What is it worth to launch a product under an existing DSP?

[Austontatious]

I have the opportunity to launch and manage my own product line out of a licensed distillery. They have spare capacity and have approached me to see if we can come to a mutually beneficial arrangement for a percentage of the net. I would have full autonomy to develop and market the product(s) as I see fit and full use of the distillery's equipment. It would be my outlay for supplies and marketing, but I avoid the time and money involved in setting up my own shop.

What is a reasonable offer, at least a jumping off point for negotiations, for the percentage split between me and the DSP holder?

[Austontatious]

A couple of items I forgot to state, in case anyone is concerned:

1 - The products will be my brand but under the distillery's label.

2 - We do not have competing product lines - I will be starting with a bourbon and they don't produce any aged spirits.

3 - This will have a contract start and end, and I will retain ownership of the trademark for the brand. Ideally this will be a head-start for my own distillery in the future, not an end to itself.

[NEPA-still-chillin]

Very good question, I will be looking to do the same in the future.

I think it depends on your business relationship, Are you working for this person? Is this person seeking to invest and make money or just help you get on your feet?

You can maybe setup a percent based division, ex.70/30 or say "X" amount on every bottle sold.

Just shooting in the dark here too, but establish a payment for the first contract, a flat fee. Then once your product is established setup a percentage split or per bottle fee.

I think your overhead is Licenses, Label design and marketing, Labels and bottles etc. It could be a bit before you make that back

[Austontatious]

All of the above. I have had the priveledge of interning at the distillery. They want to make a buck, it helps me at the same time.

How about we simplify the question: Should the greater percentage go to me for the work and the investment in supplies, or to the distillery for their license and equipment?

[Kristian]

We produce spirits for other brands so I have a little perspective from this side of the coin. It seems an easy proposition, but costs for both groups seem to creep up. Be sure to spell everything out in writing. Sure, you may help them bottle their own product once in a while, they may not charge you for the 8th resubmission of your label. In the end you may love each other or hate each other based on how much thought you put into the initial agreement. Who's paying for the sample you fedex to a potential distributor, the box it ships in, the tape to seal the box, the ink on the label and the person waiting around for fedex to pick up the box? Ridiculous right?

How much will you pay for a pallet sitting in the corner or a box of caps on the shelf per month? If you share the same bottle do you pay for your own pallet or a case as you use it? If there is a tasting room you can sell out of, do you share a percentage of the cost to run it based on your sales volume or do you sell a case to the tasting room wholesale?

Be willing to pay for the costs of your business cause whether you own the equipment and building or not it still costs a lot to run a distillery. Use of a license is not that simple. You will be using up a portion of their bond. Every month someone will have to file excise tax paperwork for your liquid, records that will need to be maintained long after you've opened the doors to your shiny new distillery. If all of a sudden they decide to stop, what happens to your brand? Will you share a distributor, will liquor stores and bartenders know the difference between your brands? When you serve your product at an event or in the tasting room but don't check the ID of that freakishly hairy 20 year old with the voice of the most interesting man in the world, who is responsible for the fine and the lost revenue when you can't sell anything for 2 weeks?

I'm off to fill my glass, good night.

Kristian

[NEPA-still-chillin]

Well said, Kristian is really airing it out.

I would say most the time minor things stated above are over looked and not considered by either party.

If it was me which it might be in the future, I would get everything in writing.

Including your agreement with the DSP and what business you will be doing, and then a plan for overhead. I would make reports and flowcharts of the product so that you can show them that you mean business also that your putting the effort into your product.

I once interned at a distillery and they did contract bottling. This was a few years ago so I forget the cost and procedures, but maybe consider finding such a place to ask them questions.

[dhdunbar]

I will try and discuss this issue in a general way. But specifics matter. The devil and the details rule applies. I apologize in advance for the length.

With that warning, if you do not want to invest in a still, you can get spirits in two ways.

· You can contract with an existing distillery to have the distillery produce spirits for you.

· You can lease the use of the distiller’s premises, equipment, and even its employees for your own use.

The route you choose determines the licensing requirements with which you must comply. In any case, you will need to be licensed. Remember that the details of the commercial arrangements you make –others are better able to suggest possible contractual provisions than I am - affect the way in which TTB and state agencies view the business relationship established by the agreements. In fact, your consideration of the fedeal and state implications may well drive the form that specific provisions, if not the whole agreement, take. For example, the provisions may affect the privileges you have under state licenses to sell either at wholesaler or at retail and the ability to offer samples. To the extent that any of that is an important part of your business model, you will want to pay careful attention. That said there is no universal answer to how states will react to the provisions of an agreement. It is strictly case by case.

I’m going to discuss alternating proprietors below. While TTB makes provisions for that sort of relationship, I would be remiss if I did not state at the outset, and in bold letters, that some states will not allow alternation under any circumstances.

Now let’s look at the alternatives.

Contract Production

You can contract with an existing distillery to have them produce spirits for you. If you do, you then have two more options. You may buy the spirits from the distiller either in bulk bottled and in cases.

If you buy them in bulk (in containers of more than one gallon), you will need to establish a distilled spirits plant (DSP) where you process and bottle them. This requires a federal basic permit and registration. Essentially, you go through the same paperwork and have the same requirements that you would have if you also distilled; you just omit distilling operations and qualify to warehouse and process. In this case you would have a bonded premises and any spirits sold to you by the producer would be under your bond from the time of shipment by the producer to the time you pay the taxes. You would get the label approval. You would not be entitled to state on the label that you “distilled and bottled” the sprits, but you could say that you “produced and bottled them.” Some craft distillers would contend this is cheating the craft spirit, but it is a long established business model. Prior to the craft movement, any number of distilled spirits plants were not distillers. They bought everything in bulk and bottled it.

If you buy the spirits in cases, which seems to be the model you envision, you do not need to qualify as a distillery. However, you will need to qualify with TTB as a wholesaler. Even if you own, from the outset, all of the grain and packaging and simply pay the distiller for the services rendered in producing and packaging the spirits, TTB will hold that you are “purchasing for resale at wholesale and while so engaged selling and offering for sale.” It will not allow you to receive the spirits and go about the business of selling them outside of the reach of regulation. Similarly, since many state tax schemes collect the taxes from the first distributor who comes to possess the spirits in the state, you will have to be licensed by the state as well.

When you buy spirits bottled by someone else, the label would have to disclose, at a minimum, the identity of the bottler. The bottler could, however, adopt a “bottling trade name,” which could be a name that you have tregistered and which you grant the distiller permission to use only when “bottling for your account.” Ditto on brand names, etc, where trademark rules apply. However, if you own the trade marks under which the product is marketed, you may also, in some instances, run afoul of a state’s “private label” legislation. This generally should not be a problem when you are a wholesaler and not a retailer, but the issue can be a snarl to untangle and I can vouch from experience that states may misstate what their laws and regulations allow and prohibit.

Finally, as a wholesaler, you could sub-job distribution to other wholesalers or sell to retailers directly. Here it is important to understand the franchise laws of the states in which you distribute. Appointing a wholesaler has contractual consequences under law. I’m not an attorney, so I cannot give legal advice, but I can advise you about the questions you want to ask your attorney when you draw the contract. Protection of the trade names and marks is one and franchise rights are another.

Alternation of Proprietorships

The second way to get spirits without investing in equipment is to lease an existing distiller’s equipment and premises for your use. If you chose this route, you would lease some or all of the existing distiller’s excess capacity. In the world of TTB, this is called an “alternating proprietorship” and TTB makes specific provisions for such an arrangement. The owner- DSP is the landlord; the leasing DSP is the tenant. As mentioned above, some states do not allow alternation.

Without getting too far into the details, under the provisions of federal regulation, you would qualify as a DSP at the same premises as the existing DSP from whom you are leasing. If approved, only one of you could operate any one portion of the DSP at any one time. When you are using a part of the premises as a tenant, in the mind of TTB that part is yours, just as if you established a standalone operation. You must have the bonds, keep the records, get the label approvals, and pay the taxes that result from your operations as the proprietor of the DSP. If TTB shows up at the door, you will have to be there to answer their questions. Also, when you are operating portions of the premises, the landlord will have to remove all spirits belonging to it from the portion you are renting. Ditto for you when the premise alternates back to the landlord. The list goes on.

The alternating proprietor model is actually quite common in beer and wine. To ensure that a large operation does not break down its production into separate entities and thus become eligible for reduced tax rates for which it is not otherwise eligible, TTB has published detailed explanations of what it expects. In those explanations, TTB gets very specific about the difference between contract production and alternation. Since there is no reduced rate for distilled spirits, the distinctions it makes may seem unnecessary, but since small distillers are pushing for reduced rates, and since contracts are often long term, you will probably want to make sure that your contractual agreement meets criteria TTB has established for breweries and wineries that alternate. Also, the TTB regulations incorporate by reference some dense provisions of the Internal Revenue Code related to “control groups” of entities, and Treasury does not give TTB carte blanch to interpret those sections in a way that might compromise excise taxes in other areas, say tires, just because that interpretioatoin would have no tax consequences to the excise taxes collected on spirits.

The specific rules are too long and too many to discuss here. For a start, look at 27 CFR 19.141, “Procedures for alternating proprietors.” If you are still interested in the possibility, as many in the wine and beer industries are, take a look at the revenue rulings that supplement the regulations.

I might add that this model could be a business venture unto itself for someone who has pockets deep enough to pay for excess production and is willing to deal with the headaches of alternation. It would allow the person to build a plant into which its own business could grow while initially spreading the cost with others through the incubator model. I see no reason, in federal regulation, that a plant could not have more than two “alternators,” which suggests the business model of operating an incubator as the primary activity in which one engages. But this collective approach comes with costs and the question of what a state will allow is a separate matter that is well beyond the scope of this post and, I mut confess, my ability to answer in mosty cases, without first sticking my nose into the rules and regulatons of the particular state.

[NEPA-still-chillin]

Good man, thanks so much for taking the time to explain that. Really I mean it, Thank you

[varocketry]

Bravo, dhdunbar, I learned quite a bit in your post. Thank you knidly.

I'll buy the first round when we're next together.