The Dynamics of Cooperatives
Updated: Jul 17, 2020
By Ashley Ellixson
This post should not be relied upon as legal advice.
Our business organizations discussion continues today with a look at cooperatives. By definition, a cooperative is a farm, business, or other organization owned and run jointly by its members, who share the profits. Cooperatives share a set of general principles such as:
Democratic Governance – Cooperatives generally have a one vote per member rule. This is different from other business organizations that usually weight each owner’s vote based on their financial stake.
Consensus Building – Cooperatives encourage members to work together if they want to take a certain action. Most, if not, all members must agree in order to make a business decision.
Community-Centric – Cooperatives are typically comprised of members from the same geographic area, i.e. town, city, county, state, or region. Since this means members live where they work, in most agriculture operations, they have less incentive to leave and are likely to invest locally.
Member Satisfaction Trumps Larger Profits – It goes without saying cooperatives must earn a profit in order to thrive. However, member wellbeing is valued above earning high profit margins. Generally cooperatives have rules in place to help keep the work environment fair and preserve members’ rights and safety.
Self-Motivation – Going hand-in-hand with being community-centric, members are more likely to invest their time and energy in the cooperative because their hard work determines the cooperative’s profitability. The decisions and work that each member puts in relates directly to the increase in wealth of the cooperative, giving each member a stake in its future.
Training – Many cooperatives usually have a training program in order to prepare new members to participate in the business.
Open Membership – Most cooperatives generally allow any person to join regardless of gender, race, religion, or social status. However, to become a member, cooperatives typically require an entry-level training program, initial investment, and final approval by all members.
Please speak with a legal representative and tax specialist before forming a cooperative. It is important to make sure your operation and its uniqueness is a good fit before moving forward. If you decide to go ahead and form a cooperative, it is important to know the steps you need to take and the decisions that need to be made moving forward. First, the group will need to decide under which legal structure it will formalize and register with government (i.e. organize or incorporate under a business organization such as an LLC or corporation). Not all cooperatives are incorporated but many chose to do so.
Each state has different requirements for incorporating, just like any other business structure. Please visit the Maryland Department of Assessments & Taxation website for details and forms for incorporation.
Forming a cooperative involves many steps and a common goal. Visiting with specialists in tax, finance, and legal areas will help in setting up your cooperative. Many states, including Maryland, have Rural Development offices that can help guide you and your members in forming a cooperative. Please see the website for Rural Development to find an office near you.
As with the other business structures Paul and I have outlined before, cooperatives come with their advantages and disadvantages as well. Many advantages of cooperatives involve sharing both expenses and risks with other members. For example, cooperatives offer purchasing and marketing power to its members. Purchasing power allows suppliers to offer discounts since they can balance lower profit margins with high sales volume. Additionally, cooperatives can purchase and pay for advertising at advantageous rates as well as market as a group, creating a brand across a geographic region. This can result in greater exposure for your individual operation which may be something you could not have afforded alone or without the cooperative.
Cooperatives also offer tax advantages. Similar to an LLC, cooperatives are not usually taxed on dividends paid to its members. This means that members are only taxed once on their income from the cooperative and not both individually and as the cooperative.
Some of the disadvantages of cooperatives involve slower cash flow, generic branding, and lack of membership and participation. While the democratic operating environment may look good to small investors, larger investors may choose to invest their money elsewhere since large investments do not translate into greater decision making power. On the flip side of the marketing power coin, members do not get their unique branding image but rather a generic brand. This can be a disadvantage to members who seek to capitalize on their unique product and brand image. Lastly, if members do not fully participate and perform their duties (for those who lack self-motivation), then the business cannot operate at full capacity and profits cannot reach their full potential. If this is an ongoing issue for the cooperative, it could risk losing members or gaining new members.
Remember, this article does not constitute legal advice. Please seek legal and tax specialist guidance in determining whether a cooperative is a good fit for your operation.