In May of 2016, the U.S. Securities and Exchange Commission’s (SEC) rules for equity crowdfunding went into effect, allowing for entities to offer equity securities in exchange for capital to non-accredited investors for the first time. Companies like Wefunder and Indiegogo/MicroVentures quickly moved into the equity crowdfunding space and began facilitating the offering of equity securities for breweries, distilleries, cideries, and restaurants.
Equity crowdfunding took most state alcoholic beverage agencies by surprise, creating a “tied house nightmare” (as one state regulator put it) on inter-tier interests between alcoholic beverage producers and retailers. For example, if a single investor were to invest in both a restaurant and a brewery, it could be a violation of state tied house laws, and cause the licenses for each to be revoked, and even in some cases, result in criminal prosecution of the licensee.
Since May 2016, Wefunder has helped raise over $5.5 million dollars from over 4,800 investors in equity crowdfunding for 11 alcoholic beverage entities. Each successful Wefunder equity crowdfunding campaign has an average of over 400 equity investors. While the success of alcoholic beverage entities obtaining funds through equity crowdfunding was anticipated, state legislatures have not yet made changes in their tied house laws to account for this new avenue for raising funding. However, two court cases in Texas may be the first to fully shed light on such attenuated inter-tier interests.
McLane and OXXO, The Texas Cases.
Texas is considered to have some of the most restrictive tied house prohibitions in the United States. To complicate matters further, there have been multiple successful equity crowdfunding campaigns on behalf of alcoholic beverage entities in Texas.
Recently, in CADENA COMERCIAL USA CORP. v. Texas Alcoholic Beverage Commission, the Texas Supreme Court decided on the issue of whether the Texas Alcoholic Beverage Commission’s (TABC) denial of retail licensure to Cadena’s convenience store chain, OXXO, was unconstitutional given that Cadena’s 100% parent company had a 20% interest in Heineken, as well as the right to place members on certain Heineken supervisory boards.
While the Texas Supreme Court’s decision was not entirely surprising, it held that Cadena’s interests were violative of Texas tied house statutes, upholding the denial of OXXO’s alcoholic beverage licenses. The Cadena Court refused to rule on what has been called the “one share rule” (the argument that a single share of ownership in two entities, in prohibition of Texas tied house statutes, would amount to a denial of licensure), but indicated that it did not feel that Texas public pension and mutual funds invested across multiple tiers of alcoholic beverage licenses amounted to the same level of violative interests in Cadena.
While the Cadena decision does give some weight to the argument that crowdfunded entities would not be in violation of Texas tied house prohibitions, the McLane Company’s recent appeal of TABC wholesaler license denial may more closely resemble the interests an equity crowdfunded entity would have. The McLane Company is a publicly traded company which is substantially owned by Berkshire Hathaway. Berkshire Hathaway has ownership interests in publicly traded funds that also own shares in alcoholic beverage retailers. While the McLane case is currently ongoing, it has the potential to create industry-wide precedent for some of the larger alcoholic beverage markets in the country.
The Problem with “Interest.”
Whether an interest amounts to a prohibited interest under applicable tied house prohibitions is initially determined by the state alcoholic beverage commission. As McLane alleged in their suit against the TABC, enforcement of such standards may not always be uniform. Additionally, other states such as New York, Delaware, Oregon, and California all have similarly strict tied house prohibitions, some that even go as far as prohibiting de minimis ownership between tiers. Even though the alcoholic beverage industry has not yet seen the enforcement of tied house prohibitions against entities who partook in equity crowdfunding, some of these entities may be in per se violation of their tied house prohibitions.
Given that the violation of tied house prohibitions poses certain risks to alcoholic beverage licensees, including fines and even criminal charges, this is one area in which entities should not test the waters without first conducting appropriate due diligence. Tied house requirements are ongoing, therefore entities may have to account for the future investments of one of their equity crowdfunding backers. When large numbers of equity investors are attracted to an offering conducted by an alcoholic beverage license holder (there were more than 950 equity investors in a recent offering conducted by Cleveland Whiskey), a significant monitoring and compliance issue is presented that many industry members are not prepared to undertake. Further, a potential merger or acquisition could result in increasing and cumbersome amounts of due diligence.
Until there is substantial resolution at the state level, alcoholic beverage entities should be careful when engaging in crowd funding, and should pay close attention to their state’s tied house regulations.
Biography
Michael E. Volz is an alcoholic beverage and business attorney at Lehrman Beverage Law, PLLC. Michael provides counsel to alcoholic beverage industry members on federal and state regulatory compliance, including: tied house and trade practice, supply chain law, and direct-to-consumer shipping. He previously worked in restaurants for over eight years while pursuing his degrees in finance and the law.
You may contact Michael Volz at Lehrman Beverage Law, PLLC. 202-449-3739, ext. 707, or by e-mail at mevolz@bevlaw.com