,” he says. And if they do allow you to walk away from an unhappy relationship, you will pay dearly—one to five times your net profits.
There's great disparity and volatility in state taxation rates. For beer, Tennessee has had the highest state excise tax at $1.17 per gallon followed by Florida and Georgia at 48 cents per gallon. Wyoming has the lowest at two cents per gallon. The U.S. average rate is about 19 cents per gallon.
State and local excise taxes on spirits are equally random. The taxes can include fixed-rate per volume taxes; wholesale taxes that are usually a percentage of the value of the product; distributor taxes (usually structured as license fees but are often a percentage of revenues); retail taxes, in which retailers owe an extra percentage of revenues; case or bottle fees (which can vary based on size of container); and additional sales taxes (note that this measure does not include general sales tax, only those in excess of the general rate). In other words, always check with your state tax authority first—and don’t count on continuity.