The Hidden Licensing Hurdle in Private Equity Alcohol Transactions

Private equity investment in alcohol-related businesses often raises a question that receives far less attention than financing, valuation, or deal structure: who, exactly, will the regulators consider to be an owner? The answer can have significant implications for diligence, transaction structuring, and ultimately the ability of the business to obtain or maintain its alcohol licenses.

Traditional diligence focuses on familiar business questions: How is the company performing financially? Who runs it? What contracts and liabilities will the buyer inherit? But when the target holds an alcohol license, a different set of questions emerges. Regulators often look beyond the transaction itself, scrutinizing the individuals who will continue to benefit from or influence the business after closing. As a result, due diligence must identify anyone who will retain an ownership stake, management authority, financing role, or other economic interest. In some jurisdictions, disclosure obligations extend even further, requiring information about spouses or other family members.

In a closely held, owner-operated business, determining who must undergo regulatory vetting is usually straightforward. The exercise becomes much more complicated in private equity-backed businesses and M&A transactions, where ownership and control often flow through layers of holding companies, fund structures, and outside investors. As a result, individuals with no day-to-day involvement in the business and, in some cases, little awareness of the licensing process, can find themselves subject to regulatory scrutiny.

Alcohol licensing reviews have a way of turning tiny details into major problems, such as:

• A busy investor three tiers up the ownership chain is reluctant to complete required disclosures, holding up a license application and, in turn, the broader transaction.
• The parties made incorrect assumptions about who must be disclosed in the first place, forcing them to reluctantly revisit ownership percentages, governance rights, or other deal terms that were otherwise settled.
• A decades-old criminal charge, an old regulatory violation, or another background concern which has no bearing on the economics of the deal suddenly raises questions about the business’s eligibility to hold a liquor license.

Structuring Around Alcohol Licensing Requirements

To reduce the burden of personal disclosures, private equity funds entering the alcohol industry often look for creative ways to structure ownership. The challenge is that alcohol licensing rules frequently differ not only across the country, but sometimes between neighboring states. A structure that works perfectly in one jurisdiction may create unexpected regulatory issues in another. When significant deal value is on the line, a “build it and hope it works” approach is rarely advisable.

Faced with these competing pressures, deal participants often look for ways to separate regulatory oversight from economic ownership. As a result, two common structuring approaches have emerged.

Option A: Single-Purpose Entity with Disclosed Individual

One approach is to form a single-purpose entity to hold the alcohol license, including a disclosed individual or other qualifying person positioned as the sole owner of the license-holding entity. That person or entity may then enter into one or more protective or economic agreements, more commonly known as an MSA or Management Services Agreement, with the private equity fund to provide the fund with the traditional economic benefits expected in such an investment. This is similar to a “harpoon” structure that is commonly used in healthcare and cannabis deals.

• Potential advantages: This structure may be relatively simple to establish, implement, maintain through the life-cycle of the investment, and ultimately position for an exit event.
• Potential limitations: This structure may not fully insulate the private equity fund or its investors in all jurisdictions or for all license categories from regulatory scrutiny, particularly where regulators look beyond strict equity ownership and focus more on control, financing, or economic benefit. Further, the fund will need to be comfortable with less operational control of the target than one might expect from a more traditional investment or acquisition, and if the relationship sours between the fund and the individual owner of the license-holding entity, then there may be contractual obstacles in removing the individual owner while maintaining stable operations. Finally, this structure could be expressly prohibited in certain jurisdictions.

Option B: Trust Structure

Another approach is to establish a trust as the sole owner of the entity holding the alcohol license with an independent trustee or board of trustees controlling the business and the fund in the position of the beneficiary of the trust. Under this approach, disclosure may be limited to the trustee(s) together with any controlling directors and officers of the licensed entity.

• Potential advantages: This structure may be more widely accepted by regulators in many jurisdictions. It also may offer the fund slightly more control of the business depending on the applicable procedures for removal and replacement of trustees pursuant to the trust documents.
• Potential limitations: Properly establishing and administering a trust can add cost, complexity, and jurisdiction-specific legal requirements.

Whatever structure is selected, the key is identifying ownership and disclosure issues before the deal closes, when they can still be addressed through the transaction documents rather than through costly restructuring or litigation after the fact.

Consult Experienced Licensing Counsel

In alcohol regulation, the right question is rarely “Can we get this deal approved?” The better question is “Will this structure still work when the company doubles in size, enters three new states, or raises its next round of capital?” The answer often depends on having counsel who understands not only alcohol law, but the business itself.

Special thanks to Jessica Kaiser, Dickinson Wright’s Lead Compliance Analyst, for her contributions to this article.