Alcohol Industry M&A: Common Pitfalls for Founders (and Avoiding Them) Part One: Formulas and Processes

By and on October 30, 2023

Given the continued strength of the US alcoholic beverage market, the alcohol industry presents numerous opportunities for acquisitions, investments and other strategic transactions from a wide variety of players. These range from small craft start-ups to larger strategic buyers, as well as investors of all shapes and sizes. In such a highly regulated industry, however, it is crucial for potential buyers and sellers to understand the complexities of the rules and regulations in order to negotiate and structure such transactions effectively.

In this blog post, the first in a series, we examine one of the common industry pitfalls and the related overlooked issues founders face when growing their alcohol business and positioning the company for a possible future transaction: failure to protect formulas and processes.

It is common for founders to focus on growing revenue during their start-up phase without dedicating time and resources to protecting their trade secrets. Trade secrets are a vital part of any company—they are the information you would not want your competitors to know, such as customer or supplier information, prices, marketing strategies, formulas/processes/recipes and any other confidential business information.

Whether you are an established brand or entering the alcohol beverage space, the ingredients that you choose for the base of your alcohol beverage can have a large impact on many aspects of your business. First, brands should consider working with flavor houses or ingredient sourcing companies who regularly collaborate with alcohol beverage companies. These companies will be the most familiar with the legal prohibitions, restrictions and limitations on certain ingredients added to alcohol beverages. Additionally, working closely with flavor houses will ensure that the ingredients used support the product’s label and advertising material claims. For example, you must avoid making any implied statements that the product contains certain ingredients when it does not. So, if a label or advertising material says, “Made with real fruit juice,” consider directly adding fruit juice or fruit concentrate as an ingredient.

Second, brands should provide any supporting documentation from the flavor houses/sourcing companies to their co-manufacturers (Flavor Ingredient Data Sheets, ingredient specification sheets, and Consejo Regulador del Tequila approvals for Tequila, for example). This will ensure that the product is being produced in accordance with the formula on file with, and approved by, the Alcohol and Tobacco Tax and Trade Bureau (TTB). Experienced alcohol counsel can review your formulas and identify any potential issues to help minimize the risk of a TTB formula rejection.

Formulas and manufacturing processes are not subject to trademark, patent or copyright protection, so how can you protect them from your competitors? Trade secrets are the only practical mechanism. The Uniform Trade Secrets Act defines “trade secret” as “information, including a formula, pattern, compilation, program, device, method, technique, or process that:

  1. Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by other persons who can obtain economic value from its disclosure or use, and
  2. Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

For example, this would include a brewery’s recipe as well as its method for mashing, fermenting, bottling and storing the beer. Indeed, at least one court has recognized that beer recipes and brewing practices may meet the threshold for trade secret protection: In Anheuser-Busch Companies, LLC v. Clark, the US Court of Appeals for the Ninth Circuit said Anheuser-Busch “demonstrated a reasonable probability of prevailing” on whether a document detailing its brewing process constituted a trade secret.

As the name implies, trade secrets will only be treated as such to the extent a founder takes prudent measures to ensure secrecy. Generally, there are two avenues for protecting your recipes and processes:

  1. Require anyone who has access to the recipe information to sign a trade secret and confidentiality agreement; or
  2. Require anyone who has access to the recipe information to sign a noncompete agreement.

In addition, when collaborating with flavor houses to create formulas, ensure the terms of the agreement are clear that you are the owner of the formula. Finally, keep the information in a secure location and provide access on a need-to-know basis to help guarantee your recipe’s protection.

Having a powerhouse product without the protections in place to block others from profiting off your idea and hard work is a worst-case scenario for any founder. Consult with experienced alcohol counsel to make certain you have updated your confidentiality agreements and practices to protect against the theft of your recipes, techniques, methods and other trade secret information that differentiate your brand from others. Protecting your trade secrets from the outset can help mitigate potential pitfalls that may arise in a future transaction.

Alva C. Mather
Alva Mather is the global head of McDermott’s Regulatory Practice Group and a member of the Firm’s Management Committee, and heads the Alcohol Regulatory & Distribution Practice. As a nationally recognized go-to lawyer for alcohol beverage regulatory, commercial and M&A matters, clients say that Alva “comes to the situation with clear leadership and strong knowledge of the food and beverage industry.” She combines her extensive knowledge of the commercial and legal landscape as well as deep understanding of the beverage industry to help clients mitigate risk, respond to challenges, and capture and pursue new business opportunities. Read Alva Mather's full bio.

Christine Dower
Christine is a litigation and regulatory compliance attorney who concentrates her practice within the Alcohol Beverage and Cannabis Industries. As a member of the Firm’s Chambers-ranked Alcohol Regulatory & Distribution Group, Christine counsels industry clients on trade practice issues, tied-house compliance, state franchise law, state and federal licensing, e-commerce, distribution agreements, third-party alcohol delivery for sale of beer, wine and spirits and other alcohol beverages. Christine also conducts alcohol and cannabis regulatory due diligence for corporate restructures, mergers and acquisitions.Read Christine Dower's full bio.