Startup tips: What to know about private equity funding, exit strategies, co-manufacturer agreements

By Ryan Daily

- Last updated on GMT

Image Credit: Getty Images - Eoneren
Image Credit: Getty Images - Eoneren

Related tags Startup company co-manufacturing acquisition

From understanding when to exit to securing favorable agreements with co-manufacturers, food and beverage startups are facing a myriad of business challenges that are likely to persist throughout 2024 as private-equity capital continues to dry up, Christopher Cain, co-chair transactions practice group at Foley & Lardner, told FoodNavigator-USA.

Exit strategies: From acquisitions to closing for good 

Over the years, food and beverage startups have increasingly turned to private-equity funding – where they offer an equity stake in their company in exchange – to fuel their business growth. In 2023, private-equity firms, which “rely very heavily on debt as part of their capital structure,” became more judicial in the companies that they invested in, and those that raised money in previous years started to see their capital reserves dry up, Cain said. 

“If you raised a bunch of money in Q2 of 2022 before the party stopped [and] if you haven't run out of money, you're going to run out of money. So, that venture money you raised is coming to an end, that runway is coming to an end, and you have to do something, and I don't think we saw the full reckoning of that in 2023 because I think a lot of those companies still had money from 2022. But that's going to run out for a lot of them in 2024.” 

Many startups that find themselves with no capital to run the business will ultimately have to decide whether they can sell the company outright or sell parts that other companies deem have some value, he explained. 

When it comes time to selling a company, food and beverage startups need to ensure that they have all their legal documentation — patents, business agreements, etc. — in order,  Cain said.

“You want to have your legal house in order, and the co-manufacturer agreement ... is one example of that. You want all of your important commercial relationships that a buyer is going to be interested in continuing, that they're all well documented, pursuant to binding agreements, that are fair to you as the company, [and] they're fair to the other side as well,” Cain said. “They're well negotiated drafted documents such that a buyer feels good about stepping into them, and then taking them on.”

Additionally, startups need to ensure that they have their intellectual property (IP) and financial houses together as well to ensure a smooth acquisition, he added. 

“One of the ways that cracks can appear in the armor is if you don't have written agreements with everyone who has touched the IP because if you don't, in certain circumstances, those other people may deem to be owners of some of the IP. They may have a license to the IP, and it just creates sort of a nightmare. So in addition to having your contract house in order, having your intellectual property house in order is also critical.”

For those startups that might be in less favorable positions, acquirers might also simply buy the company for the talent that they have — an acqui-hire — or want to acquire a specific patent or asset that the company has, Cain noted.  

"I think 2024 is going to be a mixed year, but acqu-hires have become more commonplace again because ... whether the business isn't making it either because you're not selling a product, or you're losing money and you've raised capital from venture capitalists, but at valuations that you couldn't sustain today, and so you can't raise additional capital. You're forced to either literally wind the business down, just shut it, and no one gets anything, or look for a buyer who's willing to sort of do an acqui-hire or [sell] parcels and bits of the business that they believe that value."

Working with co-manufacturers: ‘First and foremost, you really have to have a written agreement’ 

Despite the lower funding environment, aspirational startups are still entering the market, and if they want to set themselves up for success, a crucial first step is ensuring that they have a written agreement with their co-manufacturer, Cain said.   

Too often, startups entering the market do not do their due diligence of securing a written agreement with a co-manufacturer or simply opting for the co-manufacturer's pre-written agreement, which can create a host of problems, he added.  

“First and foremost, you really have to have a written agreement. I think a lot of startups, for cost reasons and otherwise lack of sort of know-how, will go with either no agreement — just sort of an invoice [purchase order] — or they'll use whatever the co-manufacturer has for their written agreement, and those are terrible ideas.” 

Startups should create their own written agreement, which should have language on what happens “if and when things do go wrong” and who is responsible in the situation, he said. Additionally, a startup should avoid an agreement where a co-manufacturer has the exclusive rights to produce a brand’s product because then they are “stuck with them,” even if there’s an issue with producing the product, he added.  

“I tell startups whether it's a co-manufacturing, a licensing, a joint venture, exclusivity is something you should run, not walk away from ... because there's usually power disparity. You don't know the person, or you don't know the company,​ and if things don't work out, exclusivity is another hurdle that you have to get over," Cain emphasized.

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