Ohio Micro-Distilleries: Go Big or Go Home

MIDDLE WEST & WATERSHED, Columbus

Timing, as it turns out, really is everything.

During one of the worst-ever U.S. economies, Greg Lehman and Dave Rigo bought a house at a low cost, flipped it for a high return, quit their jobs and dumped the profits and their retirement savings into starting a micro-distillery. Then, about a year away from Watershed Distillery's launch-what they thought would be the state's third and Columbus' first micro-distillery-a case of mistaken identity gave them pause. Bad timing followed good.

The panic arrived while they were taking a distillation class in Chicago in late 2009.

An employee at Koval, the Windy City's first micro-distillery and the U.S. sales rep for a German-based still manufacturer, told the partners they had just shipped the fledgling company's new still.

"No, we just got ours on order," Rigo told the rep. "I wish-that'd be awesome."

But the Koval employee was convinced he had it right. "Yeah, you're from Columbus, right?" he told Rigo. "Middle West, right?"

Lehman and Rigo didn't know what Middle West was, but back in their hotel later that evening, the partners frantically Googled the name and read about the other startup distillery that was about to open in Columbus. Their spirits were low for the next few days.

"We were scrambling," Rigo says. "Like, is there a big enough market to hold two micro-distilleries in Columbus?"

As it turns out, there is. Two micro-distilleries launching at the same time was not cause for panic but celebration.

"It's actually worked out really well," Rigo says. "We realized really quickly that two people doing this new thing is a story, and one company doing this new thing is just like, 'Are they crazy?' It's since become, 'Columbus has this movement going on.' "

Four years later, the two companies have doubled in nearly all measurable metrics, from output to staff to physical space. Each company's success is owed, in part, to the other's existence. The most common question Watershed gets on its tours: "What do you guys think about Middle West?" Rigo says.

They love them.

In fact, owners at both companies say, they'd love nothing more than to see more micro-distilleries open in the state. A rising tide raises all ships. But therein lies the rub, says Brady Konya, general manager and owner of Middle West Spirits.

"The most exciting thing is we could end up with 50 craft distilleries in the next few years, but we're concerned half won't stay in business," Konya says. "This isn't a hobby project; this isn't the kind of state where you can run a hobby."

Indeed, Ohio's poised for a micro-distillery breakthrough, much like the one breweries have experienced in recent years in the craft beer market. The state is now home to 20 micro-distilleries, with nine more set to open upon approval from the Ohio Division of Liquor Control. Just a few short years ago, there were only two.

Konya's worries are largely due to the small profit margins earned by micro-distilleries. As a craft distillery in Ohio you have two options, he says: You either need to be a high-volume producer or be resigned to making spirits as a hobby. There's little room for middle ground.

That's because Ohio spirits are taxed at such a high rate: $9.32 per gallon, 12th highest in the country, according to an analysis by the Tax Foundation.

You can thank the state's monopolistic liquor-control system, which runs like this: Ohio liquor producers sell their wares to the state at a wholesale cost determined by the state. The state then sells those products to liquor stores, bars and restaurants at a mark-up the state also sets. The state keeps the money it makes from this system and funnels profits to JobsOhio, the privatized economic-development agency. Ohio liquor sales generated $898 million in total revenue in 2013. JobsOhio, which operates on a July 1-June 30 fiscal year, received $188 million in profits in fiscal 2013.

This system was set up following the repeal of Prohibition, in part to curtail mob activity. But the effect today can be a restrictive one for micro-distilleries, which weren't even a twinkle in lawmakers' eyes in 1933.

In essence, profit margins are so small for today's micro-distilleries because the state's system creates a middle man in the distribution of their products, thus adding an extra layer of cost.

The taxes for liquor in Kentucky, for instance, are almost a fifth of what they are in Ohio. Kentucky, like most states, isn't a liquor-control state.

Matt Mullins, spokesman for the Ohio Division of Liquor Control, says it would be a mistake to fault the liquor-control system for a lack of growth in the spirits industry.

In fact, Mullins says, the current growth spurt of new distilleries is proof the state's liquor-control system is effective. For instance, the legislature changed state law to wipe out limits on the number of micro-distilleries in Ohio and clear the way for distilleries to offer samples and sell products on site. "That's what spurred the growth of the micro-distilleries in the first place," he says.

If anything, Mullins says, the liquor-control system can benefit micro-distilleries because it gives fledgling companies an advocate they wouldn't have in non-control states.

"The big-box stores [in non-control states] are only going to put on the shelves what they think people want," he says. Here, "We're always trying to do what we can to help Ohio businesses thrive and succeed."

But without a different tax structure, Konya says it'll be difficult for craft distilleries to make much of a profit without producing large quantities.

Other profit-generating restrictions stem from regulations that keep distilleries from also opening an on-premise bar or restaurant (like wineries and breweries do).

To change this, Middle West and Watershed have formed a guild to lobby legislators, and they hope to introduce a bill in the legislature this year that'll allow distilleries to operate in the same way brewpubs currently do in Ohio.

"We are not afforded the ability to have the brewpub model, so we must go to the glass [bottle] first and get stuck in this three-tier system that takes 40 to 46 percent of revenue out of the gate," says Middle West co-founder Ryan Lang. "Thus why most distilleries either go farmhouse-style and hopefully have very low cost structures or go all out to grow the company large enough to sustain jobs. But why can't we have the ability to have a brewpub, where we're selling directly to the consumer? That's a much greater revenue stream."

Lang hopes the bill gets taken up in the General Assembly after the May midterms, but there's also a chance it might not be introduced until 2015, he says.

In the meantime, at least one victim has already been claimed. Branch Water Bourbon, a potential new micro-distillery in Dayton, canceled plans to open last summer after encountering the various governmental regulations and fees required of new micro-distilleries.

"The alleged loosening of state regulations that got me interested in the micro-distillery were not as loose as advertised," Branch Water owner Benjamin R. Jones wrote to the Dayton Daily News in July 2013.

Two micro-distilleries flanking Columbus-one in New Carlisle, near Dayton, the other in Athens-demonstrate possible ways forward for distilleries looking to move beyond the hobbyist level. But even their unique, niche-targeted approaches are potentially perilous long-term, each says, without changes to liquor-control laws. For now, they move forward, carving out any available market share they can get and hoping craft-liquor fans will connect with their unique stories.

FIFTH ELEMENT SPIRITS, Athens

In the rolling Appalachian hills a few miles outside of Athens sits a light green shed next to a farmhouse of the same color. On this wintry morning, Kelly Sauber's tinkering around but not really accomplishing much in the 21-feet-by-21-feet building where he produces all his craft liquors. Making spicebush berry gin, elderberry brandy or sorghum rum isn't in the plans today, like it is most other days.

Sauber recently settled a lawsuit with Dancing Pines Distillery in Colorado because his distillery's name (Dancing Tree) was too similar to theirs. In November, Sauber filed forms with the federal government to change the name to Fifth Element Spirits, but the application hasn't been approved yet. Which means Sauber's kind of in a holding pattern.

So after an hour or two at the distillery, he drives into downtown Athens to check on the renovations underway at his latest endeavor, a winery and cider house called The West End Cider House.

In some ways, the timing of the lawsuit and the subsequent rebranding as Fifth Element was ideal, Sauber says, as it should coincide nicely with the opening this month of the cider house, which will be run by his girlfriend, Deanna Schwartz.

The cider house provides a nice little legal loophole for Sauber's spirits. Even though the cider house will have to buy Fifth Element products through the state at retail cost, Sauber believes the ability to almost exclusively offer his products at the bar will provide enough of a guaranteed revenue stream to be worthwhile.

"If I can push our spirits to being the primary product at our place just like a brewery or wine bar, I think it's going to keep me plenty busy where I don't have to worry about outside sales," he says. "And if people want our spirits, and it goes into the marketplace, I think our shop might help those sales potentially without having to really push it."

Beyond this workaround, though, Sauber sees a lot of his future success stemming from his own credibility as a long-time professional brewer in southeast Ohio and from the Athens community itself, a small town with a strong love of local products.

"Back in the day," he says, "you never drank any beer other than what was made in your community; that works in breweries, and I think, eventually, we'll get it to work in our industry too.

"It's a hard sell though. Our product does cost more than some other products-that's a hurdle to overcome, and we could overcome it more easily if the state gave up the control."

Indian Creek Distillery, New Carlisle

On a slow, cold and snowy Friday in mid-January, a woman, slightly past middle age, hesitantly opens the door to the Staley Mill Farm and Indian Creek Distillery.

"We were hoping you were here. We're getting a last-minute gift for a friend of his," the visitor says, alluding to her husband, who's already checking out flasks on display.

They're the first customers in more than an hour, and Missy Duer, whose great-great grandfather founded the 168-acre farm, warmly greets them and begins to show off the different flasks available for purchase.

Missy's husband, Joe, gets up from the bench seat where he was sitting with their granddaughter, Skylar, and moves toward the back of the building, where a matchstick-sized stream of whiskey is flowing slowly out of an old copper still. Skylar dips her finger in the sweet, clear liquid and licks it off (because the distillery uses such old equipment, the whiskey undergoes multiple distillations, which means there's very little alcohol in this batch).

A few minutes pass, the couple leaves, purchase in hand, and the family returns to the front room that acts as a lobby and store but feels more like a living room you'd find in a rustic log cabin.

In this room, a nearly 200-year-old story is being told. Yellowed documents hang from the walls in ornate frames beside pictures of men in suspenders, big hats and bushy mustaches. A small, half-full barrel of whiskey stands near an old fireplace. The barrel's known to leak on occasion, but Joe and Missy say they're unconcerned.

"We don't mind the smell of whiskey at all," Missy says, a knowing smile creeping onto her face.

The barrel is so old and worn and cracked it almost looks like a novelty and goes unnoticed, but the relic, like many things on the Staley Farm, is indicative of so much more. The nearly 200-year-old story it whispers is also a story of today, a tale that tells a way forward for Missy and Joe.

In 1920, George Washington Staley hid the barrel (along with some copper stills and the original family recipe for rye whiskey) in an upper floor of a warehouse. It stayed there until 1997 when the family started doing farm tours. The Staleys had not only saved the distillation equipment but also plenty of farm equipment, too, from horse-drawn buggies to home furnishings. The stills came down for display as well, and they stayed there for a few years but never silently.

"It wasn't like we had this burning desire for years and years to distill," Joe says. "I had never distilled, never brewed beer, never had an interest to, but the distillery, obviously, was the only part of the farm that was missing. It was kind of a natural process to get the distillery started again."

The goal from the start was to operate the distillery as close as possible to the way it was run in the early 1800s, including using the original stills and recipe for unaged rye whiskey.

Joe took a four-day distillation class in Wisconsin, but it wasn't much help. The methods taught weren't exactly the same as those used in the early 1800s, nor was the equipment.

Joe sought out several old distillation books, but that presented another set of challenges. Imagine trying to follow a less-than-exact recipe for cake written by Shakespeare.

"It's like, 'Heat your water up 'til you can keep your hand in it for 10 seconds,' " Joe says. "Distilling this way is very intuitive. I do a lot of things by smell, sight and sound."

After a year of trial-and-error, however, they say they've mostly figured it out. Sure enough, just a few short months after opening, Indian Creek Distillery won a bronze medal for its unaged rye whiskey at the American Distilling Institute's seventh annual Judging of Artisan American Spirits.

"We are definitely old school, and sometimes it's old school to a point where you're like, 'I think we're nuts,' " Missy says. "It'd be so easy to put a column still in the back room and crank this stuff out. It takes us an entire week to produce 65 to 100 bottles of whiskey. That's slow. On a small scale like us, that can get a little tough."

The bright spot, she says, is the story. They have that in abundance.

"We've been told we have the oldest working stills in America," Missy says. "We're not only a distillery, we're a heritage tourism destination. The combination is great for us, but if we could sell [our whiskey] without the huge tax, we could make a lot more money.

"We could have 20 more distilleries in Ohio. We won't really be competing with each other because we're all so different."