Cooperative Finance Basics
The funds needed to start and operate any business can be in the form of either equity
capital or debt capital.
Debt capital refers to loans, bonds or credit that is borrowed from
banks, other financial institutions, members or individuals that must be
paid back to the lender with interest over time. It does not give the
lender ownership rights.
Equity capital is money invested in an enterprise with no guaranteed
return. Equity investors typically receive some level of ownership and
control, and a share of the business's profit, because equity capital is at
risk if the business is not successful.
In the case of a cooperative, members, as owners, provide equity capital
in proportion to their use of the cooperative. It is part of members'
obligation as owners to share in business risk as well as business
profitability.
Cooperatives raise equity capital from members in several
ways.
1. Selling member common stock or certificates
While this typically is a requirement for membership, it is not a
significant source of ongoing equity capital for established cooperatives,
nor the primary source for start-up capital for a new co-op.
2. Selling preferred stock to members and non-members
When larger amounts of capital are needed for start-up or expansion,
cooperatives may sell preferred stock to members and non-members.
Preferred stockholders may receive dividends based on the performance of the
cooperative and the approval by the board of directors. Most state
cooperative statutes limit dividends at 8% or under.
3. Allocated and unallocated equity
To meet the ongoing need for capital, established cooperatives, like
other businesses, will reinvest some portion of annual net profits back into
the business. In the case of a cooperative, this type of equity can
either be allocated or unallocated.
Allocated equity is the portion of the annual net profit that is credited
to each member’s account based on the member’s use, or patronage, of the
co-op that year. Allocated equity is distributed in several different
ways, depending on the cooperative’s capital needs, its tax position and
type of business. The portion that is distributed back to the patron
is often referred to as the patronage refund.
Allocated equity rarely earns interest for the members. However, there is
the expectation that the cooperative will redeem allocated equity at some point in the
future, based on a redemption plan developed by the board of directors.
Equity redemption plans can be one of the most challenging aspects of
cooperative finance.
A portion of the net profit may also be designated as unallocated equity.
Unallocated equity is not credited to individual member accounts, and is
directly reinvested in the cooperative, which is responsible for the taxes.
Another source of unallocated equity is from the profits earned by doing
business with non-members.
Chart: Cooperative Net
Profit Distribution
4. Per unit retains
Per unit retains is another way for members of agricultural cooperatives
to contribute equity to the co-op. The cooperative retains a portion of each
transaction it makes with a member for products received or purchased. The
retained payments are credited to a member’s equity account, and are treated
similarly to allocated equity accounts. As with allocated equity, the
cooperative is obligated to redeem this equity at some point in the future.
New Approaches to Financing
Cooperatives may be faced with significant financial challenges if faced
with capital-intensive start-ups or new projects. Members may not be
able to generate sufficient capital, and cooperatives are not structured to
offer the return potential and control that would attract outside,
non-member investors.
The "new generation cooperative" is one structural approach to address
this issue with value-added agricultural ventures. NGCs tie membership
shares to delivery rights, which can be sold to other producers.
Another approach has been the passage of limited cooperative association
statutes in several states. These statutes permit a new type of
cooperative organization that may include investor, non-patron members who
have voting rights, and a right to a portion of net profits based on
investment. Because this may dilute patron control, this structural
variation has been controversial. (see
Legal and Taxation)