Before presenting a list of these alternatives it is important
to state that only the financial impacts of these policies are discussed
or evaluated in this and the following chapter. Whether member-patron
equity redemption policies increase the demands for a cooperative
association's services is beyond the scope of this study. That is left
to the cooperative management team involved in comparing and studying
alternative equity redemption policies.
"Settlement of Estates: Notwithstanding any other
provisions of these bylaws, the board of directors,
at its discretion, shall have the power at anytime
to pay off , or retire, or secure a release or
satisfaction of any common stock, preferred stock,
participation certificates, stock or deferred
patronage ledger credits for the purpose of facilitating the settlement of an estate. The settlement
of estates shall be made in the following manner:
-
- a) Estates will be settled in the same order
as requests for settlement are received by
the association.
- b) Estate settlements in the current year tn
which the association is operating shall be
limited to thirty-five percent (35%) of the
allocated net savings of the prior year's
allocated net savings, the balance of such
requests shall have first priority in the
following fiscal year and such estate
settlements will again be made but limited
to thirty-five percent (35%) of the allocated
net savings of the prior fiscal year." 1
Cash Refund Plans
The objective of this plan is to increase the percentage of
cash refunds from the obligatory 20 percent to a figure that covers
the tax bracket of the member-patrons associated with the cooperative.
When implemented, this plan also reduces the amount of allocated
patronage refunds that must be returned in the future. The disadvantage of this program is that it
favors the active member rather
than the inactive member who has accumulated equity in the cooperative
but no longer utilizes its services. The impact of increasing the
percentage of cash returned on the financial structure of a farmer
cooperative must be analyzed before implementation.
Shorter Revolving Period
Usually this policy alleviates the problem of retiring older
equities, but if this plan is not combined with an increase in the
percentage of cash refund it aggravates the tax problem mitigated
by the aforementioned cash refund plan. A cooperative usually
attempts to shorten its revolving fund period by restring several
years of allocated equities for several continuous years. The impact of this type of plan on the
financial structure of a farmer
cooperative must also be analyzed before implementation.
Less Proven Alternatives
The following programs have seldom been incorporated into farmer
cooperative member-patron equity redemption programs. They are being
offered as topics for generating hypotheses rather than programs that
have weathered the test of time.
Insurance
The basic idea behind this plan is to provide a basic service to
member-patrons and at the same time increase the amount of permanent
capital ln a cooperative association. An insurance member-patron equity
redemption program might work like the following:
-
- a) The cash refund to the member-patron might cover his tax obligations
on the allocated patronage refund.
- b) A small proportion of the remainder would be utilized to purchase
a life insurance policy for the member-patron -- the rest becomes
permanent equity. The insurance might be one of several types, a
policy which sets up an annuity program that begins when the member-
patron reaches a certain age, or an annual renewal term policy.
- The fact that the farmer is underinsured has often been cited as
in the following quotation:
- ". . . the farmer owns far too little in the way
of life insurance protection. Almost every insurance expert recommends that a man should own
the insurance equal to 6 to 10 times his annual
income. But the average breadwinner in America
owns less than $20,000 of life insurance, and
among the farm population this figure is even
lower." 2
- Why does the farmer need more insurance than anyone else?
- "Because Federal Estate Tax and State Inheritance
Tax have a particularly strong impact on a farmer's estate. Many farmers go through a lifetime
of hard work without realizing the devastating
impact on their families when they are faced with
a large demand for cash for Uncle Sam." 3
Mutual Fund
In this plan a number of cooperatives join together (possibly
under the coordinatton of a regional affiliate) in setting up a mutual
fund whereby each local cooperative invests a certain percentage of
net margins (sinking fund) into a joint investment fund. The earnings
from this mutual fund are then used to retire member equities. The
advantages of this program are two: it's an expilcit method of setting
aside funds for the member-patron equity redemption program and secondly,
if the mutual fund is earning a higher return on its capital investment
the program will retire equity at a faster rate than accumulated and, therefore, allow for
shortening of the revolving fund period. The disadvantage is if the opposite is true; the mutual
fund having a lower
return on its invested capital, then the cooperative will encourage
the lengthening of the revolving fund.
The Step Plan
This plan attempts to appease both younger and older members with respect to equity
redemption. The plan would operate as follows: A certain percentage of cash is returned to the
member-patrons (20% or more to comply with I.R.S. rules). Then a certain percentage of the
previous year's allocated earnings are redeemed (for example 10%). Finally, a certain percentage
of all outstanding equity is retired (for example 3%). This is called a 20-10-3 step plan. The
advantage (the compromise) of this program Is that the older member-patron is having a portion
of his equity retired while the younger member-patron is appreciating an early return on his
investment.
Preferred Stock Plan
In this plan the cooperative pays 20 percent of the patronage refund in cash--the remaining 80
percent becomes part of a non-dividend bearing allocated equity base. After 5 years this allocated
equity is converted into preferred stock with a dividend. The member-patron is permitted to cash
in the preferred stock or maintain it and receive the annual dividend. The advantage of this
program is that member-patrons who desire to support their cooperative or are in no need of
liquidity will continue to invest in the cooperative by leaving their preferred stock in the
association. The calling in of the preferred stock would be left to the discretion of the board of
directors.
Midland's Plan
This plan, promoted by Midland Inc., has been described in a previous section, but it is worth
repeating here with the other "ideal" alternatives. Under this plan a member-patron, upon reaching
a certain age, would have his equity converted to a dividend bearing bond. The bond could be
redeemed or the member could continue to earn the dividend until his death. Upon death the
value of the bond is retired to the member-patron's estate.
The Paper Loss Plan
Under this plan the farmer member-patron would receive 20% of the patronage refund in cash; the
remaining 80% would be issued as a non-interest bearing certificate. The member-patron then
seeks out an investor in the high tax bracket who buys the certificate at lower than face falue upon
which the member-patron takes a tax loss. The investor waits for the certificate to be revolved
out and claims the earning as capital gains which are taxed at a lower rate than personal income.
Cooperatives Unlimited
Several cooperative finance authors (particularly Tubbs, Wilson and Henning and Laubis) have
encouraged a system of equity capital acquisition that would also solve the equity redemption
problem-- that is, marketability of cooperative securities. The following program-- Cooperatives
Unlimited-- is an example (albeit more elaborate and ambitious than most) of one approach in
which this goal might be accomplished. Two of Cooperatives Unlimited's objectives are:
- To encourage the development of a Holding Company, controlled by a Cooperative
Voting Trust, thus enabling cooperatives to participate in the benefits available to other types of
private enterprise.
- To provide the business mechanism, through the Holding Company, for cooperatives
to gain control of successful profit companies, especially those selling to, or performing services
for the regional cooperative owners of Cooperatives Unlimited or its subsidiaries thus
obtaining access to capital, management and other resources which can result in more rapid
cooperative growth.
The capital for the Holding Company would come from the regional's purchasing of its shares and
through stock exchanges and public offerings. The Trustees of the Voting Trust would be the
board of directors of Cooperatives Unlimited who would exercise effective control of the Holding
Company while the stockholders retain their full property rights. This method of control would be
disclosed in the prospectus for the sale of the stock. The control and endorsement by the regionals
would enhance the sale of stock to the local cooperatives and to their individual members as well
as the general public. Once the initial capital is raised, acquisitions of sources of supply, services
and markets could begin. The outstanding stock of the Holding Company would have a market
value established in the over-the-counter markets. When such a market value is established,
unissued shares would be used to acquire more companies in tax free stock exchanges. 4
Aside from the complex problem of instituting such a system, the mayor disadvantage of a
program that encourages cooperative securities marketability might originate from a securites
regulation potnt of view. The element of doing business with your owners or stockholders is the
critical factor that allows securities issued by cooperatives to be considered as substantially
different from those issued by business corporations.5
This consideration of "uniqueness" might be viewed from a different point of view by the
Securities and Exchange Commission if the "marketable cooperative securities" method of equity
capital acquisition is implemented by farmer cooperatives.
Occasional Paper 3
Appendix I
Footnotes
l Copy received from Wilbur F. Klenke, Director of Services,
Kansas Farmers Service Association, Hutchinson, Kansas.
2 W. L. Balilu, Chtef Operating Officer, FEMIC, Farmiand Life, and
Farmiand Insurance Co., as quoted in Farmiand News. "New ServicP tn
Fill Insurance Gap," March 15, 1974, p. 12.
3 Ibid.
4 Ellerbe' Thomas F. Jr., "Cooperatives Unitmited -
A Concept for Cooperation," Blueprint for Cooperative
Actton, American Cooperation 1972-73, American
Institute of Cooperation 1972, pp. 149-154.
5 Weiss, Jerome P., "So You Think You're Exempt From
Federal Securities Laws?", News h r Farmer
Cooperatives, Farmer Cooperative Service, USDA, April
1Y75, pp. 6-9.
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