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Whiskey Startup investment - Equity given and retained


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I realize there are probably no fewer than 50 variables involved, but in the opinion of those who have gone through it, does the below pass a sniff test?

A business in startup with $100k invested from the founders trying to raise an additional $700k by offering 40% of the equity.

There are a couple ways to look at this. Let's look at just the opportunity cost for the investor. The annualized return of the S&P 500 was 5.35% trailing 10 years, 13.68% trailing 5 years, and 28% over the last year. A 10-year T-bill is currently 2.76%.

If we buy the S&P 500, and it grows at the most conservative rate (5.35%), we'd have 1,178,809 (a gain of 478,809) after 10 years, but that's fairly risky.

Let's assume we buy $700k in t-bills (risk-free) for 2.76%, and take the most conservative S&P rate.

y0 = -700000

y1-9 = 19,320

y10 = 719320

discount 5.35%

NPV = -137,645

We'd lose 138k, so not great, but that's a risk-free loss.

Let's assume we buy 40% of the distillery for $700k.

y0 = -700,000

y1-4 = 0

y5 = 50,000

y6 = 50,000

y7 = 75000

y8 = 75000

y9 = 100000

y10 = 100000

NPV @ 5.35% = -401,453

That calculation assumes you're making $250k net profit by year 10.

If we expand it out to 15 years, and assume the investor will get $150k per year for the next 5 years, the NPV would only be -19,516. So we haven't even broken even yet, and we're assuming we'll be netting $375k per year in years 10+

Meanwhile, the whole time you'd be making a profit almost immediately, since you'd get 60% of the net on your initial investment of $100k.

y0 = -100,000

y1-4 = 0

y5 = 75,000

y6 = 75,000

y7 = 112,500

y8 = 112,500

y9 = 150000

y10 = 150000

NPV @ 5.35% = 347,821

So under that arrangement, you'll triple your money in 10 years, and your investors will lose half their money.

If you end up making a lot more net profit, the investors might see a positive return sooner, but if you adjust for risk, it's probably not worth it. Any way you slice it, you'll end up making a lot more money than your investors will, if you can get them to buy 40% equity for 87.5% of the costs. Plus if the business goes under before year 5, you've got a lot less to lose than they do.

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I realize there are probably no fewer than 50 variables involved, but in the opinion of those who have gone through it, does the below pass a sniff test?

A business in startup with $100k invested from the founders trying to raise an additional $700k by offering 40% of the equity.

We would essentially be trying to fund 87.5% of the costs with 40% of the ownership being offered to a series of outside investors. I'm being told this is a "typical" range, but I'm wondering if anyone has any evidence to support or refute this. It seems a little optimistic to me.

I don't think it passes the sniff test. Anyone putting up 87.5% of the cash is going to get a lot more of the initial equity. The entrepreneur slice of the equity is typically going to be 25% during a Series A offering such that you are proposing. Then your $100,000 would be at the offering price of the Series A, whatever that buys you. I would estimate that counting your entrepreneur shares and cash invested, you would have about 30% to 35% of the shares if you are only putting up 12.5% of the cash.

If you are valuing 40% of the company at $700,000 (post-money) then your total valuation of the company is $1,750,000 before you have done anything. I doubt anyone will accept your paper business plan at that valuation.

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If you are valuing 40% of the company at $700,000 (post-money) then your total valuation of the company is $1,750,000 before you have done anything. I doubt anyone will accept your paper business plan at that valuation.

I agree. Trying to sell that much common equity for that much money is crazy.

If you form a C corp, buy common stock with your $100k, and sell preferred cumulative stock for $700k, convertible to 40% of all outstanding common equity after 7 or 10 years, then it gets less crazy, especially if you offer a good return (10%+) in the meantime. That would give the investors a higher claim than you on assets if the company goes under, reducing their risk and the return they'd demand.

After 10 years, the business might actually be worth $1.75m, but you'll have to compensate them for the time and risk, in the meantime.

I'm sure it's obvious by this point that equity is a lot more expensive than debt. If you can take on debt instead of, or in addition to raising capital, that's a better way to go.

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I'm sure it's obvious by this point that equity is a lot more expensive than debt. If you can take on debt instead of, or in addition to raising capital, that's a better way to go.

While debt is less expensive than equity, debt is also more risky than equity. The only thing that will force you to close is missed debt payments and judgments that force you into bankruptcy.

Selling equity and running the business with zero or very low debt is a much safer route for the long term health of the business.

Most businesses don't have positive cash flow in the early years. It is all spend, spend, spend. Having to make interest payments also in that early time frame can be the death of the company.

We made the decision to go with zero debt and raised everything with equity via friends and family.

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While debt is less expensive than equity, debt is also more risky than equity. The only thing that will force you to close is missed debt payments and judgments that force you into bankruptcy.

Selling equity and running the business with zero or very low debt is a much safer route for the long term health of the business.

Most businesses don't have positive cash flow in the early years. It is all spend, spend, spend. Having to make interest payments also in that early time frame can be the death of the company.

We made the decision to go with zero debt and raised everything with equity via friends and family.

It's tough, because too much debt is bad, but it's hard to say how much is "too much." It's good you guys made it work out with just equity. You have to balance the risks (and costs) of avoiding bankruptcy against the return you'd get via leverage. You also have to evaluate your personal risks, especially if your investors want 70% of the company, and they decide to get rid of you after 3 years of putting in 100 hour weeks for less than minimum wage. I've been there, and it sucks.

Raising equity via friends and family isn't risk-free. If you lose all their money, there's a good chance you'll lose your relationships with them too. They're the people whose couch you'll need to crash on after you lose everything!

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  • 2 weeks later...

If you really need help I do consulting work.

WWW.REDBOOTSTILLS.COM

Just a heads up.. The forum has an option to turn a URL posted into an actual hyper-link that people are then able to click on. If your going to post your URL on every single thread on the forum you should consider using this option to make it easier for people to access your site. Here, ill do it for you:

WWW.REDBOOTSTILLS.COM

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I don't think you will find investors for a liquor business with no sales and no track record, so selling equity would be very difficult. Using your personal funds for a smaller start up and retaining your equity makes much more sense. If you have a rich uncle that needs a tax write off for a few years then you have a shot. Sales of 3-5000 cases for your first year would be miraculous but if you are in an area with high foot traffic and you can get them into your plant for tours then you can sell this much or more. Most decent sized distilleries do not give tours of their operations. You can go there and see some old stills that started the business, but nobody shows you the magic behind the real scene or everyone would be a distiller.

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Most decent sized distilleries do not give tours of their operations. You can go there and see some old stills that started the business, but nobody shows you the magic behind the real scene or everyone would be a distiller.

That seems to be the difference with craft distilleries. I have probably visited 20 small/craft distilleries in the past two years and they all provided tours and talk about the process.

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"but nobody shows you the magic behind the real scene or everyone would be a distiller."

what do you mean?

Do you think Kellogg’s is going to show you how to make your own Rice Krispies or Shredded Wheat? After that maybe Coke will open their vault to show you the formula for Coca Cola (never patented because that would make it public record).

Large corporations have hidden processes, temperatures, and ingredients that they NEVER disclose to the public or they would put themselves out of business. Every one has a secret that makes their particular brand stand out above the rest and they will not disclose that secret to you. The employees of these companies sign lengthy non disclosure agreements and non compete agreements to keep their people from stealing trade secrets.

Another good example, the eleven herbs and spices in KFC. The formula is split so that none of the employees EVER sees the complete formula. Part is made in one location, part in another.

Do you know why Grey Goose tastes so much better than the rest of the premium vodkas? You can ask them and they will tell you some bs about water or whatever, but the truth is something completely different.

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Large corporations have hidden processes, temperatures, and ingredients that they NEVER disclose to the public or they would put themselves out of business.

Businesses don't succeed because they have a better secret recipe than other companies. And as has been noted on this forum before a better product rarely translates to higher profits or a more successful business.

Another good example, the thirteen herbs and spices in KFC. The formula is split so that none of the employees EVER sees the complete formula. Part is made in one location, part in another.

No doubt the secret recipe tripe worked well for Sanders and his business as a marketing ploy, but even Sanders knew and admitted that there are better recipes.

It is well attested that Harland Sanders asked Bill Summers of Marion-Kay Spices in Brownstown, Indiana, US to recreate his secret blend of 11 herbs and spices. While alive, Sanders recommended the Marion-Kay seasoning to franchisees over the corporate version, as he believed the latter had been made inferior by its owners. In 1982, after Sanders' death, KFC brought a lawsuit against Marion-Kay and the latter was barred from selling its mixture to KFC franchises. The Marion-Kay seasoning is still sold under the name "99-X," and according to Sanders biographer Josh Ozersky, it is indistinguishable from the original KFC recipe"

Don’t ask, I will not discuss this.

Well, thats a shame as am I sure the rest of the distillers on the forum have just been sitting around waiting for someone to show up and tell us all why Grey Goose tastes so good. Guess I won't try to make Vodka as I am now doomed to failure without your secrets.

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Nobody makes a perfect product. Tito's is not a perfect vodka, it is a very good vodka. Jack Daniels is not a perfect whiskey, though some may disagree with that point as well.

Marketing, consistency of product, and availability will drive the market along with many other factors, we all know that.

I like your post about the KFC formula!

DId you guys see that guy on TV who went around attempting to replicate all of the secret formulas? He got to the point where he thought he had KFC down, but the fryer they use cannot be sold to the public. The manufacurer actually loaned him one and according to the tasters he was very close.

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Just to be clear, that quote is from wikipedia.

DId you guys see that guy on TV who went around attempting to replicate all of the secret formulas? He got to the point where he thought he had KFC down, but the fryer they use cannot be sold to the public. The manufacurer actually loaned him one and according to the tasters he was very close.

And I actually ran into a few articles about folks duplicating the KFC recipe when I Goggled this.. It is pretty amazing how well KFC (perhaps even more than Coke) has built up the secret recipe legend! lol..

I for one appreciate this forum and community specifically because of the openness and the attitude of helping others that so many members demonstrate. Fifteen years ago you might have been able to get away with keeping new comers out of your industry by not sharing information and processes with them, but not anymore. The advent of the internet and so called "information revolution" has simply changed that. You want to make whiskey? You don't need an old uncle with a secret recipe he is willing to share anymore. You want to make vodka? You don't need someone who was in on the ground floor of Tito's to tell you if they are using GNS, you can just Google it yourself and find a former employee who shared "By the way, I didn't say Tito's wasn't distilled 6 times, I just said that it is distilled 2 times at Tito's distillery." ;)

If your willing to put the time and energy into researching, all the info you need is there. This forum certainly makes it easier, but if fldme does not want to share with me some suggestions on how much back-set to put in my rye mash a few hours researching and I can get ratios used by lots of old moonshiners and most of the major bourbon makers as well. I simply believe that in today's world its not about having more secrets/information than the other guy, but more about how well you can apply that information and put it into practice..

Apologies for the thread hi-jack..

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I don't think you will find investors for a liquor business with no sales and no track record, so selling equity would be very difficult.

I think you would be surprised just how easy it is to find investors for this type of business. It mostly depends on the credibility of the people that are raising the money. If the presentation is professional and the founders have a history of success, it is very easy to attract investors.

We raised $300,000 from investors to get started in 2011. It was a combination of friends, family and local residents that read articles about us in the local newspaper that reported on our plan.

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Thank you!

I just type the stuff in, I didn't see where to hype link. Maybe because I'm doing this on my phone.

Just a heads up.. The forum has an option to turn a URL posted into an actual hyper-link that people are then able to click on. If your going to post your URL on every single thread on the forum you should consider using this option to make it easier for people to access your site. Here, ill do it for you:

WWW.REDBOOTSTILLS.COM

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  • 1 month later...

I realize it is off topic, but I disagree with the "secret recipe" statement by Mr. Thurmon. The fact is that you can take my grain bill and run it on my equipment and not come up with the same product, everything we do is subjective to the distiller. Added to that, there is almost no market for identical or knock off products in liquor. Anyone CAN buy bulk alcohol and pay a lab to recreate the flavor of Captain Morgan. No one does because it is much more difficult to convince a Captain Morgan (or Jim Beam or Jose Cuervo) fan to drink your liquor than it is to attract new customers who prefer something different. There was a book written probably 20 years ago called "Big Secrets" that explored the secret recipes of Coke and Pepsi. It turns out that the original families had intermarried at various times and so it was nearly a certainty that they both knew each other's recipes. They didn't copy each other because it was MORE profitable to have a different product than to try and rip each other off. Liquor is like that - it makes more sense to make your own product than to copy someone else's.

Back on topic - I really like this thread. The business analysis of equity vs. other types of investment is fascinating and very eye opening.

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