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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)