Features of new generation cooperatives

What is a New Generation Cooperative?

For the purposes of this guidebook the abbreviation NGC will be used for the term New Generation Cooperative.

An NGC is simply a form of business organization that combines features of a traditional cooperative with those of an investor-owned corporation.  An NGC is typically involved in the value-added processing stage of an agricultural product, once the commodity has moved past the farm gate.  The focus of an NGC is on value-added processing rather than commodity production.  For instance, the NGC structure has been used to transform durum into pasta products, spring wheat into frozen dough, and bison into packaged meat.  NGCs are formed to allow producers to retain an interest in their commodities once they have moved past the farm gate, thus allowing them an opportunity to gain part of the marketing share of the consumers’ food dollar.

The NGC structure emerged in the United States and was originally based on a California model of cooperatives that required producer agreements as well as up-front equity investments from members.  NGC members, who are agricultural producers, sell their commodities to their cooperatively-owned processing business.  Any earnings that the NGC generates from value-added activities are then distributed back to the members in proportion to the amount of commodity they delivered to the cooperative.

Major features of the NGC structure include:
 


Delivery rights

 Shares in an NGC can be used to assign membership to producers and to allocate delivery rights.  There are generally two types of shares in an NGC: membership shares and special investment shares that convey delivery rights and obligations (sometimes these latter shares are known as delivery rights shares).  Producers purchase these special investment shares that obligate them to deliver a certain amount of farm product to the cooperative each year.  For instance, one special investment share may give the producer the right and obligation to deliver one tonne of wheat to the cooperative every year.  In the case of an NGC that processes livestock, the share may give the producer the right and obligation to deliver one animal to the cooperative every year.  Because delivery rights are tied to special investment shares, they ensure that members provide up-front equity capital to the NGC that is proportional to their level of use of the cooperative.  Each member’s equity position in the cooperative is therefore equal to the member’s patronage level with the cooperative.  Any patronage refunds that the cooperative generates are distributed to members according to the level of product that they delivered to the NGC.

 Essentially, delivery rights shares act as a two-way contract between the producer-members and the cooperative; they obligate the producer-members to deliver product each year to the cooperative, and in turn they obligate the cooperative to accept delivery of the product.  Typically there is an underlying producer agreement that accompanies the special investment shares of the cooperative.  Each member must sign this producer agreement, which outlines details such as the quality specifications and delivery methods that the member must follow.  The agreement also indicates such things as the method of valuing the commodity to be delivered and how the producer will be paid.  It will also include details concerning the measures to be taken when a member fails or refuses to deliver the quality and amount of commodity specified under the agreement.  Each NGC will structure producer agreements to serve their particular needs.

 Members will typically receive two streams of income from the NGC: during the year, they will be paid an amount (determined by the cooperative) for the commodity they deliver to the firm.  Then, at the end of the year, they will receive a portion of any value-added processing returns that the cooperative was able to generate throughout the year.

 The use of delivery rights assures producers a market for their product, and assures the cooperative a steady source of its primary input.  Access to a steady source of inputs may give the NGC a competitive advantage over competitors who lack a captive source of supplies.  With producer agreements that indicate delivery arrangements in place, management can coordinate their input supply so that the processing facility is efficiently utilized.  Quality stipulations are specified; if the producer cannot fulfill his delivery commitments with his own product, then he must make arrangements to purchase the product from elsewhere to fulfill the delivery requirements.  Otherwise, the cooperative will make arrangements to purchase the needed product from another source and charge the member for the difference.

  The total quantity of delivery rights equity shares that the cooperative sells to producers depends on the processing capacity of the cooperative’s operations.  The cooperative only sells enough shares so that it meets its efficient capacity level.  For example, if the cooperative plans to operate a facility that has a capacity to process 75,000 tonnes of grain each year, then it will sell 75,000 equity shares that each require the owner of the share to annually deliver one tonne of grain to the cooperative. 

 In some cases, the NGC will reserve the right to lower the amount of commodity that is to be delivered.  For example, consider a special investment share that obligates the member to deliver one tonne of canola to the cooperative.  The company may reduce this quantity on a pro rata basis to all members if its marketing needs change during the year.

  The price of each special investment share in an NGC is typically determined by dividing the total amount of equity capital that the cooperative requires to finance the business by the processing capacity of the cooperative’s facilities.  Continuing with the above example, if the cooperative determines that it requires $12 million in equity capital to establish a 75,000 tonne annual processing operation, then the price per special investment share will be found by dividing $12 million by 75,000 tonnes.  Thus, the initial price per special investment share would be $160.  Afterwards, market conditions will determine whether or not the special investment share will appreciate or depreciate in value.

  The special investment shares that allocate delivery rights are separate from membership shares.  In most cases, each individual producer holds only one membership share, but can hold more than one special investment share.  Sometimes producers are required to purchase a minimum amount of special investment shares to be considered for membership in the NGC.  Voting rights are attached to membership in the cooperative, and therefore each producer only has one vote in the cooperative’s affairs, regardless of how many special investment shares he may hold.  This is consistent with the democratic principle of one member, one vote that characterizes most cooperatives.  The cost of a membership share is typically a nominal amount.

Selected1  membership

  In contrast to many traditional cooperatives that accept new members on a continual basis, membership in NGCs is restricted once the targeted amount of special investment shares are sold.  Once the targeted amount of special investment shares are sold, new members will only be allowed if an existing member wishes to sell some of his shares to another producer.  This ensures a stable level of supply of product for the NGC; membership may change somewhat because producers wish to sell some of their special investment shares, but this does not change the supply of product being delivered to the cooperative.  The sale of shares between producers typically requires approval from the board of directors before they occur.  By doing so, the board can ensure that shares are not purchased by ineligible persons.

Significant level of initial equity investment

  Because of the presence of delivery rights, the initial equity investment required from producers is higher for a NGC than that found in more traditional cooperatives.  American NGCs have generally raised between 30 and 50 percent of their total capital requirements from the sale of delivery rights shares.  U.S. lenders typically want to see a 40 to 50 percent member equity position for new cooperatives, depending on their assessment of the risks involved.  Financial institutions in Canada will evaluate the NGC’s potential based on its strengths and weaknesses.  Producers must pay for the right to deliver their commodities to the cooperative; in order to participate in the cooperative's value-added processing, producers must provide up-front capital by purchasing shares that convey delivery rights.  The NGC usually sets a minimum required number of delivery rights shares that an individual producer must purchase in order to be eligible for membership.  For example, the minimum required investment in one American NGC was set at $4,800 U.S., which represented 800 shares at $6 each.  Each share represented the right and obligation to annually deliver one bushel of the commodity to the NGC.

 Because the members invest a significant amount of equity and are obligated to deliver product, they tend to remain more committed and involved in a NGC than they might be in a traditional cooperative.

 In comparison to a more traditional cooperative, the NGC receives a higher level of equity financing at the start of its operations.  The NGC is therefore in a position at the end of the year to return a greater portion of its patronage refunds in cash to its members, rather than retain them in the business as additional equity financing.  In other words, since the members invest a significant amount of capital up front, most of the net earnings generated can be returned to members at the end of the year rather than used as retained equity financing for the business.  The added value that the NGC has contributed to the members’ commodity is therefore returned to the members each year.  Because equity is received prior to start-up, the NGC may be able to avoid difficulties that sometimes occur when trying to raise capital.  If the NGC decides to expand its operational capacity, then it issues more delivery rights shares, which provide the necessary equity financing for the expansion.

Transferability of delivery rights shares and the opportunity for appreciation or depreciation in the value of delivery rights shares

  Members of the cooperative are typically allowed to transfer their special investment shares to other members or other producers who wish to become members, subject to board approval.  The price of special investment shares that are sold among producers is negotiated by the producers themselves, according to the perceived market value of the shares.  The board of directors does not set prices of shares transferred between producers.  The price of the delivery rights will be based on the earning potential they represent, and will therefore fluctuate according to the performance of the cooperative.  If the cooperative is performing well and the buyer perceives strong earning potential from owning the delivery rights, then he may offer a price that is higher than that originally paid by the member.  The selling member would therefore be able to realize a capital gain from the appreciation of the share value.  Thus, in addition to the opportunity to receive patronage refunds from ownership of delivery rights, the member might also benefit from an appreciation in value of these rights if he chooses to sell the special investment shares.  In such a situation, the member is able to sell his shares and immediately receive the market value for those shares.  Alternatively, if the buyer perceives that the earning potential is weak, then the share might have decreased in value for the member.

 The buyer should verify with the cooperative that the seller in fact owns the shares prior to the sale.  The transfer of ownership does not take place until the cooperative has been notified and the transfer is recorded on the books of the cooperative. If he is not already, the buyer needs to become a member of the cooperative in order to own special investment shares.  Thus, if he is not a member at the time, the purchase of shares should be made conditional on his becoming a member of the cooperative.

Expansion of the business is typically funded by new issues of delivery rights shares

  When a NGC is ready to expand its operations by means such as increasing its current plant capacity or building an additional facility, it generally finances the expansion by issuing new special investment shares.  In other words, future expansion is financed in the same way as the original start-up of the NGC.  The number of special investment shares issued and their price is determined according to the processing capacity of the expanded facilities.  By issuing further delivery rights shares, the NGC is able to rely on new financing rather than retained earnings of the business to finance expansion activities.

1Selected membership is sometimes referred to as "closed" membership in the United States.

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Sources:

Harris, A. 1998. Financing agricultural co-operatives: An overview. Booklet funded by the Canada/British Columbia Farm Business Management Program.

Harris, A., B. Stefanson and M. Fulton. 1996. New generation cooperatives and cooperative theory. Journal of Cooperatives 11: 15-28.

Johnson, Dennis A. 1995. The rise of new wave cooperatives. Year in Cooperation Vol. 2 No. 1: pp. 8-9. Minnesota Association of Cooperatives.

Lawless, G. 1996. “New Generation” farmer cooperatives conference: A summary.  University of Wisconsin Center for Cooperatives. Online. Retrieved July 22, 1998. http://www.wisc.edu/uwcc/info/ngconf.html .

Patrie, W. 1998. Creating ‘Co-op Fever’: A rural developer’s guide to forming cooperatives. Rural Business - Cooperative Service, U.S. Department of Agriculture, RBS Service Report 54. Available online. http://www.rurdev.usda.gov/rbs/pub/sr54.pdf  or www.rurdev.usda.gov/rbs/pub/sr54/sr54.htm .

Stefanson, B., M. Fulton and A. Harris. 1995. New generation cooperatives: Rebuilding rural economies. Centre for the Study of Co-operatives, University of Saskatchewan. Available online. http://coop-studies.usask.ca/pdf-files/Rebuilding.pdf .