The Law of Cooperative Corporations University of Arkansas LLM Program, Agricultural Law, 2007 Fayetteville, Arkansas April, 2007 James R. Baarda Finance

5. Equity redemption 4. Base capital plans 3. Revolving fund system 2. Patronage based equity 1. Techniques and sources Finance Syllabus: Finance

5. Non-member equity 4. Globalization issues 3. Strategic alliances, subsidiaries 2. Limited liability companies 1. “New generation” cooperatives Innovations

InvestmentOperationsFinance Administrative Expenses Physical Assets Sales Financing Expenses Net Margins Purchases Current Assets Investments Plant,PropertyEquipment Short-termLiabilities Long-termLiabilities Equity

Syllabus: Finance, pp ImplementationImplementation - Statutes - Articles of incorporation - Bylaws - Certificates - Policies and practices Legal Foundations

Syllabus: Finance, pp. 1,2 [Persons] may form a non-profit, cooperative association, with or without capital stock, under the provisions of this Act. Common statutory provisions No association shall issue stock to a member until it has been fully paid for. Any association organized with stock under this act may issue preferred stock, with or without the right to vote.

1. Techniques and sources Syllabus: Finance, pp. 1,2

Debt Capitalization Short-term liabilities Short-term liabilities - Secured interests - Transaction based Long-term debt Long-term debt - Loan agreements - Membership indebtedness - Bonds

Syllabus: Finance, pp. 1,2 Equity Capitalization Membership equity Membership equity Patronage-based equity Patronage-based equity Hybrids Hybrids “Outside” equity “Outside” equity Off balance sheet financing Off balance sheet financing

Cooperative Principles The User-Owner Principle: Those who own and finance the cooperative are those who use the cooperative. Syllabus: Introduction, p. 23

Syllabus: Finance, pp Principles and Finance Cooperative objectives Cooperative objectives Obligation to finance Obligation to finance Ownership and control Ownership and control Burden of finance Burden of finance Objectives, burdens, benefits Objectives, burdens, benefits

User-Control User-Ownership User-Benefit

User-Control User-Ownership User-Benefit

Syllabus: Finance, pp Patronage based equity

Patronage Refunds Patron Sales to Cooperative Percentage of Total A$20, B$10, C$25, D$12, E$14, Syllabus: Operations, p. 62

Syllabus: Finance, p. 8 Patron Patronage RefundCashEquity A$2,469$1,235 B $618 C$3,086$1,543 D$1,481$740 E$1,728$864 “Retained” Patronage Refunds

Syllabus: Finance, p. 8 Patronage Refunds Paid in Cash YearPercent in Cash

Syllabus: Finance, p. 9 Per-Unit Retains PatronHead DeliveredEquity A20$200 B50$500 C30$300 D75$750 E45$450

Syllabus: Finance, pp. 1,2 Each member also agrees to provide capital in such amounts as determined by the board of directors based on physical units of product marketed through the association. Such per-unit retains shall be allocated to the member’s capital credit account. A bylaw provision Per-Unit Retains

Distribution of Net IncomeProportion Cash Patronage Refund31.3% Non-cash Patronage Refund42.4% Unallocated Equity15.2% Dividends on Equity1.5% Taxes9.5% Distribution

Distribution Cash Non-cash Unallocated Dividends Taxes

Syllabus: Finance, pp Revolving Fund System 1. Equity contribution 2. Member equity totals 3. Current equity needs 4. Excess equity capital 5. Redemption of excess

Syllabus: Finance, p. 10 Patron Equity Year 1 Equity Year 2 Equity Year 3 A$1,235$1,010$960 B$618$400$500 C$1,543$1,550$1,900 D$740$900$450 E$864$350 Added$5,000$4,210$4,160 Total$9,210$13,370 Desired$10,000 Excess$3,370

Syllabus: Finance, p. 10 Patron Equity Year 1 Equity Year 2 Equity Year 3 A$1,235$1,010$960 B$618$400$500 C$1,543$1,550$1,900 D$740$900$450 E$864$350 Added$5,000$4,210$4,160 Total$9,210$13,370 Desired$10,000 Excess$3,370

Syllabus: Finance, p. 11 Revolving Fund System PatronRedeemed Year 3 A$832 B$416 C$1,040 D$499 E$582

Syllabus: Finance, pp. 1,2 If at any time the board of directors determines that the financial condition of the association will not be impaired thereby, capital credited to members’ accounts may be redeemed in full or in part. Any such redemption of capital shall be made in order of priority according to the year in which the capital was furnished and credited, the capital first received being the first redeemed. A bylaw provision Revolving Fund System

Syllabus: Finance, pp Base Capital Plan 1. Equity contribution 2. Member equity totals 3. Current equity needs 4. Member share

Syllabus: Finance, p.12 Base Capital Plan Patron Percent Business Equity Desired Amount Redeemed A24%$2,400$805 B11%$1,100$418 C41%$4,100$893 D16%$1,600$490 E8%$800$564

InvestmentOperationsFinance Purchases Administrative Expenses Physical Assets Sales Financing Expenses Net Margins Purchases Current Assets Investments Plant,PropertyEquipment Short-termLiabilities Long-termLiabilities MemberEquity

InvestmentOperationsFinance Purchases Administrative Expenses Physical Assets Sales Financing Expenses Net Margins Purchases Current Assets Investments Plant,PropertyEquipment Short-termLiabilities Long-termLiabilities MemberEquity Patron A -- $3,205 Patron B -- $1,518 Patron C -- $4,993 Patron D -- $2,090 Patron E -- $1,364

Net Worth as Percentage of Total Assets

InvestmentOperationsFinance Purchases Administrative Expenses Physical Assets Sales Financing Expenses Net Margins Purchases Current Assets Investments Plant,PropertyEquipment Member Equity Short-termLiabilities Long-termLiabilities

InvestmentOperationsFinance Purchases Administrative Expenses Physical Assets Sales Financing Expenses Net Margins Purchases Current Assets Investments Plant,PropertyEquipment Member Equity Short-termLiabilities Long-termLiabilities Current Assets 51.4% Fixed Assets 30.8% Other Assets 17.7% Current Liabilities 39.1% Long-term Debt 20.8% Equity Capital 40.9%

InvestmentOperationsFinance Purchases Administrative Expenses Physical Assets Sales Financing Expenses Net Margins Purchases Current Assets Investments Plant,PropertyEquipment Member Equity Short-termLiabilities Long-termLiabilities Current Assets 51.4% Fixed Assets 30.8% Other Assets 17.7% Equity Capital ========== Allocated Equity 76.5% Unallocated Equity 23.5%

Syllabus: Finance, pp Regular or specialRegular or special ConflictsConflicts Establishing rights, obligationsEstablishing rights, obligations Description of the systemDescription of the system Board of directors’ roleBoard of directors’ role Equity Redemption

Syllabus: Finance, pp Debt or equityDebt or equity - Significance - Balance sheet - Set-off - Atchinson County Equity Redemption Convertibles, redemptionConvertibles, redemption

Syllabus: Finance, pp Legal issuesLegal issues - Contract - Course of conduct - Liens on equity - Setoff - Valuation Equity Redemption

Syllabus: Finance, pp Degree of obligationDegree of obligation - Fiduciary relationships - Sources of obligation - HAJMM v. House of Raeford Equity Redemption Importance of clarityImportance of clarity Flexibility v. certaintyFlexibility v. certainty

Syllabus: Finance, pp Triggering eventsTriggering events - Membership change - Patronage change - Passage of time Equity Redemption Lambert v. Fishermen’s DockLambert v. Fishermen’s Dock Accounting and “convergence”Accounting and “convergence”

5. Equity redemption 4. Base capital plans 3. Revolving fund system 2. Patronage based equity 1. Techniques and sources Finance Syllabus: Finance

5. Non-member equity 4. Globalization issues 3. Strategic alliances, subsidiaries 2. Limited liability companies 1. “New generation” cooperatives Innovations

Cooperative Challenges – External Globalization Globalization Concentration Concentration Industrialization Industrialization Size and complexity Size and complexity General and specific General and specific

Cooperative Challenges – Internal Meeting the “competition” Meeting the “competition” Member expectations Member expectations Diminished commitment Diminished commitment Finding good people Finding good people Management ambitions Management ambitions

Inherent Cooperative Limitations Homogeneity Homogeneity Horizon Horizon Scope Scope Membership Membership Governance Governance Equity Equity Competitive yardstick Competitive yardstick Markets and growth Markets and growth

1. “New generation” cooperatives Syllabus: Finance, pp

“New Generation” Cooperatives – Capital – Capital Capital requirements Capital requirements - Total capital - Capital and product Up-front contribution Up-front contribution Syllabus: Finance, pp

“New Generation” Cooperatives – Delivery – Delivery Unit measures Unit measures Capital and delivery basis Capital and delivery basis Right and requirement Right and requirement Syllabus: Finance, pp

“New Generation” Cooperatives – “Closed” membership – “Closed” membership Total production needs Total production needs Equity investment Equity investment Syllabus: Finance, pp

“New Generation” Cooperatives – Tradable Equity Interests – Tradable Equity Interests Producer to producer Producer to producer “Market” price “Market” price Syllabus: Finance, pp

“New Generation” Cooperatives – Market Orientation – Market Orientation What can be marketed What can be marketed What can be produced What can be produced Commodity acceptance based on market forces Commodity acceptance based on market forces Syllabus: Finance, pp

Conditions for “New Generation” Cooperatives Capture value-added benefits Capture value-added benefits High capital requirements High capital requirements Efficient processing system Efficient processing system Response to market signals Response to market signals Product differentiation Product differentiation Syllabus: Finance, pp

“New Generation” Cooperatives – What’s new, what isn’t? – What’s new, what isn’t?

2. Limited liability companies

Limited Liability Company As cooperative organization As cooperative organization As joint venture As joint venture

3. Strategic alliances, subsidiaries

Cooperative “plus” Cooperative “plus” - Subsidiaries - Joint ventures - Strategic alliances Alternatives

Cooperative Members Product Delivery Final Product Marketing Dividends Product Payment Product Delivery Independent Business Cooperative Coordinating Mechanism

Cooperative Product Delivery Final Product Marketing Dividends Investment Dividends Product Payment Independent Business Co-owned Entity Cooperative Members

Accredited Investors Joint Venture New Markets, LLC Operating LLC Preferred Cash Returns Guaranteed Redemption Tax Credits Cooperative Members Cooperative

Operating LLC Cooperative Nonprofit University, Government Assistance Product Delivery Final Product Marketing Public Funding Sources Development Assistance Cooperative Members Investment, Dividends Accredited Investors Investment, Dividends

4. Globalization issues

5. Non-member equity Syllabus: Finance, pp

Emerging Views Of Equity Competition and markets Competition and markets New cooperative ventures New cooperative ventures Capital intensive ventures Capital intensive ventures Member perceptions Member perceptions Capturing firm value Capturing firm value

Definition of “Outside” Equity Not based on the patronage relationship. Relationship is one of investor-corporation, not primarily patron-cooperative Not based on the patronage relationship. Relationship is one of investor-corporation, not primarily patron-cooperative

Examples Preferred stock Preferred stock - Unrestricted investors - No voting rights - Limited voting rights - Full voting rights - Liquidity

Full “membership” Full “membership” - No patronage requirement - Limited voting rights - Full voting rights - Board membership - Liquidity Examples

From objectives to obligations From objectives to obligations - Mandated objectives - Obligations - Expectations A few ideas A few ideas Opposing objectives Opposing objectives What might this mean?

“The objective in corporate finance is stated, most broadly, as the maximization of firm value and, more narrowly, as the maximization of the stock price.” Corporate finance textbook Corporate finance textbook Corporate Objectives

American Law Institute American Law Institute “[A] corporation should have as its objective the conduct of business activities with a view to enhancing corporate profit and shareholder gain.” What might this mean?

“[M]ost modern courts have accepted the principle that the controlling shareholders as well as the directors and officers owe a fiduciary duty to other shareholders -- to public shareholders in a public corporation and to minority shareholders in a close corporation.” From Objectives to Obligations

To member/patrons To member/patrons - Multiple relationships - Objective The User-Benefits Principle: The cooperative's sole purpose is to provide and distribute benefits to its users on the basis of their use. Corporate Objectives

To “outside” equity holders To “outside” equity holders - Single relationship - Corporate-equity holder Corporate obligations Corporate obligations Cooperative Objectives

Constituency issues Constituency issues The agency problem The agency problem Equity holder conflicts Equity holder conflicts Private agreements Private agreements Implied obligations Implied obligations Corporate Objectives

Implications Selected operating strategies Selected operating strategies Allocation, distribution of benefits Allocation, distribution of benefits Financing practices, strategies Financing practices, strategies Secondary issues Secondary issues

Selected operating strategies Selected operating strategies - Pricing and profitability - Entity value maximization - Scope and market choices - Non-patronage business Implications

Allocation, distribution of benefits Allocation, distribution of benefits - Benefits allocation - Relational transactions - Timing, distribution - Fixed or variable fund flows Implications

Financing practices, strategies Financing practices, strategies - Decoupling - Leverage - Valuation -- from member/ patrons to markets - Benefits bias Implications

Secondary issues Secondary issues - Local benefits - “Consumption functions” - Cooperative roles - “Trickle down” Implications

Scope of decisions Scope of decisions - Voting power and control - Levels of obligation - Measuring performance - Legal mandates or constraints Governance

Types of decisions Types of decisions - The new balancing act - Horizons - Guidance to management/staff - Professional advisors - Now who makes what decisions? Governance

Represent Members Establish Policies Engage Management Oversee Assets Preserve Co-operative Assess Performance Inform Members

Control Benefit Finance USE

Avoided the “big” questions Avoided the “big” questions - Less competitive cooperatives - Less beneficial cooperatives - Less innovative cooperatives - Loss of cooperative presence To Change, or Not to Change Too cautionary? Too cautionary?

Adopt/adapt – or die Adopt/adapt – or die Preserving the cooperative Preserving the cooperative - Understand implications - Informed decisions - Design accordingly Alternatives

Cooperative “plus” Cooperative “plus” - Subsidiaries - Joint ventures - Strategic alliances Alternative business forms Alternative business forms - Cooperative characteristics - Non-cooperative Alternatives

Each cooperative’s decisions Each cooperative’s decisions Redefine “cooperative”? Redefine “cooperative”? Redefine public policy? Redefine public policy? - Current events - Restriction v. flexibility - What principles should apply? Policy

Who will establish policy? Who will establish policy? - For each cooperative? - For the country? - Sectors, needs, and interests - Who are the players? - The importance of process Alternatives

Enormous pressures to change Enormous pressures to change Great range of responses Great range of responses Significant implications Significant implications Preserving the cooperative idea Preserving the cooperative idea No easy solutions No easy solutions Substantial work needed Substantial work needed Leadership needed Leadership needed Conclusions

5. Non-member equity 4. Globalization issues 3. Strategic alliances, subsidiaries 2. Limited liability companies 1. “New generation” cooperatives Innovations