Cooperatives in the United
States
Introduction
What is a cooperative?
Cooperative
characteristics
User-benefits
User-owner
User-control
Limted
return on equity capital
Reasons for formation
Business structures
Sole proprietorship
Partnership
General corporation
Limited liability
company
Cooperative
Introduction
A cooperative
represents a unique way of organizing a business. In the United States,
there have historically been three basic categories of business structures:
sole proprietorship, partnership, and corporation. Cooperatives are
a type of corporation. Corporations other than cooperatives will
be referred to here as general corporations. A newer type of business
structure, the limited liability company (LLC), has also recently emerged
in the United States (Frederick). When referring to all business
structures other than a cooperative, the term investor-oriented firm (IOF)
will be used. The term IOF will used when referring to any business
firm other than a cooperative.
Cooperatives are
in no way restricted to the agriculture industry or to rural areas.
They can be found in many different sectors of the economy, including credit
and financial services, housing, utilities, health care, child care, and
insurance. There are more than 40,000 cooperatives in the United
States. These cooperatives provide products or services that serve
one out of every four American citizens (Rapp).
Cooperatives,
like other business entities, are formed out of economic motivation; there
is an identified economic need or opportunity to be met. A cooperative
allows a group of people to achieve economic goals. By combining
their resources in a cooperative, a group of people can achieve objectives
that they could not do if they acted alone. Once started, cooperatives
compete with and are subject to the same marketplace demands as other businesses.
There are differences among the basic categories of business structures,
however, in areas such as legal requirements, governance, and tax treatment.
These differences are examined later on.
What is a cooperative?
Although there
is no universally accepted definition of a cooperative, it is generally
described as a business that is organized, owned and democratically controlled
by the people who use its products and services, and whose earnings are
distributed on the basis of use rather than investment. The people
who use and own the cooperative are referred to as members.
A cooperative operates for the benefit of its members. A distinct
feature of a cooperative organization is that the role of owner and patron
are closely connected. A patron refers to a person who uses the cooperative.
A cooperative is distinct because there is a linkage between the ownership
and the users of the business. A cooperative is also distinct because
it distributes its earnings to members according to the level of business
conducted with the company rather than the level of equity investment.
Cooperative
characteristics
A cooperative has three general attributes
that distinguish it from other types of business structures (Cobia; Frederick).
They are:
-
the user-benefits principle
-
the user-owner principle
-
the user-control principle.
As you can
see, the emphasis in cooperatives is on the users of the business, who
are also the investors. In IOFs, the emphasis is on the investors,
who might never be users of the business. One of the key features
of new generation cooperatives is to increase the emphasis on the role
of users as investors of the business.
The
user-benefits principle:
As mentioned,
the cooperative operates for the benefit of its members. Members
represent the people who use and own the cooperative. Earnings that
the cooperative generates during the year are distributed to members according
to the level of individual business that they conducted with the cooperative
during that year. Earnings are therefore distributed according to
the level of use rather than level of equity investment.
The user-owner principle:
The people who
use the cooperative are its owners. Since they own the cooperative,
the members are responsible for providing equity capital in order to finance
the cooperative’s operations. Typically, members finance their cooperative
in three different ways: by direct contribution of membership fees or purchase
of equity stock, by allowing the cooperative to allocate some of the net
income earned from member business to member equity accounts rather than
distribute them in cash, and through assessments on some regular basis
such as per unit of product sold or purchased. There are three main
methods by which members finance their cooperative: direct investment,
retained patronage refunds, and per unit capital retains. A member
is usually required to make some sort of payment when he joins the cooperative.
This direct investment might be the purchase of a membership share or some
sort of common or preferred stock. A patronage refund occurs once
the cooperative determines how much earnings it has generated during the
past year. Once the earnings are calculated, they are distributed
to members according to how much business that each one has done with the
cooperative during the year. Members who have done business with
the cooperative are called patrons. These distributed earnings are
called patronage refunds. Usually, not all of the patronage refunds
are distributed as cash. Some of the patronage refunds are retained
in the cooperative and allocated to members’ equity accounts instead.
Retained patronage refunds occur when the cooperative does not distribute
all of the patronage refunds in cash. Per unit capital retains can
be a financing option for cooperatives that market products that are produced
by its members. In such a situation, the cooperative withholds a
portion of sales proceeds due to its members.
The user-control
principle:
Members, through
their role as owners, control the cooperative. They exert their control
through voting power. Members vote to elect a board of directors
and may vote in other affairs of the cooperative, such as major proposed
policy changes. Generally, control is based on a one member, one
vote principle; each member has only one vote in the affairs of the cooperative,
regardless of the level of business that he conducts with the cooperative
or the level of equity that he has invested.
Other Cooperative Features:
Limited
Return on Equity Capital
In order to ensure
that a cooperative allocates its earnings to members according to the amount
of business that they transacted with the cooperative during the year rather
than level of equity invested, federal and state statutes limit the level
of dividends that can be paid on capital. Most state agricultural
cooperative laws limit dividends paid on capital to a maximum of 8 percent
(Vogelsang et al). Limiting the return on equity helps cooperatives
to focus on meeting the members' needs in their role as patrons of the
cooperative.
Reasons for
Formation
Although there
can also be societal reasons for forming a cooperative, cooperatives are
started for various economic reasons. For instance, the following
reasons have given as to why cooperatives are organized:
-
Improve bargaining and market power.
For instance, many agricultural cooperatives were formed because farmers
felt they were being taken advantage of by merchants and railroad companies.
Because the size of their individual operations was small and there were
so many of them, farmers did not have a lot of bargaining power when they
negotiated as individuals. By joining together in a cooperative,
farmers could increase their market power when dealing with other parties
(Torgerson).
-
Reduce costs. For instance, agricultural
supply cooperatives can help to reduce costs of production inputs by buying
in large volumes, thus taking advantage of volume discounts.
-
Obtain products and services that are otherwise
unavailable. The U.S. rural electric cooperative system is a classic
example. In the 1930s, only one out of ten farms had electrical power,
mainly because existing companies did not want to provide electricity to
rural areas. Due to the low population density and wide geographical
areas, existing companies could not profitably provide power to rural areas
at reasonable rates (Cobia). Cooperatives were formed by rural residents
to provide at-cost electric service. Today, rural electric cooperatives
operate approximately half of the electrical lines in the U.S. (Frederick;
NRECA).
-
Expand new and existing market opportunities.
For instance, many new generation cooperatives are formed to seek out and
service emerging niche markets, such as the demand for bison meat.
-
Improve product or service quality.
-
Increase income.
Business
Structures
In the United
States, there have historically been three basic types of business structures
used to organize a business: sole proprietorship, partnership, and corporation.
A newer type of business structure known as the limited liability company
(LLC) has also recently been introduced. The type of business structure
used to organize a business is based on many factors, including the amount
of capital required to finance the business, the number of owners involved,
and taxation issues. Legal and accounting professionals are usually
consulted to help choose the appropriate structure. The different
business structures are only briefly described here.
Sole Proprietorship
A proprietorship
is a business that is owned and controlled by one person. This is
the oldest and most common form of business structure in use. Typical
examples of businesses that are operated as proprietorships include farms
and small businesses such as restaurants and flower shops. This type
of business structure is used more dominantly in farming than in any other
sector of the U.S. economy (Ingalsbe). As the sole owner of the business,
the proprietor is responsible for providing equity capital and making the
key managerial and strategic decisions involved in running the business.
He is responsible for all debts and losses that the business might incur;
in other words, the owner bears unlimited liability for the debts and losses
of the business. In return for bearing the risk of loss and providing
the equity capital, the owner is entitled to any profits that the business
generates. Profits are taxed once, as part of the owner’s income
at the applicable personal tax rate.
Partnership
A partnership
is a business that is owned and controlled by two or more individuals.
Typical examples of businesses that are operated as partnerships include
professional law and accounting firms. Some farms are also operated
as partnerships, most commonly between a parent and child.
The rights and responsibilities of each partner are usually described in
some sort of partnership agreement. This agreement will provide the
details as to how business decisions will be made and how voting power
is allocated among partners. It will also stipulate how earnings
are to be allocated among partners. Note, however, that a partnership
can be found to legally exist even without a written agreement.
As owners, the
partners are responsible for providing equity capital to the business.
There can sometimes be two types of partners: general and limited.
Limited partners provide equity capital to the business in exchange for
the opportunity to share part of the earnings that the partnership may
generate. Limited partners are not permitted to be involved in managing
the business, however, and in return for this passive involvement they
are permitted limited personal liability in the debts and losses that the
partnership may incur. General partners provide equity capital and
participate in the management decisions that the cooperative undertakes.
Each general partner is personally liable for the debts and losses of the
partnership. Profits of the partnership are taxed once, as part of
the partners’ incomes at the applicable personal tax rates.
General Corporation
A cooperative
is a type of corporation. For our purposes, corporations other than
cooperatives are referred to here as general corporations. A general corporation
is a legal entity that operates like an artificial person; it has the right
to own property, enter into contracts, buy and sell products and services,
borrow money, and be held liable for debts and other damages. Corporations
account for most of the business activity conducted in the U.S. (Cobia).
They range in size from small businesses owned by one person to large multinational
organizations owned by thousands of people. Equity capital is raised
by selling shares to investors. Ownership of a general corporation
occurs by purchasing shares of the corporation’s stock. Owners are
known as shareholders. The amount of votes that each shareholder
receives is tied to the number and class of stock that he or she owns.
In contrast to a sole proprietor or general partner, shareholders of a
general corporation have limited liability for any losses or debts that
the business incurs; they are only liable to the extent of the equity amount
they have invested in the business. In return for providing equity
to the corporation, shareholders are entitled to receive any dividends
that the corporation may distribute. The amount of dividends each
shareholder receives is based on the number and class of shares that he
or she owns. Profits of a general corporation are taxed twice, once
at the corporate level at the applicable corporate tax rate, and again
at the shareholder level when profits are distributed as dividends, at
the applicable personal tax rate.
Limited
Liability Company
A limited liability
company (LLC) is a newer type of business structure used in the U.S. that
combines features of the other structures. In particular, the LLC
combines the single tax treatment of a partnership with the limited liability
for owners found in a corporation. Similar to a cooperative, the
owners of an LLC are referred to as members. The rights and responsibilities
of the members are described in an operating agreement. This agreement
will provide the details as to how business decisions will be made and
how voting power is allocated among members. The LLC’s members are
usually the ones who provide equity capital to the business. The
operating agreement stipulates how earnings are to be allocated among members.
In an LLC, earnings (or losses) are usually allocated according to the
member’s level of equity investment. Similar to the owners of a corporation,
liability of the LLC’s members is usually limited to their level of equity
investment in the business. Similar to the partners of a partnership,
the earnings of an LLC are taxed once, at the member (owner) level.
The LLC does have the option, however, to elect to be taxed as a general
business corporation (Frederick).
Cooperative
As mentioned,
a cooperative is a particular type of corporation. Cooperative members,
like shareholders of a general corporation, have limited liability for
the losses and debts of the business. Their liability is limited
to the amount of equity the member has invested in the cooperative.
The primary difference between a cooperative and the other types of business
structures described here relate to ownership and the distribution of earnings.
The owners of a cooperative are the people who use its products or services
in some capacity: they are the patrons of the business. In
a sole proprietorship, partnership, and general corporation, the owners
might never be patrons of the business. For instance, a person might
own shares in a general corporation such as Archer Daniels Midland, and
thus be an owner of the company. That same person, however, might
never conduct any business with ADM. In contrast, a person might
be a member (and therefore an owner)of a cooperative such as Cenex Harvest
States. That same person will use the services provided by the company.
For instance, he may market his grain through the cooperative. Thus,
a cooperative is distinct because there is a linkage between the ownership
and the users of the business. A cooperative is also distinct because
it distributes its earnings to members according to the level of business
conducted with the company rather than the level of equity investment.
References
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