University of Wisconsin Center for Cooperatives

Cooperatives: A Tool for Community Economic Development


CHAPTER 7

FINANCING COOPERATIVES
 
 
This chapter explains the financial basics of cooperatives, including: 
  • discussion of member equity and its role in financing cooperatives;
  • how profits are allocated among co-op members;
  • sources of member equity; 
  • attracting equity from non-members;
  • equity redemption;
  • patronage refunds;
  • taxation of cooperatives;
  • how to conduct an equity drive; and
  • financing New Generation Cooperatives.
 
If you look at the successes and failures of cooperatives, fundamentally, they are linked to how well a cooperative performs its economic purpose. 
Dennis Johnson
St. Paul Bank for Co-ops
 

A. Financial Structure of Cooperatives

Earlier sections of this Manual discussed what makes a cooperative distinct from other types of businesses.  A review of some of the key operating principles of co-ops will illustrate how these differences are related to cooperative financing.
 
1. User-owner principle
This principle suggests that the co-op members – those who use the cooperative -- should provide equity (ownership financing) in proportion to their use of the co-op.

2. User-benefit principle
Financial benefits of cooperative membership are distributed to members in proportion to their use of the cooperative - unlike other types of businesses, where benefits are distributed according to the amount of investment.

3. User-control principle
The one member-one vote rule by which cooperatives operate serves to distribute power equally among all the current member owners.

4. Limited return on equity
Investors’ return is limited by law to 8%.  By limiting the return available on investment, co-ops limit the accumulation of wealth by a few owners.
 
The only fear needed in organizational efforts is the fear of missing the opportunity to invest. 
Bill Patrie
North Dakota Assn. of
Rural Electric Co-ops
 

1. Member Equity

Recall that a cooperative is initiated by a group of people who share a mutual need, and who start a business designed to meet that need.  In order to cover the co-op’s start-up costs, each member of the group contributes some money (often in the form of capital stock).  The money that members invest in the co-op is known as member equity.

Member equity represents the members ownership interests in the assets of the company.  As risk capital, it is subject to loss.  Member equity is used to purchase equipment, supplies, inventory, and any other assets the co-op needs to get up and running.

If the members of a co-op are unable to generate sufficient funds to cover all of the assets needed, they usually seek a loan.  Although co-ops can borrow money from the same lending institutions as other businesses, many co-ops have found that it is helpful to approach a bank that is familiar with cooperatives. Most banks require that the members contribute at least 50% of the total funds needed by the co-op.  Members should have a financial stake in the cooperative, evidenced by their investment in it.

Owners, as providers of equity capital, take the business risks and enjoy the profits of their success; they should be the major contributors of capital. The level of equity invested by the owners signals to the banker the commitment of the owners to both the concept and the company.
 
The inescapable axiom is that control follows ownership.  (Members) must provide risk capital if they are to control their cooperative organizations.  If others...put in risk capital, then they gain the right to influence and possibly control the organization and claim (its) benefits. 
Randall Torgerson
Rural Business-Cooperative Service, USDA
Thus, in most cases, a new co-op starts with some combination of equity from its members and debt from a lending its members and debt from a lending institution.  Member equity, however, is the primary source of a co-op’s financial stability.
 

2. Allocation of Equity

Member equity is recorded on the cooperative’s books in two different ways.  Allocated equity is designated (or allocated) to individual member accounts in proportion to their use of the co-op.  Unallocated equity is not assigned to each member’s account, but is left in a general fund.  Most co-ops use unallocated equity to build a capital base and to use as a cushion from operating losses.

The requirement that each member’s business with the co-op be tracked and their allocated equity account be adjusted to reflect their activities place additional burdens on cooperative accounting.  Thus, it is vital that the co-op obtain the services of qualified and experienced co-op accountants.
 
A sufficient level of capital is crucial to successful and long-term operation of any business. 
 

3. Sources of Member Equity

Not all member equity comes from direct investment as described above.  In fact, there are three primary sources of member equity:
1. Direct investment from members
2. Retained earnings
3. Per-unit capital retains
 
A central business proposition is based on an economic opportunity.  This...can be so powerful as to engender sacrifice, commitment and loyalty to the cooperative, helping it to survive.  
Bill Patrie
North Dakota Assn. of 
Rural Electric Co-ops
 
The first is direct investment.  New cooperatives usually obtain direct investments from their members, often in the form of capital stock shares.  These shares are evidence of the members’ investment and carry  with them all membership and voting rights.  With established cooperatives, new members are usually required to make a similar purchase of capital stock or membership certificates, which entitles them to membership and voting rights.

The purchase of one or more shares of common stock is usually the first investment a new memmemb makes in a cooperative. This stock purchase entitles the member to voting rights in the co-op, usually on a one-member, one-vote basis.  Non-cooperative businesses pay dividends on stock based on the number of shares owned, but in cooperatives, stock dividends are limited by state law (8% in WI).

The second source of member equity, retained earnings, is another way to generate  equity after a co-op is up and running.  When a co-op makes a profit on its operations, a portion of those profits (also called net earnings or net income) are usually distributed to the members on the basis of the amount of business they do with the co-op, and a portion is retained by the co-op as an investment in the business.

Many co-ops pay part of their net income (usually 20%) in cash to their members (more about this below under patronage refunds), and retain the remaining funds for future capital needs.  These retains are allocated to each member’s account, although some co-ops also keep a portion of the net income as unallocated reserves.

Thus, retained earnings are simply the co-op’s profits that are kept by the co-op in order to build it for the future.  Conversely, if the co-op loses money, that  loss must be absorbed by the members, in Many co-ops design a program to repay the equity of members who no longer use the co-op due to retirement or relocation.  Some co-ops have a revolving equity redemption program in which the oldest equity on the books is paid out regardless of whether the members are still active or not.  In most cases, the shares are bought back from the member at par or book value, whichever is less.

The third source of member equity, per unit retains, are used primarily by farm marketing cooperatives.  The co-op retains deductions from the sale proceeds of each member’s goods through the co-op.  These per unit retains are calculated either as a percent of sales dollars or as a unit of weight or volume.  One advantage of this type of equity is that it is not dependent on the co-op’s net income as are retained earnings.
 
 
Empowerment and the development of community leadership is in the background of every cooperative.  Empowerment opens up a great many options to...develop leaders. 
Theresa Marquez
CROPP Co-op
 

4. Equity from Non-members

Thus far, we have discussed only the types of equity that are generated from members.  Outside investors often don’t consider co-ops to be good investments, for several reasons:  Earnings are distributed on the basis of patronage, not on the basis of the amount of investment; return on investment is limited, usually by state law; stock in co-ops cannot be traded on the stock market and does not increase in value over time; and control of the co-op is usually one-member,
one-vote, regardless of the number of shares owned.

Clearly, an investor who is concerned primarily with making a profit on his or her investment would not find a traditional co-op attractive.

However, there are a few mechanisms by which non-members may invest in cooperatives.  The primary one is preferred stock.

Most co-op bylaws allow cooperatives to issue preferred stock, which does not provide voting rights.  Dividends on preferred stock are paid out before any payments are made to common stockholders. Thus, the sale of preferred stock can be an effective way to attract non-member investors if the co-op desires to do so.

Other methods for cooperatives to build equity from non-members include retained income generated through day to day business conducted with non-members and per unit retains on the sale of goods produced by non-members.
 

5. Equity Redemption

Allocated member equity is considered temporary capital, thus cooperatives have an obligation to eventually repay equity to their members.  Although failure to redeem equity is considered an injustice to members, the co-op board of directors must have the authority to
 

Equity redemption programs are intended to promote the cooperative principle of having co-ops owned and controlled by current members.  However, they also complicate the management of the co-op’s capital, and must be done judiciously in order to prevent any adverse financial impact on the co-op.  The board of directors and the management must ensure that the co-op is adequately capitalized at all times.

Note that unallocated member equity (equity that is not assigned to individual member accounts) is considered permanent capital.  Thus many co-ops use unallocated equity to build a capital base which is not redeemed.  It is important that unallocated equity not be allowed to become too large a portion of the total equity in a cooperative, however.  Since management, not the members, control unallocated equity, such a situation leads to declining user control in the co-op.
 
 
Your co-op’s on-going success depends on constant vigilance to business basics and keeping in contact with your members. 
Karen Zimbelman
Cooperative Consultant

6. Base Capital Plan

Some co-ops use what is called a base capital plan as an alternative to the equity building and equity redemption methods described above.  Under such a plan, each member invests equity in proportion to their use of the co-op over a base period of years.  This ensures that each member’s investment is in proportion to his  or her use.  Base equity plans can also be designed to respond effectively to the co-op’s need for capital.

Underinvested members continue to invest over time, using direct investment, retained patronage, or per unit retains to do so.  If a member becomes overinvested in relation to their use of the co-op, they can receive a partial refund to correct the balance.  As always, the board of directors should have authority over when and how the co-op may return equity to these members.
To build cooperatives is not to do the opposite of capitalism, as if capitalism did not have any useful features.  Cooperation must...assimilate the methods and dynamism of capitalism. 
Don Jose Maria
Mondragon Pioneer

7. Patronage Refunds

Patronage refunds are a key mechanism by which cooperatives practice their principles.  As noted above, when a co-op makes an annual profit, part of this net income is distributed back to the members in proportion to their use of the co-op during the past year.  In effect, such patronage refunds are a demonstration of the cooperative principle of benefits in proportion to use.

About 20% of net income is usually distributed to the members.  The remaining income is retained by the co-op in order to ensure a firm capital base for the co-op’s future.  However, the co-op allocates the retained portion to each members account.  Tax laws require that co-ops notify each member in writing of their patronage refunds and the total amount allocated to the members account.

Reinvestment of patronage refunds is a key way for members to meet their obligation to provide the capital for the co-op in proportion to their use of it.  It is important that co-op policies on patronage refunds be communicated to the members effectively.  Members need to understand their role in providing sufficient capital to the co-op so that is able to grow and thrive.  Without sufficient communication on this subject, members may have unrealistic expectations regarding when and how much patronage refunds they may receive.
 
THIS CONSUMER CO-OP IS EMPLOYING ITS EQUITY PLAN TO FINANCE EXPANSION 
 
A LETTER TO CO-OP MEMBERS* 
“FINANCING OUR DREAM” 

There are a number of costs involved with a project like moving into a new building.  Among these costs are acquisition of the building and land, remodeling or rebuilding, purchasing equipment, and the expense of additional inventory. 

The cost to acquire the chosen property is $850,000.  The costs involved with remodeling or rebuilding depend on what sort of design is chosen and to some degree on external factors such as changes the city may require to bring everything up to current code.  The estimated remodeling costs are $775,000.  The anticipated cost for equipment is $475,000.  Additional inventory is estimated to cost $220,000.  Construction fees are estimated to cost $228,000.  Start-up costs, including interest, staffing and promotion, are estimated to be $90,000.  First year working capital is estimated to be $50,000.  Combining these costs with an overrun allowance of 10%, we are looking at a total project cost of $2,956,800. 

This may seem like a huge sum, but luckily our Co-op has been profitable for many years now and we currently have $466,000 in retained earnings.  We also have $235,200 in available member equity contributions.  These two funds total $701,200.  The projected profits for this fiscal year are budgeted at $57,000, which brings the member contribution total to $758,200; slightly over a quarter of what we need for this project.  You can see that we are off to a good start. 

Funding for the remaining portion will be accomplished through a variety of means.  The National Cooperative Bank and our Credit Union are aware of our plan and both have offered us comfort letters indicating that they intend to help us with funds.  We anticipate borrowing up to $1,812,000. 

The other big chunk will come from members.  Another $100,000 (plus) could be raised through member equity contributions.  The Co-op anticipates selling $400,000 in member bonds.  The total of cash reserve, member contribution (member equity and member bonds), and funds borrowed from financial institutions is $3,070,200. 

*This letter to Williamson Street Co-op’s members was written by Anya Firszt and Gene Hahn and is reprinted with permission. 

8. Taxation of Cooperatives

(Material is reprinted with permission of USDA, Donald A. Frederick Attorney)

Farmers, like other Americans in busi-ness, are dedicated to individual initiative and the private enterprise system. But individual family farmers often have little economic power when dealing with large sellers of farm supplies and purchasers  of commodities. So they have formed cooperatives to gain the advantages of group action and some of the benefits of modern business corporations while maintaining control "down on the farm.” Farmers’ cooperatives play an important role in our free enterprise agriculture.

Cooperatives Pay Taxes

Cooperatives have the same rights and responsibilities as other American businesses, including the obligation to pay taxes. Cooperatives, like other businesses, pay significant taxes.

First, cooperatives pay the special taxes assessed all businesses. These include real and personal property taxes, sales taxes, employment taxes (to finance social security, unemployment compensation and workers’ compensation benefits), gasoline and diesel fuel taxes, license fees, motor vehicle registration fees, and excise taxes on telephone, power, and other utility services.

Second, cooperatives and their owners pay a single income tax on margins, usually at the owner level. This is the same tax treatment applied to most U.S. businesses.  Of the five common structures of American business, only investor-general corporations have their margins taxed at both the business entity and individual owner levels.  And only 12 percent of American businesses are operated as investor-general corporations.

Most business taxes are applied uniformly to all affected taxpayers, including cooperatives.  Certain aspects of income taxation are unique to each form of business. While some variations exist, most States with income taxes generally follow the Federal model in taxing cooperative margins.

Federal Income Taxes

The central feature of cooperatives Federal income tax liability is that net margins are not taxable income to both the cooperative and the patron if they are distributed or allocated to patrons on the basis of business done with the cooperative according to certain well-defined rules. The Internal Revenue Code recognizes cooperatives’ operating principle of providing services at cost.

Therefore, refunds of net margins to patrons on a patronage basis are subject to federal income tax only once.  This treatment is available to other businesses choosing to refund net margins in the same way.  Rules cooperatives and patrons must follow to be eligible for this tax treatment are found in Subchapter T of the Internal Revenue Code.

Subchapter T contains a definition of a patronage refund. Unfortunately, the Code uses the term "patronage dividend’’ instead of "patronage refund’’ but to avoid confusion and reflect more common terminology.

Subchapter T defines a patronage refund as "An amount paid to a patron by an organization...
1 . On the basis of quantity or value of business done with or for such patron,
2. Under an obligation of such organization to pay such amount which obligation existed before the organization paid the amount so paid, and
3. Which is determined by reference to the net earnings of the organization from business done with or for its patrons.’’

Written Notices of Allocation

A cooperative has several options in distributing its patronage refunds and taking advantage of the tax treatment available under Subchapter T.  It may simply pay out all of its earnings in cash. This is usually done by cooperatives that do not need to generate additional capital, or those whose members finance by other methods.

The most popular method of distributing patronage refunds is to pay out part of the refund in cash and part in noncash form called a ‘’written notice of allocation.’’  Funds represented by a written notice of allocation are retained by the cooperative, not as profit, but as a capital investment by the patron in the cooperative.  The tax code permits the notice to be in a variety of forms so long as it is in writing and informs the patron of the total amount allocated to him or her on the books of the cooperative and the portion that is a patronage refund.

Members determine how much of the cooperative’s net margins are to be retained in the cooperative to meet its capital needs.  The written notice of allocation is evidence of a patron’s share of that investment. This method of financing helps the association comply with the cooperative principle of obtaining financing from current patrons on the basis of their use of the cooperative.

A cash refund is deductible by the cooperative in the year the funds being returned were earned and is taxable income to the patron in the year received.  Members and their cooperative have two alternative tax treatments available for retained funds evidenced by written notices of allocation.  Specific tax treatment will depend on whether a written notice of allocation is qualilied’’ or ‘"nonqualified.”

“Qualified” and “Nonqualified”

If a cooperative elects to meet the Specific requirements of the Code to ‘’qualify’’ written notices of allocation, funds represented by qualified written notices are treated just like a cash patronage refund for tax purposes.  That is, the cooperative deducts the entire amount from its taxable income in the year the funds are earned and the patron includes the entire amount in his or her income in the year the written notice is received. (A cooperative is allowed 81/2 months from the end of its tax year to complete its tax returns and make its patronage distributions.)
 
The requirements to qualify a written notice of allocation are:
1. The written notice of allocation must be part of a patronage refund package of which 20 percent or more is paid in money or qualified check and either
2a. The patron has the option of redeeming the written notice of allocation at face value for cash within 90 days of issuance or
2b. The patron has consented to include the face value of the written notice in his or her taxable income.

As used above the term "money" includes both cash and a regular bank check.  A "qualified check" is a specially prepared bank check that can be used to establish a patron’s consent to include the noncash portion of a patronage refund in his or her income lor tax purposes.

A patron can "consent" to include the face value of the written notice of allocation in taxable income in any one of three ways:

1. By joining a cooperative whose bylaw clearly states membership in the cooperative constitutes such consent, provided the patron is given a copy of the bylaw and a written statement of its purpose. This is the most common method of establishing consent.

2. By signing and furnishing a written consent to the cooperative before the end of the taxable year in which the patronage occurs.  The consent must be revocable. Unless it provides otherwise, written consent remains in effect for all subsequent years until it is revoked.

3. By endorsing and cashing a qualified check.  A qualified check is one carrying a clearly printed statement that endorsement and cashing of the check constitutes consent by the patron to take into account, as provided in the Federal income tax laws, the stated amount of any written notices of allocation that are paid as part of the patronage refund of which the check is also a part.

A cooperative may elect not to meet al1 the requirements to qualify a written notice of allocation.  For example, it may pay less than 20 percent of the patronage refund in money or qualified check, or it may not have its patrons consent to take the face amount of the refund into account for tax purposes.  A written notice that for any reason does not meet the requisites for qualified status is called nonqualified.

A cooperative that issues nonqualilied written notices of allocation must include the face amount of the notice in its t.axable income for the year the covered funds are earned and pay tax on these funds at regular corporate income tax rate.

The patron receiving a nonqualilied written notice allocation does not pay an immediate tax on the funds it represents.  However, when the cooperative pays out the money represented by the nonqualified notice to the patron, the money received is taxable income to the patron in the year received, and the cooperative deducts the mount paid from income in the year paid according to formulas established in the Code.

Per-Unit Retains

Members usually have alternative methods of meeting their obligation to finance their cooperative. They may make out-of-pocket investments, such as buying a membership or shares of stock. They may leave a portion of their patronage refund in the cooperative, as previously described.  Patrons of marketing cooperatives may also invest in their cooperative by authorizing it to deduct a portion of the proceeds of sale, based on the dollar value or physical volume of products marketed through that cooperative.  This method of financing is called per-unit retains.

Tax treatment of per-unit retains generally parallels that of patronage refunds.  A cooperative is required to pay tax currently on its per-unit retains unless they are evidenced by certificates qualified under the law.  The patron is required to include the face value of a qualilied per-unit retain in his or her income for tax purposes in the year received. The certificate is qualified only if the patron consents to include the face amount of the certificate in current income. If the patron receives a nonqualified certificate, the amount it evidenced is not reported as income until the money it represents is paid to the patron.

Because per-unit retains are deducted from payments for products there is no cash distribution rule similar to the 20-percent requirement to qualify a written notice of allocation.

Patronage refunds and per-unit retains are often confused.  The main distinction is that patronage refunds are based on net margins while per-unit retains are based on the amount of business conducted without regard to margins.
 
THIS TAX INFORMATION 
is reprinted with permission and is available in a brochure format from: 

USDA/Rural Business-Cooperative Service(RBS), STOP 3255, Washington, D.C. 20250-3255. 

The mission of the Cooperative Services (CS) Program of USDA's Rural Business-Cooperative Service(RBS) is to enhance the quality of life for all rural residents by assisting cooperatives and other businesses and by establishing partnerships with rural communities.

Cooperative Services achieves this mission by helping rural residents form new cooperative businesses and improve the operations of existing cooperatives. This help is delivered in the form of direct technical assistance, and research and information products. Other RBS program areas can provide financial assistance to qualified cooperatives and other rural businesses.

RBS is part of USDA's Rural Development mission area. It was created in 1995 when USDA consolidated rural economic programs that had previously been scattered among various USDA agencied. RBS encompasses the former Agricultural Cooperative Service and much of what was the Rural Development Administration.

For most of the past century, USDA's cooperative assistance work has been concentrated on agricultural cooperatives.  While agricultural marketing and supply cooperatives remain a primary focus of USDA's efforts, the cooperative program can also provide assistance to other types of rural cooperatives as well.

Tax  Planning Alternatives

The tax treatment available to businesses operated on a cooperative basis is a simple concept - a cooperative operates at cost, so it has no true income to tax.  However, as the earlier sections of this pamphlet indicate, when that concept is melded into our complex Federal income tax system it also becomes quite complex.

Careful tax planning is is as important for farmers and their cooperatives as it is for all other individuals and businesses.  This is especially true when patronage refunds are involved because almost every decision will have significant tax consequences for both the cooperative and its farmer-patrons.  Here is a brief summary of some of the choices available:

1. How to finance the cooperative?  Members may supply equity capital through out-of pocket investments, patronage refunds, or per-unit retains.  Initial investments to start a cooperative usually come from the members.  When the cooperative generates margins, retained patronage refunds generally become the principal source of capital.  Only a limited number of cooperatives use per- unit retains.  A combination of these methods is permissible.  The role each is to play in capital formation should be planned.

2. Who is to receive patronage refunds?  A cooperative may pay patronage refunds to all users or only to member-users.  If margins on nonmember business are not returned to nonmember users on a patronage basis, then the cooperative pays corporate income taxes on this money.

3. Whether to "qualify” its paper:  Most cooperatives "qualify’’ their written notices of allocation (and per-unit retain certificates) because members find it to their advantage to accept immediate tax liability for their investment in their cooperative, and thereby give the cooperative the easiest possible access to needed financing.  It is permissible to qualify part of an allocation and not the remainder.  The extent to which nonqualified allocations are made generally depends on the cash needs and tax rates confronting both the members and the cooperative at the time of allocation.

4. How to "qualify.’’  The vast majority of cooperatives use a bylaw provision to obtain the necessary consent to qualify their allocations to members. The required explanation can be provided at the time the producer files application for membership, and the pre-existing legal obligation to conduct business on a patronage basis is established.  A separate written consent is usually obtained from nonmembers if their business is to be conducted on a patronage basis.

Bylaws only bind members, so bylaw consent is not available for nonmember business.  Qualified checks can be issued only as part of a patronage refund, and are rarely used because of the uncertainty over whether patrons will cash them.

5. How to redeem old patronage paper?  If current patrons are to meet their obligation to finance the cooperative, then written notices of allocation and per-unit retain certificates that have been on the books of the cooperative for many years should be paid off.  The redemption schedule should not be so rigid that it interferes with the cooperative’s efforts to raise needed capital.  However, the existence of some kind of formal redemption program is clearly compatible
with cooperative principles.

Member-patrons of each agricultural cooperative must collectively decide which alternatives best fit their needs and the operation of their cooperative.


C. Financing New Generation Cooperatives

This article by Dennis A. Johnson, President and CEO, St. Paul Bank for Cooperatives, is reprinted with permission.

In this article, prepared for Year in Cooperation, a cooperative development magazine published by the Minnesota Association of Cooperatives, Johnson addresses major questions the Bank is asked and major concerns it has in financing new cooperative ventures.

Success stories of new- venture farmer cooperatives prompt many calls to the St. Paul Bank for Cooperatives from would-be founders of cooperatives with visions of a piece of the action. Through the years the Bank has been involved in the start-up of many successful cooperatives and a few-very few-that did not succeed.  Those experiences have led us to a set of inescapable truths about financing new cooperative ventures.

While we are a relationship business and our goal is to assist in cooperative development to the fullest extent feasible, those truths are why we must sometimes say “no” to financing requests. Lee Estenson who heads the Bank’s processing and marketing lending team, has developed sort of a cookbook of risks to be addressed and questions to be answered in financing new-venture cooperatives.  I’m singing notes from Lee’s songsheet as I tell you what we look for in financing them.
 
Addressing The Risks
Five major risks -- market, technological, construction, operating and government policy-- must be considered with every new-venture cooperative financing request.  Ignoring any one of them, in effect, extends a clear invitation to failure.
 
Market Risk
Market risk is the first and foremost risk to address, and the first market risk factor to look at is whether or not there is a need for the product you want to produce.

If so, who are your customers? Your competitors? What stands in the way of entering the market? What advantages do you have? What disadvantages? Assuming that your advantages outweigh your dis- advantages, how large is your market?

What is your likely market share? Finally, do you have management qualified to assess your market niche and develop a marketing strategy or plan and implement it?
 
The Marketing Plan.
Before your new-venture cooperative can be financed it will need a marketing plan; who will develop it? Who will determine how the products you plan to produce will be positioned in the marketplace? Will you employ consultants or will you staff for this work? If you step is to use the information you have assembled to determine your market niche by market segment and customer.  You must then develop market objectives for each market segment or customer, with strategies for accomplishing each objective and action steps and deadlines for each strategy.

The next step is to develop marketing, material and a sales approach for each marketing segment or customer. Finally, you need a customer calling plan with a timetable of customer calls, a specific marketing approach for each call and a specific and attainable follow-up schedule.
 
Technological Risk
Technology can be both friend and foe; the more new ground you’re breaking with technology the higher the risk.  Hopefully, also the higher the reward, but hope never counts as collateral.

These are the questions about technology you must be able to answer:  Will your plant use proven equipment brands?  Are any new processes on the horizon that may dramatically affect your profitability?  Does current technology dictate a certain minimum or maximum plant size? Does your manufacturing process provide end-product flexibility or is it single-purpose? Is your management qualified to assess the technology and make informed recommendations regarding processes and brands? Finally, will your proposed plant be environmentally acceptable?
 
Construction Risk
If you’ve been involved in construction of any kind you have learned that unless you have a turn-key (firm price) contract you can fairly assume that the final cost will exceed projections. The only question is:  By how much?  You need answers to these questions before you can evaluate construction bids: Is the plant site environmentally acceptable?  Are experienced engineers/contractors available? Have design engineers provided for sufficient equipment to deliver the projected volume of products?  Is the project turn-key (firm price) or subject  to change?  Are estimated construction costs reliable and the proposed construction timetable reasonable? Are bids firm or open to overruns?

Have you had third-party verification of design, costs and timetable?  Are adequate construction monitoring controls in place to protect both investors and lenders? And do you have management qualified to evaluate contractors and bids and to oversee a complex construction project?

Operating Risk
Another fair assumption is that startup won’t be as smooth as projected.  Here’s the checklist on startup to consider in the planning stages:  Are the timeframes for startup and the operating assumptions reasonable?  Are sale s price assumptions consistent with your marketing strategy?  Are projected expense assumptions reasonable and verifiable?  Are full-capacity expectations reasonable?

How low can sales prices and/or production levels decline before your debt servicing, capability is endangered?  How high can your expenses, especially feedstock prices, increase before endangering your debt- service capacity?  Under reasonable operating assumptions, will the project provide an acceptable return to investors?  Is the equity level adequate to maintain lender support through prolonged periods of financial stress? And do you have management qualified to run the plant efficiently and produce quality products?
 
Government Policy Risk
Of all of the factors to assess in starting a new cooperative venture, government policy may be the most elusive.

Do your best to assess how government policy affects market growth, market prices,  operating permits and costs, and plant profitability. Then do your best to get a fix on the likelihood that government policy may change.
 
Summing It Up
If you have come up with satisfactory answers to the questions I have asked, the odds are in your favor.  Now ask yourself one more time;

  • Are there customers out there?
  • Will they want your product?
  • Can you make money supplying your product to them?
  • Are you and your fellow producers willing and able to accept the risks of starting a new venture?
If the answers are yes, tell yourself that risk cannot be avoided but can be managed.

Then prepare to commit many, many long days to your project.



 
Ten Serious Hazards For New-Venture Co-ops  

 1. Plant specifications are not met. 
 2. Construction contract problems, such as delays and overruns. 
 3. Lack of serious commitment by the owner-members. 
 4. Location that puts the business in a noncompetitive situation. 
 5. Market projections are overly optimistic. 
 6. Unrealistically low operating cost projections that cannot be met. 
 7. Faulty marketing assumptions based on government data. 
 8. Problems with management. 
 9. Excessive debt-to-equity ratio. 
10. Led by an outside promoter. 

 
 
Cash Course In Financial Structure  
For the New-Venture Cooperatives 
 
Equity  
New-venture permanent assets to be financed include land, plant, equipment. other assets, startup losses, and a minimum level of permanent working capital.  Owners should have as much invested in the permanent assets as lenders.  The rule of thumb for permanent asset financing is 50 percent equity and 50 percent debt. 

Risk-reducers, such as project feasibility, firm marketing contracts, pooling concepts, turn-key construction costs and quality management, can lower the equity requirement, but rarely to less than 35 to 40 percent. 
 
Working capital  
Minimum permanent working capital (a) required to annually “zero out” for 30 days, or (b) required to margin loan advances of approximately 65 percent of acceptable inventories and 80 percent of acceptable receivables. 

Operating capital available through short-term seasonal loans to finance fluctuations in current assets. The maximum seasonal loan typically does not exceed three times permanent working capital. 
 
Loan duration 
The length of a loan depends on its purpose Term loans for new plants and equipment usually are repaid in 10 to 15 years. 
 
Cash-flow requirements  
Annual term principal repayments should take no more than 50 to 65 percent of annual cash after tax-earnings less patronage refunds received plus depreciation. 
 
Interest rates  
Rates typically will be prime plus 2 to 25 percent for new-venture construction projects. Some fixed-rate options and rate-reduction incentives are usually offered for successful construction management and startup. 

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