organizational structure options: cooperatives and corporations

March 25, 2009|Print


Possible Business Structures for a Slaughter/Processing Facility

Excerpted with permission from Curtis, K. R.*, M. Cowee, A. Acosta, W. Hu, S. Lewis, T. Harris. 2007. Locally Produced Livestock Processing and Marketing Feasibility Assessment. Technical Report UCED 2006/07-13: University Center for Economic Development, Department of Resource Economics, University of Nevada, Reno.

Contents

Traditional Cooperative

A cooperative is a business entity that is member-owned, meaning the business is controlled and owned by the same people who utilize its services. The owners of the cooperative finance and operate the business, striving for a mutual benefit by working together. By combining resources, the overall production costs are decreased, and the production capabilities and marketing successes are increased. Cooperatives are run similar to other business entities and usually incorporate under state laws. They require bylaws and a board of directors, who set policy and hire managers to run the day-to-day operations. In addition to the user-owned aspect, two other characteristics make a cooperative different from other business organizations: they are user-controlled, and user-benefited (Rapp and Ely, 1996).

The user-controlled characteristic refers to the election of a board of directors and the ability of common stock holders and/or cooperative members to vote on major organizational issues. User-benefited characteristics include the distribution of resources based on the member’s use of the organization. Cooperatives provide a direct cost savings through the purchase of bulk supplies, increases in market access, a distribution of overhead and fixed costs as well as the allocation of profits based on usage to the members. Cooperative members may finance the start-up and operation costs of the organization through a variety of methods. One option is for members to make a direct financial contribution through a membership fee, or through the sale of common or preferred stock. Another finance method is for the cooperative to withhold a portion of the net earnings from cooperative members for reinvestment back into the organization. Finally, assessment fees can be charged based on the number of units procured from each member, or based on the number of units sold after processing. The advantage of soliciting a direct contribution or utilizing the sale of stock is the upfront cash requirements to purchase capital equipment and building services. Assessment fees and/or net earning withholdings are more beneficial once the cooperative has begun operations and require working capital or future replacement cash.

It is vital to the success of a cooperative that owners stay informed of the business practices. A cooperative is a democratically controlled organization that operates through a majority vote. Members have a monetary interest in the financial well-being of the organization and rely heavily on the education and success of the other member producers. While the pooling of resources helps reduce risk in the market place, judgments and decisions made on one farm can affect the profitability of other cooperative members.

New Generation Cooperative

The “New Generation Cooperative” (NGC) is similar in structure to traditional cooperatives, but the NGC focuses on marketing niche strategies rather than the traditional cooperative roles, such as production and storage. One of the main focuses of the NGC is delivery rights, which are tied directly to the initial investment required from each member. The NGC establishes a production volume, and then sells shares based on a delivery commitment from farmers, which stipulates that enough of the NGC's product is produced to fulfill the NGC's capacity requirement. One disadvantage of this system is the inability of the cooperative to encompass new producers, as the production capacity is already maximized at inception. However, delivery rights may be sold or traded to other members of the cooperative and future expansion can allow for the sale of additional delivery rights.

NGCs normally maintain a marketing agreement with the member producers, whereas traditional cooperatives do not. Because NGCs are limited to purchasing products from their members only, they require a much narrower level of quality standards than traditional cooperatives. The process of identity preserved is used to ensure that an acceptable quality product is grown by members, or it can trade lower quality member grain for the higher quality grain needed for processing.

The key advantage to NGCs is the fact that the organization can supply a large amount of its own start-up capital. NCGs can typically generate 30%-50% of their start-up capital, lowering long-term private debt commitments and freeing up future profits for larger dividend payments to farmers (Harris, Stefanson, and Fulton, 1996). Additionally, delivery rights ensure a reliable volume of product for the cooperative, while guaranteeing a home for the producer’s product. It also allows the cooperative to better react to market conditions.

New generation cooperatives may choose a combination of options, but usually organizations stay within a stock or non-stock form of capital acquisition. Potential members may feel more comfortable with stock options, as it is a more commonly understood system of capitalization.

Capitalizing refers to the amount of money needed to begin operations and the mechanism for acquiring the cash. Important decisions include whether the cooperative will issue stock or non-stock options (i.e. membership dues), borrow from traditional financial institutions, and determine minimal rates of return for its members. The goal is to provide enough working capital to begin and maintain operations while sustaining manageable debt levels for the organization and making the investment affordable to prospective members.

Ownership certificates come is a variety of forms, including common stock, preferred stock, membership certificates, and capital certificates. In terms of cooperatives, common stocks are shares of the cooperative representing membership/ownership in the cooperative and are accompanied by voting rights. Common stock can be divided into classes, each carrying different voting privileges and assessed different values. Those with more privileges are more expensive to purchase. Cooperatives usually do not pay interest on common stock issued. Preferred stock is nonvoting stock that can be issued to both members and nonmembers of the cooperative. The proceeds from the purchase of preferred stocks are usually used for capital investment and. As with common stock, preferred stock can be divided into classes, each with a different value receiving different scales of interest payments. Preferred stock owners receive interest for their investment, and are usually given their interest dividends before the distribution of profits to common stock holders. If the organization ceased to exist, preferred stock holders are compensated first.

If the members of a cooperative decide that they do not want to offer stock, membership is derived through membership certificates. Voting rights accompany membership certificates, which are issued once membership dues are paid. Usually memberships and capital certificates are insured, but are non-interest bearing.

Capital certificates are similar to preferred stock, but are not issued as stock. They are sold in a variety of denominations and do not have accompanying voting rights. Interest may or may not be paid to capital certificate holders, but nonmembers may purchase the certificates.

NGCs require a marketing contract, making all members producers. In an NGC, preferred stock and/or capital certificates are generally not offered. After the cooperative has begun operation, members continue their investment by providing additional risk capital. This can be accomplished in a variety of ways. The cooperative may retain a portion of earnings as an additional investment into the organization. This can be done in two ways: through the payment or retention of a per-unit fee for each member, or through the retention on the overall cooperatives net earnings. Either way, the equity investment is credited to the members’ equity accounts and held as a liability on the cooperatives balance sheet.

Cooperative Legal Considerations

The legal considerations cooperatives must consider include the drafting of articles of incorporation, creating bylaws, membership applications, creating and maintaining marketing and purchase agreements, and revolving fund certificates. While the Capper-Volstead Act of 1922 and the Farm Credit Act of 1971 have aided cooperatives in their ability to work together in the handling, processing and marketing of their goods, and allows them to borrow jointly, cooperatives are still subject to numerous antitrust laws and are responsible for all tax codes relating to their enterprise.

Articles of incorporation give the cooperative a distinct legal standing. It limits personal liability for debt incurred by the cooperative, excluding the amount of their initial investment. The articles of incorporation also describe the nature of the business entity, its location, the proposed duration of the association, and the names of the principle parties involved. Once drafted, the articles are filed with the Secretary of State, activating the cooperative.

Bylaws define how the cooperative will conduct business. The bylaws describe membership requirements and list the rights and responsibilities of the cooperative's members. They also discuss voting procedures and the board structure that will govern the cooperative.

Membership applications are composed of five main parts: the applicant’s statement addressing membership; the signature of the applicant; a statement of cooperative acceptance; signatures of the board president and secretary; and a statement of the duties and intent of the prospective member. A membership certificate may be issued to each member as evidence of entitlements to the organization.

Marketing and purchasing agreements set the standard of quality acceptable to the cooperative. They also state how the proceeds of the cooperative will be distributed, once deductions for operating and capital expenditures have been taken. Often marketing and purchasing agreements are required when seeking outside financial backing.

The revolving funds certificate is a written receipt for capital investments and retained earnings that will eventually be revolved or redeemed. These investments may be deductions based on a per-unit of production, reinvested earnings, or original capital subscription, if not issued in stock form. All legal documents should be written with the help of a lawyer to ensure state provisions are addressed. Appendix A contains the name and contact information for several agricultural lawyers located in Nevada.

Investing risk capital is the responsibility of all members. The amount of risk capital invested is an important decision for the cooperative's members to consider. It must cover a large portion of the start-up and operational costs, so that outside investors feel comfortable that the membership will work to make the operation successful. Members must also invest enough capital to give them a financial stake in the success of the enterprise.

Most private loan institutions will require the cooperative members to assume at least 50% of the capital risk, but it may take many years for the members to acquire this percentage. Long-term credit is available through federal and state sponsored credit programs. Sources of facility loans include: USDA Rural Development; Cobank; St. Paul Bank for Cooperatives; and National Cooperative Bank. Many commercial banks and credit unions have local programs for small business start-up, such as Bank of the West. Cooperatives can apply for short-term loans to cover operating costs during the first year of operation. These are acquired through the Farm Credit System and the National Cooperative Bank (Rapp and Ely, 1996).

C Corporation

The C corporation is the traditional form of corporation, which is a business entity that provides limited liability to its owners and shareholders, meaning the personal assets of the owners and shareholders are protected from the financial issues of the corporation (Legalzoom.com, 2006). Unlike a sole proprietorship or partnership, a corporation exists as a separate legal entity, and therefore is taxed separately from its directors and shareholders. When a C corporation goes public, it may have an unlimited number of shareholders (who are the legal owners of the corporation), who do not have to be residents or citizens of the United States.

The C corporation is managed by a board of directors elected by the corporation's shareholders and makes policy decisions on the corporation's behalf, while the officers and employees of the corporation conduct the business dealings of the entity. As mentioned, the directors, employees, and shareholders of the corporation are not personally liable for the corporation's debts. However, it is the responsibility of the directors and officers to ensure that certain formalities are observed on the corporation's behalf. This includes formalities such as annual meetings, appointment of officers and election of directors, and issuance of stock. Perhaps the largest responsibility of the corporation is to maintain enough capital to protect the corporation from any business debts. In the event that these formalities are not observed, shareholders may be held personally liable for corporate debts.

S Corporation

S corporations are C corporations that have elected to file for S corporation tax status. Filing as an S corporation combines the limited liability of the C corporation with the tax status of the sole proprietorship or partnership. The main difference between C corporations and S corporations (and also the major advantage to S corporations) is the tax treatment. While C corporations are subject to double taxation, S corporations are granted "pass through" taxation because all of the corporation's profits are passed on to the shareholders in the form of dividends, so there is no taxation at the corporate level. Another advantage to the S corporation is that the corporation's directors may pass business losses through to their personal income tax return. The biggest disadvantage of the S corporation is the restrictions that are placed on shareholders: an S corporation may not have more than 100 shareholders, who must be citizens or residents of the United States.

Limited Liability Company

As the name implies, a limited liability company (LLC) is a business ownership structure that provides limited liability to its owners, called members. The main differences between the LLC and the corporate structure are that the LLC is more flexible and less formal than the corporation, and the two entities are subject to different tax laws. An LLC can also serve as the general partner in a limited partnership, giving the individual owners protection from liability, financial or otherwise.

Some of the advantages of the LLC are the operating flexibility they provide, including the fact that a board of directors is not required as with corporations, and there is currently no requirement in Nevada for an annual meeting of the shareholders. As with S corporations, LLCs are also free from double taxation because the LLC members report their share of profits or losses on their personal income taxes. The LLC is not taxed at the business entity level. The final advantage to the LLC is the limited liability the entity provides to its members. Disadvantages of the LLC are that they do not require an operating agreement, the lack of which may lead to management issues, and the fact that while the LLC isn't subject to double taxation, it may be taxed at a higher rate than a corporation.

References

  • Legalzoom.com, (2006). “Incorporations Library 2006.” Online. Available at http:www.legalzoom.com/law_library/corporations/forming.html. Retrieved December 2006.
  • Rapp, G. and G. Ely, (1996). “How to Start a Cooperative.” Report number 7, USDA Rural Business Cooperative Service, September 1996.

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