New California law sparks growth among craft distillers

On March 12, Timo Marshall held an event at his Spirit Works Distillery in Sebastopol to celebrate the release of his cask-strength rye whiskey.

While such release parties are common among local wineries and breweries, it was a big deal for Marshall because, thanks to a new state law that went into effect Jan. 1, it was the first time he could actually sell his product on site at an event. For him, there would be no more directing customers to the nearest supermarket that carries his spirits - and wondering if they actually bought it.

“It went really well,” said Marshall, who with his wife, Ashby, opened the business three years ago in the trendy Barlow center in Sebastopol. “I have bumped into lots of people who said they haven’t been here for a year and now they are planning to come.”

Other local and statewide craft distillers are also experiencing sales increases because of the new law. It was hammered out as a compromise last year with the politically powerful lobby representing wholesalers, who feared that on-site sales would cut into their business.

Distillers and analysts are now predicting a boom in the craft distilling category, in large part due to the new law. There are about a dozen distilleries in the area. The growth could mirror what occurred in the craft beer business a decade ago, where stalwarts such as Budweiser, Miller and Coors have lost market share to artisans.

“It’s like the Wild West for people getting involved,” said Jim Harrelson, co-founder of Do Good Distillery in Modesto and president of the California Distillers Guild, which represents about 40 of the 60 craft distillers in the state. He has seen customer traffic at his business increase 30 percent since the new law went into effect.

But the impact of the new law goes beyond the distilleries. The changes have also attracted the interest of suppliers and other professionals such as bottlemakers and cork producers, financial services firms and lawyers, who all stand to gain revenue as the craft spirits industry’s reach grows.

“This is just the start of what we expect,” said Tracy Sheppard, senior lender for Live Oak Bank’s wine and craft beverage group, which is located in Santa Rosa.

The new law for the first time defines a craft distiller operating in California, limiting it to those that produce up to 100,000 gallons of distilled spirits annually.

The law, authored by Assemblyman Marc Levine, D-San Rafael, allows distilleries to sell up to three 750-ml bottles per customer per day on site. It also allows license holders to open an on-site bar or restaurant and have tastings where they can make cocktails and mixed drinks, a growing business with mixologists performing at cocktail-themed events.

The craft distillery market is still a small sliver of the overall spirits marketplace. The Distilled Spirits Council estimated that the overall U.S. retail market reached nearly $72 billion in 2015.

Craft accounted for 0.53 percent of shipments within California in 2014, according to a data analysis by alcohol beverage industry consultant Jon Moramarco. But that figure was a 40 percent increase over 2013 shipments. He noted that the California craft beer segment was at 3.9 percent a decade ago and now stands at about 9 percent.

“They will grow. It’s going to grow slow,” Moramarco said. “They’re about 10 years behind craft beer.”

So far, 38 distillers have active or pending craft distilling licenses with the California Department of Alcoholic Beverage Control, spokesman John Carr said. There are 133 businesses that have a license to be a distilled spirits manufacturer in the state.

One of those new craft license holders is Sonoma Brothers Distilling Co. in Windsor, operated by twin brothers Chris and Brandon Matthies. The distillery recently sold $350 in spirits during just a two-hour span, said Chris Matthies, who is a firefighter for the Santa Rosa Fire Department.

Sonoma Brothers is trying to determine what type of events to hold to attract customers, though it has limited hours because both brothers have full-time jobs.

Chris Matthies said he is considering starting a spirits club, where members can come for special events and to pick up their bottles. If the sales continue to grow, it may allow them to hire an employee to manage the tasting room and help with marketing.

“You see the wineries next door to us and they have $1,000 days,” he said.

One major advantage for selling on site is that the profit margins are much higher for manufacturers, making it a sustainable business. A craft distiller can see up to 60 percent of bottle price eaten up by wholesalers that purchase their product for retail, said Bill Owens, founder and president of the American Distilling Institute, which represents U.S. small-batch, independently owned distillers.

“It makes a huge difference in order to become profitable,” Owens said.

His group now has more than 1,000 members, up from 500 in 2010.

The projected growth comes at a time when barriers to entry into the field still remain. For example, equipment for a small distillery can easily cost $1 million. Also, brown spirits such as whiskeys and bourbons can take one to two years to age, causing delays in return on investment.

The federal excise tax on spirits equals about 21 cents per ounce of alcohol, compared to 10 cents for beer and 8 cents for wine, according to the Congressional Budget Office.

“There’s a lot of things that are stacked against the beginner,” Owens said.

So why do they still enter?

“You know how much fun it is?” Owens asked rhetorically.

In fact, the new small entrants come as larger wineries and beer companies have entered and expanded into the market, sensing an opportunity. They include E&J Gallo Winery, Guerneville’s F. Korbel and Brothers and Graton-based Purple Wine + Spirits, which just recently introduced D. George Benham’s Sonoma Dry Gin.

Suppliers also are sensing an opportunity. The American Distilling Institute’s annual conference, which starts Tuesday in San Diego, has more than 140 listed vendors, including manufacturers that produce corks, packaging, labels and malt products. Sheppard of Live Oak Bank is attending the conference to search for new business.

Locally, M.A. Silva USA of Santa Rosa has found a growth market in the spirits sector for its cork tops and bottles, said Michael Riel, chief operating officer.

The spirits industry still represents a “single digit” of its overall business, Riel said, but it helps provide diversification from its main business working with wineries. “We actually do see an impact,” he said. “It’s still very small.”

Riel, who at age of 18 had a small distillery in Munich, is a fan of craft distilling, singling out Germain-Robin in Ukiah for its brandies. He noted that the county’s dwindling apple acreage could be preserved through farmers using apple brandy as a revenue driver to keep their business sustainable.

Farms in the European Alps produce brandies and have turned them into “a cash cow,” he said.

“That’s the only reason the farms are in existence there,” Riel said.

Back in Sebastopol, Marshall said the law has allowed him to hire another employee for his tasting room. He also has a new counter coming in to handle more customers who will come in for a pour.

Within a month, Marshall plans to extend his visiting hours from Thursday through Sunday from 11 a.m. to 4 p.m., to Wednesday through Sunday from 11 a.m. to 5 p.m. to take advantage of the foot traffic at the Barlow.

“It makes us financially viable to have more staff,” he said.

Marshall said he plans to experiment more to see what types of events will attract customers. He said he thought that cocktail tasting may not be a viable avenue given the small amount, 1.5 ounces, that can be served per customer per daily visit.

But the future looks bright, he said, noting how quickly his $79 bottle of rye whiskey, with enhanced spicy notes of clove and nutmeg, has flown off his shelf in just a few weeks. “We’re pretty close to five or six cases left,” Marshall said.