Sharing a Brew : Irvine’s Bayhawk Ales Offers Intoxicating Lure to Investors, but the Risk Could Leave Them Flat

Bayhawk Ales Inc. is barely a bubble in the huge beer market, but more than 300 investors have wagered $1.2 million so far that the fledgling Irvine microbrewery will be a success.

Operators of the pint-size brewery, which pours out about 1,500 gallons of ale a week in full view of patrons in an upscale bar and seafood restaurant, paint a romantic picture of providing investors entree into an industry that is going nowhere but up.

Investors get business cards identifying them as “founders,” according to a prospectus describing a brewery stock offering that seeks to raise $1.7 million. They will serve in “an army of volunteer marketers” that pitch the company’s products to friends and business associates, and will be invited to exclusive beer-tasting parties.

Pauline Cook bought $1,000 worth of Bayhawk Ales stock right away, and said she plans to buy more soon.

“I like to be on the ground floor of things,” said Cook, 71, vice president of Stacoswitch Inc., a Costa Mesa electronics company. “I have been around for a while, and I was really impressed with the current management,” she said.

But close readers of Bayhawk’s prospectus will find repeated warnings of the speculative and volatile nature of the investment. The company is also raising eyebrows in some quarters by liberally using the name of the Irvine restaurant, McCormick & Schmick’s, that houses the microbrewery.

The prominent regional restaurant chain leases Bayhawk space to operate but says it has no other financial link to the small brewery, which has run newspaper ads urging prospective stock buyers to call its general manager “at McCormick & Schmick’s.”

Bayhawk, which sells its ales exclusively through a small number of bars and restaurants, plans to raise a total of $1.7 million through a so-called direct offering to sophisticated investors--the first public stock sale for a Southern California microbrewery. The offering requires California investors to have $250,000 in net worth and $65,000 annual income, which presumably makes them savvy enough to decide whether to gamble on an unproven venture.

And Bayhawk is unproven. The prospectus warns, for example, that investors “will incur immediate substantial dilution” in the value of their shares. Investors paid $1.65 a share for the stock, but the price was determined arbitrarily by management, the prospectus says. The brewery had negative net worth of $173,575 on March 31.

Investors may also have trouble selling their stock because the shares are not traded on a public market, the prospectus says.

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Price Waterhouse, the company’s accountant, has included a statement that Bayhawk has no operating history and is dependent on selling stock or borrowing money to finance its operations. “Such factors, among others, raise substantial doubt about its ability to continue as a going concern,” the statement says. The report, however, was prepared in January, about a week before Bayhawk began production, a Price Waterhouse partner said.

Bayhawk was founded by James W. Bernau, president of an Oregon winery and a former lobbyist in that state. Bernau, who did not respond to repeated interview requests, is planning to build microbreweries throughout the country under the banner of his holding company, Willamette Valley Inc. Microbreweries Across America., the prospectus says.

An attorney for Bernau said the entrepreneur could not talk because of the Securities and Exchange Commission’s 90-day “quiet period,” which prohibits comments during a public offering that could be interpreted as promoting the stock.

But Bayhawk general manager David B. Voorhies minimizes the risks and says the brewery’s use of the McCormick & Schmick’s name is proper. He said Bayhawk’s showcase brewery was built in the Irvine restaurant because the exposure would benefit both businesses.

As to profitability: “We can make money in the keg business alone,” said Voorhies, 44, a former civil engineer who is making his first foray into microbrewing. He was a home brewer for five years.

“We can make money and we will make money,” he said. “We’re still in a period of growth.”

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But Bernau’s strategy has created a stir in the microbrewing industry, where most brewers consider themselves craftsmen whose goal is to create fine beers and ales. Critics say Bernau seems intent on making money by selling the glamour of a trendy business.

“I think Bernau is manipulating uneducated consumers,” said Vince Cottone, a Seattle-based beer industry consultant. “It will make him a lot of money, but I can’t see his investors making a lot of money.”

Bernau maintains tight control of his businesses. He is the sole director and majority owner of Bayhawk’s parent, Willamette Valley, which will retain 55% to 82% of the Irvine brewery’s stock after the offering. He also sells stock direct, rather than through a brokerage, which doesn’t provide much ready market for investors’ shares because there are no underwriters who have pledged to trade the stock.

“An investor has an equal chance at playing Lotto,” said Paul Shipman, president and chief executive officer of Red Hook Ale in Seattle, whose stock was underwritten by Smith Barney brokerage.

The bulk of revenue from the Bayhawk offering is designated to pay off a $1,089,698 loan from Willamette. If the Bayhawk brand sells well, the company plans to build a larger brewery. The expansion, which would cost up to $2.4 million, would be financed through a second stock offering.

According to the prospectus, Bernau plans to spend only 10% of his time managing Bayhawk’s operations. In addition, the Bayhawk subsidiary is obligated to pay fees to the parent company for accounting, management, sales and marketing services. The company said it would provide the services at cost, plus a markup of no more than 18%.

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For Bernau, though, the technique of selling the sexy business of microbrewing seems to be working. He has raised nearly $13 million in similar sophisticated investor offerings for a winery in Oregon, a microbrewery in Portland and proposed breweries in Seattle and Denver.

He hasn’t been faulted for performance, however, and some in the industry say that other criticisms of the entrepreneur are just sour hops.

The numbers for Bernau’s flagship Nor’Wester brand ale in Portland show strong growth. In 1993, his Portland brewery produced less than 2,000 barrels, but by 1994, production had increased more than 700% to 16,777 barrels, according to the Institute of Brewing in Boulder, Colo.

In the 1980s, he used the same marketing techniques to build his Willamette Valley Vineyards into one of the top three wineries in the state. That company’s stock--originally underwritten by Bernau--has multiplied in value several times and recently was listed on the NASDAQ exchange.

“The pioneers are the ones with the arrows in their backs,” said Will Rosenthal, a Portland investment banker and microbrewery consultant.

What Bernau is rapped for is overreaching. Among other things, he has attempted in the past to link his products to prominent microbrewing industry people and companies without first obtaining their permission.

John Campbell, owner of Lang Creek, a well established Montana microbrewery, said he had to hire a lawyer to force Bernau to stop using Lang Creek’s brand name, Tri-Motor Ale.

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Today, in prominently mentioning the McCormick & Schmick’s chain in the prospectus for Bayhawk, Bernau is treading the same shaky legal ground, says William Crookston, a USC management professor. “It’s clearly unethical for them not to have disclosed the proper information in the prospectus,” Crookston said.

The general manager, Voorhies, says Bayhawk uses the chain’s name just to help people locate the brewery.

Restaurant co-owner Doug Schmick says he hopes the link will not be misconstrued. “People should be investing in the microbrewing industry on its merits alone. We are in no way endorsing Bayhawk Ales.”

Bayhawk investor Carl Anderson, a 46-year-old state fish hatchery manager in Glenwood, Wash., is unintimidated by the risks.

“If your investment is safe, your return is modest,” said Anderson, who said he has invested more than $5,000 in several Willamette Valley microbreweries, including Bayhawk. “With high risk, there is high potential.”

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Know Your Brewer

The craft-brewing industry, which includes brewers of less than 1 million barrels per year, experienced 50% growth in 1994 with sales of 2.5 million barrels. Four industry subgroups: * Regional specialty breweries: Small operations producing between 15,000 and 1 million barrels per year. Example: Anchor Brewing Co. of San Francisco, makes Anchor Steam * Contract brewing company: Markets and sells beer brewed to its specifications by existing breweries. Example: Boston Beer Co., produces Samuel Adams * Microbrewery: Produces less than 15,000 barrels per year, mostly for distribution to restaurants, taverns, retail stores and to customers for on-site consumption or takeout. Example: Bayhawk Ales * Brew pub: Restaurant/brewery selling at least 50% of production to customers for on-site consumption or takeout. Example: Huntington Beach Beer Co.

Sources: Institute for Brewing Studies, Bayhawk Ales; Researched by JANICE L. JONES / Los Angeles Times

Brewing Up Business

Bayhawk Ales, a microbrewery within McCormick & Schmick’s Seafood Restaurant in Irvine, is part of the growing trend toward small-scale beer production. U.S. microbreweries and their sales in barrels:

Breweries

1994: 192

Sales

1994: 456,553

BAYHAWK ALES AT A GLANCE * Business: Microbrewery * Ownership: Willamette Valley Inc. * Location: Irvine * Founded: Feb. 14, 1994 * President: James W. Bernau * Brewer: Steven Peterson * Facility: 17-barrel brewery with fermentation tanks and kegging system * Production: Up to 10,000 barrels annually

Beer Talk * Origin: Undetermined, but archeological expeditions have revealed ancient Egyptian recipes for similar beverages * Ingredients: Malted barley, water, hops and yeast * Ale: Brewed with yeasts fermenting at higher temperatures (high 50s to low 70s) for 8 to 10 days. Described as fruity, tart or tangy * Lager: Brewed with yeasts fermenting at lower temperatures (mid-30s to mid-40s) for 8 to 10 days and then allowed to sit (or lager) for approximately three weeks. Described as clear, crisp. Most American beers, such as Coors and Miller, are lagers. * Barrel: Equals 31 gallons (two kegs)

Brew Pubs Lead Industry

Brew pubs make up the majority of more than 750 U.S. craft breweries: Brew pubs: 55% Microbreweries: 30% Contract brewers: 13% Regional specialty breweries: 2%

Sources: Institute for Brewing Studies, Bayhawk Ales; Researched by JANICE L. JONES / Los Angeles Times