The significant majority of DSPs in the U.S. are appropriately described as startup businesses. Now when I say a DSP is a “startup”, I don’t necessarily mean that it has just begun operations. Instead, I mean that the business is operating in the style of a business that has just begun operations. Usually, that means a very lean enterprise which is probably undercapitalized and which is being driven more by the passion and optimism of its founders and supporters than by obvious economic promise.
If this sounds like a challenging environment that’s because it is. But this challenge isn’t impossible to overcome. In fact, when you consider that every company you’ve ever heard of (e.g., Google, Apple and Microsoft – currently the three largest US companies as measured by market capitalization) can trace its roots back to a startup you begin to realize that significant opportunities await those willing to take risks.
That said, if your DSP is too strapped for cash, it may not have the funding to buy the grain for that delicious new recipe you want to unleash on the world – let alone to buy the equipment to distill it in. What’s a startup to do?
First, take some consolation in knowing that you’re not alone. The vast majority of startup businesses face some measure of financial insecurity. DSPs are no exception. And like other businesses, DSPs can avail themselves of a number of avenues for soliciting (and hopefully receiving) outside investment. Note, however, that because of the specific nature of the state and federal regulations covering alcohol, you will be subject to some additional hurdles not imposed on startups in “dry” industries.
Before we get to those additional hurdles, we should talk a little bit about the laws that likely apply. First, please note that any time you receive something of value for your business (e.g., cash, credit or that shiny new still) and you provide in return some kind of an interest in your business (e.g., stock, LLC membership interests or even just an IOU), you’ve likely stumbled into the land of state and federal securities laws. I love securities laws. [Note: I also love overpeated whisky and stinky cheese – so my tastes may not be representative of the population as a whole.] But under federal securities laws every sale of a security (in our example, the thing your business gave in return for the value provided) is either (1) registered; (2) exempt from registration; or (3) illegal. The first of these options is extremely expensive up front. The third of these options tends to be pretty cheap up front, but catastrophically expensive later on. The second alternative is usually the best.
Unfortunately (or fortunately, depending whether you’re the kind of guy who likes stinky cheese), there are a host of rules that govern what you can and cannot do in an exempt offering of securities. Some exemptions allow you to advertise your offering, whereas some exemptions prohibit general solicitation (like advertising) of investors. Some exemptions say you can sell to anyone, but other exemptions say that you can only sell to so-called “accredited investors”. This is complicated stuff, and I’m only talking about the federal rules. State rules may (or may not, depending on what you’re trying to do) also apply. So before you pass go and collect $200 from that investor – in fact before you even talk with that investor – do yourself a favor and get legal counsel involved.
So now you’ve got your trusty lawyer by your side and you’re ready to take in those investments. What else should you be concerned about? For starters, don’t forget that when you filled out your permits with the TTB (and likely with your state as well – depending on where you’re operating), you likely had to provide them with extensive background information about everyone who own an interest in your business. Selling securities now means that you may need to update that information. And if you sell so much to any one individual that he or she obtains a 10% stake, they’re going to need to pass the background check you passed when you started on this journey. Occasionally, you’ll need to pass on a potential investor (or limit his or her ownership percentage) because of prior misbehavior. So exercise some discretion when considering who to invite to your particular party.
At the same time, let me give you the advice that I give all my startup clients – which is that you should not be too insistent to maintain absolute control over your business that you pass up investment that might have been really helpful. Far too often entrepreneurs needlessly struggle along because they were fearful of giving up control or of losing too big of a slice of the equity of their company – when if they’d just been willing to reduce their ownership stake a bit more than they wanted they might have been able to attract a real champion to the team. The best investment comes from individuals who can not only write the funding check but who also bring some meaningful skills, experience or contacts to the table. Investors like that are golden – and can mean the difference between success and failure.