University of Wisconsin Center for Cooperatives

Cooperative Equity Retirement:
Some Guidelines and Practices

By Michael L. Cook, Assistant Professor, Department of Agricultural Economics, Texas A and M University, College Station, Texas
Richard Vilstrup, Professor, Agricultural Economics and Meat and Animal Science, University of Wisconsin-Madison
Frank Groves, Professor, Agricultural Economics, University of Wisconsin-Madison. and Chainman, University Center for Cooperatives, University of Wisconsin-Extension

UWCC Occasional Paper No. 3 - February, 1980

This paper is based on a portion of Michael Cook's PhD thesis, "An Economic and Legal Analysis of Farmer Cooperative Equity Capital Redemption Policies," University of Wisconsin-Madison, 1976. Financial support for the research was from Hatch Project No. 1694, and The Cooperative Foundation through the University Center for Cooperatives.   

INTRODUCTION

For years cooperative writers have been recommending that agricultural cooperatives establish member-patron equity redemption policies and practices. There are numerous economic and institutional reasons for cooperative management and boards of directors to become increasingly concerned with this important area of cooperative management. 1

One example is a recent Report To The Congress 2 by the Comptroller General's Office which reviewed several ways in which equity redemption policies and practices of farmer cooperatives "could be improved." The report goes further in recommending:

"...that the Secretary (of Agriculture) direct the Cooperatives Unit to conduct, jointly with the Extension component of the (USDA's) Science and Education Administration, a national campaign to motivate cooperatives to adopt voluntary equity redemption programs that are fair to both current and former members. We recommend further that if cooperatives are not wliling to adopt more equitable redemption programs voluntarily, the Secretary develop a legislative proposal to make it mandatory for cooperatives to: The legislation should include a clause that cooperatives that do not comply with the requirements would lose their tax exemption status."3
Other examples include recent state and federal legislative proposals to require mandatory revolving of equity capital after a certain time period, the report of the National Commission for Review of Anti- trust Laws and Procedures, proposals to eliminate the required teaching about cooperatives in Wisconsin schools and numerous complalots by members about the lack of any equity retirement policy in many cooperatives.

These recommendations are harsh in nature and would have a devastating impact on the financial structure of many farmer cooperatives. Before proposing some gutdelines and alternative equity redemption programs, it is appropriate to examine whether the lack of equity retirement programs in farmer cooperatives is widespread or not.

PRESENT SITUATION

In an April 1977 report, 4 the USDA summarized the frequency and types of equity redemption programs. Using 1974 data from a survey of 857 U.S. cooperatives, the study found that 71 percent of all farmer cooperatives in the U.S. have some sort of program for redeeming equity capital to member users. The remaining 29 percent had no program. It was also estimated that 32 percent of U.S. farmer cooperatives carried out systematic programs for retiring retained equities. Thirty-nine percent of the surveyed cooperatives had equity redemption programs that function under special circumstances, such as death or retirement.

The question of what percentage of equity capital was owned by inactive members was a matter of concern in the USDA study. The USDA estimated that 32 percent of the equities retained by cooperatives without equity redemption programs and 22 percent of the retained equities held by cooperatives that had systematic or special redemption programs were owned by inactive members. Table I presents a more detailed summary of the equity redemption programs used by cooperatives, by membership and function.

In a 1975 study of equity redemption practices in Colorado cooperatives, a team of researchers found that only 14 percent of the ol firms in their survey had written equity redemption policies.5 Colorado cooperatives did retire estates promptly (32 percent) but less than 15 percent of the cooperatives redeemed equity of members who became disabled, retired, or moved from the area. The Colorado study also indicated that 37 percent of the cooperative members were classified as "inactive." This 37 percent held 23 percent of the member equity. 

    Table I. Equity redemption programs used by cooperatives, by
membership and function -- 1977
   
                                  Both
               Systematic Special systematic    All   No    All
Type of Co-op  only       only    and special   prog. prog. coops
    
                                 Percent
    
Federated:
    
Marketing        39        8       14            6l   39     100
Farm supply      36       20       12            68   32     100
Related service  50        6       13            69   31     100
Total 
  federated      40       12       13            65   35     100
    
Centralized:
    
Marketing        17       30       17            64   36     100
Farm supply       3       54       28            85   15     100
Related service   6       22       ll            39   61     l00
Total 
  centralized    l2       39       20            71   29     100
                       
All 
  cooperatives   l2       39       20            71   29     100
    
    
Source: United States Department of Agriculture, Equity
Redemption Practices of Agricultural Cooperatives, FCS Research
Report 41, April 1977.

The Comptroller General's Office sampled 83 cooperatives in their 1979 study and came to the same general conclusions as the USDA study as to what is the current situation with respect to equity redemption programs. Their Report estimated that only 30 percent of U.S. cooperatives had systematic programs for retiring member equities. The authors of this study expressed particular concern over the absolute value of equity outstanding and the age of the equity certificates.

The figures estimated in these three studies indicate that a relatively small number of cooperatives have developed systematic equity redemption policies or programs. The need for increased efforts to "motivate cooperatives to adopt voluntarily' equity redemption programs that are fair to both current and former members" 6 is certainly appropriate.

GUIDELINES

The following guidelines are presented as an aid to cooperative association policy makers in developing farmer cooperative member- patron equity redemption policies and programs. These guidelines are suggestive in nature only, but they may assist in developing an orderly approach to equity redemption.

STEP l: A special committee appointed by the board of directors to study the cooperative's member-patron equity redemption policy is needed. Possible members of the committee and resource persons for providing information throughout the study might include: interested members, the general manager, the chief financial officer, staff people of credit institutions such as the Bank for Cooperatives, affiliated regional cooperative's fieldmen and their supporting staff, the state council of cooperative's staff , state university extension personnel, the cooperative's legal counsel and representatives of the cooperative's auditing firm. The committee should be expected to report within a specific time period.

STEP 2: The committee should consider the following four questions before deliberating on any specific proposals:

a) What is the relationship between the member-patron equity redemption program's objectives and the overall cooperative objectives?
b) What effect will the equity redemption program have upon the financial structure of the cooperative?
c) What effect will the equity redemption program have upon the cooperative's existing organizational structure?
d) What is the effect of the equity redemption program on the service to member-patrons?
STEP 3: An analysis of the equity capital acquisition program presently employed by the cooperative should be made. The more detail with which this analysis is made the better. Items such as how equity capital is acquired, in what quantities, and how successful past equity capitalization methods have been should be documented.

STEP 4: An analysis of the equity capital redemption program presently practiced by the cooperative should be made. This analysis should also be done in as much detail as possible. If this policy has not been described in writing, it would be a good management practice to do so.

STEP 5: The state statute pertaining to cooperatives should be studied. When performing this step a written summary of statute sections related to bylaws, articles of incorporation, general capital reserve limitations, and member voting and equity retirement will be of most interest.

STEP 6: The cooperative's articles of incorporation and bylaws should be reviewed with respect to equity acquisition and redemption sections. It is important to complete steps 5 and 6 before continuing for several reasons:

(a) so that no laws are violated,
(b) to determine whether the bylaws need to be changed,
(c) to determine whether the services of an attorney should be employed.
STEP 7: Evaluate the cooperative's long range growth plans -- this will help determine the amount of equity capital needed to support the planned growth rate and what amount of funds will be available for equity redemption. It is important to remember that the equity investments by a cooperative's member-patrons is its capital foundation. Over the long-run the association can expand only as fast as its equity base expands. Debt capital can be used temporarily, but it is a supplement to and not a substitute for equity capital.

STEP 8: Alternative equity capital acquisition methods should be studied. Once the cooperative's long-range growth plans are understood, it is necessary to acquire the equity base to build a strong financial structure. Building a sound equity base is the most important objective in tints step; however, it must be remembered that equity does not only have to be acquired but it also must be serviced. In the cooperative method of equity financing, retirement of member-patron equity is a necessary function of servicing tints equity base. Many different capital acquisition policies might be adopted -- including the cooperative's present method of capital financing. Located in Appendices I and II of this publication are a number of equity capital acquisition and redemption plans utilized by cooperatives throughout the United States.

In the following steps it is assumed that cooperative management has decided to consider alternative methods of equity acquisition and retirement. It is further assumed that whether or not a cooperative is considering the transfer from the traditional revolving fund method of equity financing to a more "permanent" type of equity acquisition, it is deemed essential for the cooperative to initiate a more formalized member-patron equity redemption policy. The next ll steps suggest some guidelines to follow in the pursuit of this goal.

STEP 9: Management should develop a member-patron profile. This is the first requirement in planning an equity redemption program. The profile may contain various kinds of information, but the most essential for this program is the age or birth year of the member-patron. Other information that might be solicited could be: intentions to retire, intentions to liquidate the farm business, intentions to move from the community, etc.

STEP 10: Establish the amount of total equity capital held by the cooperative by year.

That is:
1930 = $100,000
1931 = 72,000
1932 = 121,000
etc.
STEP 11: Analyze the distribution of the data collected in Step 10. Perhaps five percent of the total allocated patronage appears "due" each year, or perhaps analysis of this equity distribution will show an irregular distribution of member-patron equity capital.

STEP 12: Develop a member-patron equity redemption program based on the information obtained from the analysis of the member-patron equity distribution completed in Step ll. First, the establishment of a priority rank tor retiring member equity should be made. This priority rank should be applied in cases where retirement of financial interests of all inactive members upon demand involves too heavy a burden on the finances of the association.

In the priority rank, preference should be given to cases where circumstances are beyond the immediate control of the member. Briscoe, et al. recommend the following subjective priority ranks: 7

a) Retirement of equities due to death of member.
b) Retirement of equities to members who either move out of the community or quit farming but stay in the community.
c) Retirement of equities to members who could, but do not' patronize their cooperative.
Once the member priority ranking of equity redemption has been set, alternative member-patron equity redemption programs should be evaluated.

STEP 13: A comparison of the financial impact on the capital structure of the cooperative of each of the member-patron equity redemption programs considered worthy of further evaluation should be made. This might be accomplished by use of a number of analytical techniques.

STEP 14: The financial impact on the capital structure of the cooperative of a possible equity redemption program encouraged by some regional farm supply and marketing cooperatives should be studied. See Appendix I of this publication for a review of a number of regional cooperative equity redemption programs.

STEP 15: A policy for the retirement of voting rights should be developed along with the member-patron equity redemption policy. By developing a method of retiring voting rights, legal control of the cooperatives can be maintained in the hands of the active member-patrons.

STEP 16: A control mechanism built into the equity redemption policy should be developed so that flexibility remains an important option for the Board of Directors. This control device might include any of the following provisions:

(a) specific evaluation times, such as monthly, semi-monthly, or semi-annually tor analyzing the progress of the program,
(b) guideline financial ratios to warn of possible future problems to the financial structure of the cooperative,
(c) an evaluation of alternative member-patron equity redemption programs,
(d) an analysis of the financial impact of the alternative programs,
(e) a report of legal changes or constraints,
(f) the committee's final recommendations.
STEP 17: Once a financial plan and the legal changes necessary to implement the new member-patron equity and voting rights redemption plan is approved by the Board of Directors, the general membership and the cooperative employees should be informed.

STEP 18: A membership education and information campaign should be conducted before members vote on the plan, especially if it is necessary to make changes in the cooperative's bylaws. A well informed membership might react in many positive ways (increased interest in the cooperative, increased patronage, increased participation) which would help facilitate the transfer to a more complicated member-patron equity redemption program.

STEP 19: The details of the new policy should be written up formally (perhaps by an attorney) so that copies may be sent to the legal representatives of deceased member-patrons who may request information about the member-patron's equity when settlement of estates is at issue.

STEP 20: Management should implement the member-patron equity redemption program.

Some cooperatives may develop member-patron equity redemption programs that are designed to shorten the length of the traditional revolving fund. When equity of extremely old vintage has been retired, the cooperative may wish to consider adapting a modified revolving fund plan -- sometimes called a "permanent capital" plan. A few guidelines are offered for the cooperatives tn this position.

STEP 21: Determine the desired level of capital requirements of the cooperative association.

STEP 22: Compute the level of equity needed to service debt and the existing equity capital.

STEP 23: Utilizing equity distribution information obtained from the member-patron profile discussed in Steps 9 and 10, determine each member's equity responsibility for the coming year.

STEP 24: Each year the member-patrons' balance and equity responsibility in this modified revolving fund is updated by the use of some type of moving average.

There are farmer marketing cooperatives implementing these last four financing steps, but to the author's knowledge, no farm supply cooperative has yet introduced this method of member-patron equity financing into its system. When following or instituting these steps, it is essential to remember what Manuel said about the member-patron equity redemption problem:

"Paramount in all the deliberations is that a sense of fairness prevail: Fairness to the retiring member as well as those continuing in the association." 8
Appendix I
Appendix II

Footnotes

1 Cook, Michael Lee, "Increased Institutional Pressure for Mandatory Equity Retirement in Farmer Cooperatives," The Cooperative Accountant, Vol. XXIX, No. 3, Fall 1976.

2 United States General Accounting Office, Report To The Congress, CED-79-106, July 26, 1979.

3 Ibid. pp. 44-45.

4 United States Department of Agriculture, Farmer Cooperative Service, Equity Redemption Practices of Agricultural Cooperatives, Research Report 41, April, 1977.

5 Scofield, Alton, Forrest E. Walters, J. Hugh Winn, and William Spencer. Retirement of Member/Stockholder Equity Capital in Marketing and Purchasing Cooperatives, Department of Economics, Colorado Extension service, Miscellaneous #11, December 1975.

6 United States General Accounting Office 1979, op. cit.

7 Briscoe, Nellis A., James R. Enix, and Per P. Anderson, Retirement of Control and Ownership Equities of Inactive Cooperative Members, Bulletin B-659, Oklahoma Agricultural Experiment Station, Stillwater, Oklahoma, July 1968, Page 20.

8 Manuel, Milton, Retiring Control and Equities of Inactive Coop Members, Kansas Agricultural Experiment Station Circular 346, Manhattan, Kansas, March 1947.

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