CBB // What are some of the basic mistakes breweries make when taking on debt?
KS // Breweries don’t do a great job of planning out what they’re going to need, what they’re going to use it for, and how they’re going to pay it back. One of the first things I recommend, whether it’s a startup brewery, a brewery looking to expand, or a mature brewery looking to borrow money for any purpose, is to do a sources and uses schedule. It’s a simple exercise, but it’s not commonly done. It can make a really big difference in avoiding some of the pitfalls in getting over your head with debt and not being able to pay it back.
“Sources” are where you are going to get the money, and “uses” are what you’re going to use it for. It’s a very basic starting point to make sure the two add up because sometimes they don’t. Often, brewers will say, “I need a million dollars for my expansion,” and they’ll list out what they want to buy, but they forget that a bank isn’t going to give you 100 percent. It’s going to give you 70–80 percent. So you’re going to have to come up with the difference. The first step toward avoiding that surprise at the beginning is to ask, “Do I have enough money?” and “Where am I going to use it?”
Equally important is to cash flow it out. Create a basic pro forma that says, “Here’s what my debt payments are going to look like, and here’s what my projected cash flow is going to look like.”
CBB // What type of relationship between payments and revenue makes sense for small breweries?
KS // The bank is going to have covenants in the loan. One is to essentially say “Prove to me that you can pay it back.” They’ll use what’s referred to as a debt service coverage ratio—they want to make sure there’s more money coming in than going out. Bankers set that bar kind of low in my opinion, and certain ratios won’t seem hard to meet.
But the reality of your business is that you’ve got other cash- flow drains that the bank isn’t going to hold against you. For example, if you’re a growth brewery and you’re taking on new customers and buying new inventory, you’re tying up cash in those items, but the bank doesn’t care about that. That’s more collateral for them. So I prefer to look at it as A) what is the bank going to require, and B) can you really pay it back while continuing to grow your business?
Almost everyone gets surprised when they’re growing and they have no cash; it’s just a function of the math. If you do a simple pro forma, you can avoid a lot of those problems.
CBB // How do breweries accurately forecast the positive revenue impacts of debt-financed growth?
KS // Most of the situations where breweries get into trouble are appropriate purchases. You can kill two birds with one stone if you do your cash-flow forward-looking pro forma relative to paying back the bank.
Start with a sales projection—who’s going go buy my beer, where is it going to go, am I going to have to expand my markets, am I working through a third-party wholesaler network, am I self-distributing. Under either of those cases, look at some simple metrics such as what your points of distribution are—rely on your wholesalers if that’s the route to market.
Do a thorough analysis as to where those sales are going to come from—which brands, what customers, and whether the wholesalers are on the same page with that. You can expand all you want, but if your partners aren’t on board with that, you might be in for a surprise.
The old line “plans are useless, but plans are indispensible” is really true. The planning process will show you just how thoroughly you’ve really thought this through. Sales are tough to project, but they’re not impossible, and if you do the work, you at least have a game plan. I’d run right through your pro forma and ask, “What is it going to do to my margins? Will I see some improvement in margin percentage because I’m brewing bigger batches?” Run through all the operational questions and apply it to your financials, then see what drops out at the bottom.
CBB // Most breweries that run into issues with debt get there by making incorrect predictions about future upside. How can breweries be more realistic?
KS // It’s always helpful to have a couple of scenarios. The old standard is to do a best-, worst-, and middle-case scenario and prepare for each of the outcomes. Clearly you want to look at the worst- case scenario, if (for example) expected demand doesn’t continue due to increased competition or so forth. Ask the question “what if this doesn’t happen?” and see what it looks like—is it growth of only a few percentage points or flat revenue? Are you risking everything, or do you have a backup plan?
Everybody falls victim to rosy projections. You look historically at what has happened, and you project that into the future. You think it’s going to continue forever, and it simply doesn’t.
But I’m a big fan of working through your wholesalers. They know the market and where that brand sits with them as far as how much priority they put on it. Some wholesalers, if the brand is doing really well, you can go to them and plan it out.
CBB // How do you recommend evening out the ups and downs of business cash flow?
KS // I typically recommend a line of credit. Cash is nice to have on hand, but it’s equally nice to have a working-capital line of credit, even if you don’t need it—especially if you don’t need it. A bank will likely look toward assets such as accounts receivable and inventory, which they tend to like to loan against, and those track nicely to growth. If your sales are growing, your accounts receivable and inventory are growing, and if those are growing, your cash is going down. Eventually you’re going to turn those assets back into cash, but there’s that drag in the cash cycle that can be very painful for a period of time.
CBB // That cushion can also give businesses a false sense of security. How does a brewery stay disciplined about using that line of credit?
KS // Many lines of credit will have conditions that require you to pay it down to zero on an annual or twice-annual basis. That creates some discipline to say, “It’s not there for you to constantly be on this line of credit.”
It’s for those seasonal bills. Like here in New England, May through September you’re selling a lot of beer, you’re spiking inventory and receivables. So if you’re trying to smooth out that calendar, you’re building in April, you’re ramping sales in May and June, then you start to get cash in July, August, and September.
The line of credit is there to ride out a seasonal part of the business. But just like any loan or credit, there has to be discipline, and it’s probably better if the bank imposes that discipline on the brewery via a mandated pay down.
CBB // Are there any other big points on debt that breweries tend to miss?
KS // I think not a lot of time and energy are devoted to a finance strategy. Brewers spend time building a strategy for their brands. “What do I want in my portfolio?” We talk about that all the time, but I’m not sure I’ve run into too many folks talking about finance strategy, looking at the aggregate of the capital structure. Breweries should be asking what kind of business they want to have, in terms of term debt, working-capital line of credit, revolving equipment line of credit, etc. Ask the question, “How are we positioned, not just from a cash perspective, but from a total financing perspective?”
A lot of people ask, “How do I grow my business.” You can talk about working with wholesale partners and points of distribution, etc., but really the question is, “Why do you want to grow your business?”
Think about why you want to do this. Is it really just to get bigger?—because there are so many financial and operational things that change when you grow. And so many of them are hidden, and you don’t find out about them until you grow. So the first question is not how you grow; it’s why you grow.
Kary Shumway is the CFO for Wormtown Brewery and offers courses on brewery finance topics at Craft Brewery Finance.