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How to Open a Distillery

  • Why You Need a Distillery Business Entity
  • Selecting a Distillery Business Entity
  • How to Open a Distillery

Distilling is different from other industries in some ways, especially when it comes to regulation. But distilleries are just like most other businesses in that their owners almost always should set up business entities to protect themselves from potential legal liability. A “business entity” for our purposes is a company with its own independent legal identity, such as a corporation or limited liability company (LLC).

Sole Proprietorships and General Partnerships Are the Default Businesses for Craft Distilleries If you are manufacturing alcoholic beverages without a business entity, chances are that you are a sole proprietorship if you are the only owner, or a general partnership if you are working with co-owner partners.

Sole proprietorships and general partnerships are extremely common types of businesses because they can be formed by accident. If you do business alone under your personal name, or some made-up business name (also known as a “DBA” or “assumed business name”), you are a sole proprietor by default. If you go into business with other owners who help you manage the business, also known as “partners,” your company is a general partnership by default. You do not have to sign any contracts with anyone or file anything with the government to be a sole proprietor or general partnership, the law imposes those labels on you.

Because sole proprietorships and general partnerships are just labels, they are not business entities with a separate legal identity from you. You’re doing business in a personal capacity and therefore can be personally liable if something goes wrong. If someone comes looking for payment on a debt, they can try to take your personal assets in a lawsuit. Although all states have laws to prevent you from being left penniless on the street, facing personal liability can be a tremendous burden on you, especially if you have accumulated assets beyond your personal home and vehicle.

For extremely low-risk businesses, going without a business entity is an acceptable risk. For example, if you sell $500 worth of greeting cards on Etsy each year, you can probably do so as a sole proprietor and be just fine. But for entrepreneurs starting a craft distillery, you will be facing multiple kinds of liability.

First, you will likely have potential contractual liability. Contractual liability is risk you take on voluntarily by making agreements with others. You might have a lease for your physical space, contracts with vendors for inputs or packaging, a bank loan, agreements with distributors, etc. In any contract, something could go wrong or you might run low on cash to make a payment.

Second, you will likely have potential non-contractual risks, sometimes called “tort” risks. This is risk you face regardless of whether there is a contract involved. These kinds of risks come in many forms, some of which are difficult to foresee. For example, if you permit visitors in a tasting room, what happens if someone slips and falls? What if a bottle of your product shatters and injures someone? Or, imagine that you hire a head distiller who steals a recipe from a competitor? In each scenario, the aggrieved person could very well look to you for payment. This is especially true in the distillery business because a single mishap—someone choking on a foreign object in bottle for instance—could lead to millions of dollars in losses.

A separate business entity, such as a corporation or LLC, will generally shield its owners from personal losses if something goes wrong. In other words, if you do run your distillery through an entity, the entity is the “person” conducting business, not you personally. If something goes wrong, the entity will be sued, not you. Only the entity’s assets are at risk. If some catastrophic loss occurs, and your entity has a liability it can’t pay, then your entity goes into bankruptcy, not you. Accordingly, we advise all of our clients to form entities in the early stages of starting a distillery.

Merely forming the entity is not enough, however. You must actually conduct business through that entity. This means your entity should sign contracts, own the equipment and other property, and should hold itself out publicly as the entity that runs the distillery.

You must also keep your company finances separate from the personal finances of the owners. Obtain an Employer Identification Number for the entity. You can do this yourself on the IRS website. At a minimum, you should also develop a relationship with a CPA who can advise you on setting up a separate company bank account, taxes, and bookkeeping. If your personal finances are muddled with company finances, such as by combining bank accounts or failing to track income and expenses separately, the separate legal status of your business entity can vanish.

 

After forming an entity, you should obtain sufficient liability insurance for your distillery, too. Liability coverage puts the insurer on the hook if you have an unforeseen claim against your company. Just make sure the insurance policy covers against all the reasonably foreseeable liability you might face. In the event of a lawsuit, you want the insurance company paying your attorneys and covering losses if they occur. Start by consulting with an independent insurance broker, not a captive agent working for a single insurance company.

Should you start your craft distillery through a sole proprietorship, a partnership, a limited liability company (LLC), an s-corp, or a c-corp? As described in Why You Need a Business Entity for Your Distillery, a sole proprietorship or general partnership are probably not good choices for you. In most instances, the decision comes down to whether to form a corporation or an LLC. We’ll make that decision easy: for almost all new distilleries, an LLC is the right choice. Below, we explain the difference between LLCs and corporations, why LLCs are generally preferable, and how the s-corp and c-corp labels fit into all of it.

Corporations are the traditional, tried-and-true business entity that has existed in one form or another for hundreds of years. They are created under state law, so the rules vary across the country, but they generally are set up using the same format in each state. Corporations generally have a more rigid, hierarchical structure. Shareholders are at the top—they become owners by buying shares or stock in the company. Shareholders make money on their investment by receiving dividends out of the company’s income. Below the shareholders is a board of directors. Directors are elected by the shareholders and are responsible for the corporation’s major strategic decisions. Some corporations pay their directors for their service. Directors also generally select the company officers. Officers are the executives running day-to-day operations, and their titles vary from company to company. They include “CEO,” president, secretary, CFO, etc. Below the officers are the rest of the company’s employees.

Corporations are typically formed by filing articles of incorporation with your state’s government, usually the secretary of state’s office, along with a fee. The articles describe the general structure of the company and describe the kinds of stock that exist. Well organized corporations also have bylaws to provide rules for how the company is managed and how its directors and officers make decisions.

The LLC is a more recent innovation. It was not until 1977 that Wyoming first passed a law enabling business to incorporate as LLCs. Today, the majority of new American business are LLCs. You can form an LLC in every state, even if you have no co-owners.

The owners of an LLC are usually called “members.” An LLC is an entity formed when a member files a certificate of organization (or similar) with the state government, along with a filing fee. The certificate of organization is usually simpler than a corporation’s articles of incorporation. Often, it is just a one-page form calling for your company address and the name and contact info for just one member.

Well-organized LLCs are usually governed by a contract called the “operating agreement,” which describes how the LLC is structured similarly to a partnership agreement in a partnership. The LLC’s owners sign the operating agreement to become members. The operating agreement can be as simple or complex as you want it to be. It can describe how the company is managed, how income is distributed, and what happens if someone wants to leave the company. It can also describe different kinds of ownership interests, much like different classes of stock in a corporation. Most states allow for some members, called “member-managers,” to run the company and for other members to participate in the company as passive investors. The members of a company receive company profits in the form of “distributions.”

Both LLCs and corporations are business entities with legal identities separate from their owners. If the entity is sued or otherwise liable for something, it is the entity’s assets that are at risk, not the personal assets of the owners. For a distillery, which is a moderately risky type of business, this kind of protection is very useful, especially when combined with proper liability insurance.

There are other similarities. Both LLCs and corporations are typically acceptable vehicles for soliciting investors. Both require periodic filings with and (potentially) payment of fees to the state government, their own tax preparation, and their own finances. But, for most new distilleries, LLCs are a better choice.

The TTB, the Federal agency that regulates distilleries, does not particularly care what kind of company you have, but you should. Accordingly, for most new distilleries, especially smaller businesses, the LLC is preferred over the corporation. They are more flexible and easier to run and set up.

Corporations have a hierarchical, rigid structure of shareholders, directors, and officers. Drafting the governing documents can require a bit more legal work than an operating agreement for an LLC.

Running a corporation also requires more clerical work. Someone has to keep shareholder ledgers, call director elections, conduct director and shareholder meetings, draft and track corporate resolutions, and deal with other corporate formalities. These are tasks that can divert your attention from running your distillery. In larger companies, these levels of formality can be helpful by distributing clear decision-making power among different people, especially when there are managers or investors who have diverging interests. This can happen, for example, where some investors are interested in seeing a company grow rapidly so it can be sold off, while others may not want rapid growth and instead prefer to treat the distillery as a lifestyle business. But in smaller distilleries, there may only be one to four people who own and run the company, and oftentimes they are close friends or family. If they set themselves up as a corporation, the same handful of people will be shareholders, directors, and officers anyway. An operating agreement can allocate managerial authority among these people in a simpler, more efficient way.

Most distillery owners we work with have heard of the “c-corp” and the “s-corp,” and mistakenly believe that these are types of business entities they might use to run their distilleries. However, these terms are not types of business entities but are simply tax classifications. In other words, a company might be taxed as one or the other during its lifetime even though it is incorporated as a single type of business entity.

Without going into too much detail, suffice to say that a c-corp structure is generally undesirable for new distilleries. A company taxed as a c-corp is subject to “double taxation.” That is, the company pays taxes on its earnings, then the shareholders pay tax on the dividends they receive. It’s an inefficient arrangement, especially for owners. Two other tax classifications, partnerships and s-corps, are more common for craft distilleries. In both a partnership and an s-corp, the company does not pay income tax on its earnings. Although you should work with a CPA from day one to ensure you’re being taxed efficiently, many distilleries are best served by being taxed either as a partnership or s-corp. Often, your CPA will advise you to switch from being taxed as a partnership to being taxed as an s-corp when your distillery begins generating sufficient income. Although it may be somewhat more complex to file your tax return as an s-corp, that expense can be offset through tax savings.

The reason LLCs are often better for new distilleries is that they are tax chameleons. They can be taxed as partnerships, s-corps, or c-corps if you write your operating agreement correctly. Thus, in its early stages, your distillery can be treated like a partnership, then it can elect s-corp status after it gets off the ground (for up to three years after formation). If you want c-corp status for some reason, that’s possible too. By contrast, corporations must be taxed either as a c-corp or an s-corp, depending on how they are set up.

Although LLCs are more flexible from a tax standpoint, there are somewhat complex tax rules that govern which classification your LLC can select. Be sure to consult with an attorney and a CPA when setting up your company to ensure you comply with those rules.

Although LLCs are a streamlined option for most new businesses, sometimes corporations are still better. These are some of the advantages:

Angel investors and venture capital funds might prefer to buy stock in a corporation because they are more familiar with a corporation’s structure. This is especially true where the investors don’t personally know the company’s managers. Investors may also perceive that stock is easier to resell to someone else than ownership in an LLC, even though this is untrue as a general rule.

It is possible to offer equity (ownership) to attract talented employees to your company in either a corporation or an LLC. However, seasoned executives might be more familiar with corporate stock options than they are with the kinds of incentives an LLC might offer.

There may be tax reasons for which your CPA will advise you to set up a corporation and seek c-corp status. For instance, it may be easier to provide fringe benefits to executives and employees through that structure.

Regardless of the entity you choose, your distillery is off to a much stronger start if you do your homework up front. Before you or your co-owners spend a dime on your business, form a competent team to advise you, including an attorney and a CPA. They will ensure you do not encounter any nasty surprises just as you’re trying to get off the runway.

You need a distilled spirits plant permit (DSP) to start a new distillery. DSP permits are issued and regulated by the Alcohol and Tobacco Tax and Trade Bureau (TTB), which is a branch of the Treasury Department. The TTB has tried to create a straightforward online DSP permit application. However, complex federal rules that apply to this process can make applying for a DSP permit much more difficult than it may appear at first glance, even through the online system.

If you’re interested in starting a DSP, we suggest that you take the following steps before beginning the application process, regardless of whether you hire an attorney to assist you. As you review the checklist, keep in mind that it provides only a general overview based on our experience with the TTB. This checklist does not:

  • Cover every issue you may need to address with the TTB. Each distillery is different and the TTB may require you to provide different information and documentation based on your unique circumstances;
  • Address state or local licensing issues that you will also need to consider before starting a distillery; or
  • Provide any assurances that the TTB will approve your DSP permit application. Again, the TTB carefully considers the individual information provided by each distillery in deciding whether to approve their application.

You can apply for a DSP:

  • individually (a sole proprietor);
  • as a partnership between two people or two companies; or
  • or as a legal entity such as a corporation or limited liability company (LLC).

Selecting the right business structure is important to your business’s success. Each structure has different legal and tax implications you should consider. However, we recommend forming a business entity to operate your distillery to help you avoid personal liabilities. In addition, for more information on the different business structures and how to decide which is the best fit for you, click here.

Once you select your business structure you must form the business by filing documentation with the appropriate state entity, usually the secretary of state. The secretary of state will provide you with a certificate showing that your business has been registered. You will need to file that documentation with the TTB.

If you are opening the business with partners or other co-owners, you will also need to provide the TTB with information detailing each partner’s ownership interest and role in the business.

An EIN is a nine-digit number used by the IRS to identify your business entity. An EIN is something all business entities need for filing taxes. You will also need an EIN to apply for a DSP permit. We strongly recommend that you form a relationship with a CPA early on. A CPA will help you set up a bookkeeping system and obtain your EIN. However, you can also get an EIN yourself. Just go to: https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online

You may want to operate your distillery under a name other than your business name. This is commonly known as operating under an “assumed business name,” a “DBA” (doing business as), a fictitious business name, or a trade name. To operate under an assumed business name, you usually must file an application with the appropriate office in your state.

There are good reasons for using a DBA. First, DBAs allow you to operate multiple businesses without having to create separate legally entities for each. They also allow you to select easily recognizable and memorable names for each business you operate. For example, Doe Family, LLC may own a brewery and distillery which they operate as Jane’s Brewpub and Janie’s Distilling, respectively. Jane’s Brewpub and Janie’s Distilling are assumed business names.

The TTB requires you to file state-issued certificates showing you registered your assumed business name with your DSP permit application.

Along with your distillery name, you should select your logo early on. Logo selection isn’t essential for filing an application with the TTB, but it is essential to developing your brand. Your name and logo are the most prominent things identifying you and separating you from your competitors in the alcohol beverage industry. You’ll almost certainly want to include them on your labels and on other products to advertise your brand.

Do not rush this part of setting up your new business. By far the most common problem we see in new distilleries after they obtain a DSP is that they realize all too late that they are unintentionally infringing another alcoholic-beverage manufacturer’s trademarks. In an industry as crowded as alcoholic beverages, this is exceedingly common.If another company uses the same or a similar logo or name, it could confuse customers or dilute your brand. Perhaps worse, a motivated competitor using the trademark before you could threaten you with litigation for infringement. That is why properly researching your prospective marks and registering them is so important. MWS Rose’s Intellectual Property practice group can help you trademark and protect your brand.

For federal permitting purposes, the following rules generally apply to the location and use of your distillery.

  • Your distillery cannot be located in a residence, or in a yard or enclosure connected to a residence;
  • Your distillery cannot be located on a premise where beer or wine is produced;
  • You cannot apply for DSP permit until you have already leased, purchased, or finished constructing the distillery;
  • Your distillery cannot be spread out over multiple locations; and
  • You cannot sell your distilled products on your DSP premises.

If you need to do one of these, your best course of action is to discuss the matter with an experienced attorney.

Wherever you locate your distillery, you will need a copy of a lease for the space or a deed for the property. You will have to show the TTB that you are legally entitled to occupy the location when the DSP permit is to be issued.

Starting a distillery can be very expensive. Rarely do we see distilleries succeed with less than $350k in initial funding, although more cash is usually advisable, especially if you plan to make products that take time to age. Thus, you will likely need to raise capital to get your distillery started. The capital you need may be in the form of equity (selling an ownership interest in your business), debt (a loan), or some combination of the two. When someone loans a business money, the business signs a legal instrument such as a promissory note or bond setting forth the business’s repayment obligations. The TTB will require you to file those instruments with your DSP permit application.

The TTB does not require you to show that you complied with state or federal securities law. However, you are still required to comply with those laws and should certainly ensure that you are doing so when you borrow money or sell equity in your business. Securities regulations are especially important when borrowing money from or selling equity to investors who will not actively participate in managing your business. If you are required to comply with any securities law and fail to do so, you could be subject to administrative, civil, or criminal sanction. Consult a knowledgeable lawyer whenever you raise money for a new business.

Federal regulations require distilled spirits to include certain ingredients and to be made a certain way. For example, bourbon whiskey is defined as whiskey produced in the U.S. that does not exceed 80% alcohol by volume, is made from a fermented mash of not less than 51% corn, and is stored at not more than 62.5% alcohol by volume in charred new oak containers.

You must provide the TTB with the following information about your products:

  • The types of spirits you plan to distill;
  • The ingredients you intend to use to make each spirit;
  • How much of each spirit you will distill;
  • How much of each spirit you will age and store at your DSP; and
  • The location and type of container you will use to age and store each spirit.

Answering these questions will also help you to decide the type and size of equipment you’ll need to start your distillery. For more information on acceptable formulas, visit the TTB’s website.

After you settle on your major pieces of equipment, you’ll need to draw a floor plan of your distillery showing those major pieces of equipment. The TTB will also want to see which parts of your distillery are used for production and storage of products on which you have not yet recorded federal excise taxes (also known as “untaxpaid spirits”). These areas need to be separated from areas accessible to the public. Some system manufacturers, such as Corson Distilling, have staff on hand to help with this process and to prepare the drawing.

You don’t need to have your equipment installed or even present at your distillery when you file your application. You will, however, be required to submit information about your major equipment such as: size, type, and serial number. We recommend firming this up with a distillery equipment manufacturer before preparing your DSP application.

The TTB does have an online permit system for DSP applicants to use. However, the system can be confusing. It requires you to accurately describe your operations, provide the information identified above, and to submit a plant floorplan that complies with the TTB’s excise tax regulations.

Starting a distillery can be complicated. We’re here to help you with your federal permitting and other legal needs. If you have questions or would like to discuss our rates or packages, please do not hesitate to contact us.

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