Phil Kenkel writes in Southern Ag today: Most farmers and rural residents know that agricultural cooperatives are farmer-owned but don’t think much more about their structure or how they are financed. While all businesses are financed by a combination of debt and owner equity, there are fundamental differences in financing a cooperative relative to a typical investor-owned business.
Typical Business Financing is Separate from Operations
Most businesses in the U.S. are owned by one group of individuals, the investors, and do business with another group, the customers. Under this structure, it is logical to separate financing from operations. If the business is generating, or projected to generate, adequate profits, there should be a pool of outside investors willing to provide equity capital. This structure allows for business financing to be separate from operations and marketing.
Profits from typical businesses are returned to their owners and investors in the form of retained earnings, dividends, and stock buy-backs. Those profit distributions create the incentive for equity investment. Customers of these businesses (who are not investors) do not receive a share of the profits.
Cooperative Financing is Combined with Operations
Under the cooperative business model, cooperative customers are also owners. Due to this structure, identifying financing for a new cooperative cannot be separated from the process of identifying its customers. New cooperative organizers must simultaneously identify individuals to be both cooperative users and investors and established cooperatives must obtain all the capital they need for future expansion through their user-investors.
Cooperatives distribute profits to its owner-customers in proportion to use. Therefore, there is no direct benefit from owning equity in a cooperative, rather the rationale for equity ownership is related to the use of the cooperative. In traditional, open membership cooperatives, a portion of the profits are distributed in the form of equity, often called “stock patronage”. That equity is typically redeemed into cash by the cooperative at a later date and is thus referred to as “revolving equity”. Under this cooperative structure, equity ownership is accumulated as a by-product of using the cooperative. In other situations, such as processing cooperatives which are more capital intensive, the cooperative stock is combined with a usage right. Under that structure the equity investment is a prerequisite to use.
Understanding Cooperative Equity Financing
Agricultural cooperatives are an important part of our rural landscape, with many of our legacy cooperatives having been in business for over 100 years. Understanding cooperative structures for acquiring and managing equity is key for continuing the cooperative business model. Merging the roles of users and investors has major implications for cooperative operations and planning. Groups who are interested in forming a cooperative must not only analyze the customer base, but they must also determine whether potential customers are interested in investing in a user-owned business. Established cooperatives must create systems to match use and investment on a long-term basis.
Having two stakeholder groups, investors and customers, sounds complicated while merging those two groups sounds simple. In reality, the ownership element of the cooperative business model is more complicated relative to other firms. Agricultural cooperatives create great benefits in keeping markets competitive and improving the financial results of their farmer-owners. I view cooperatives as a better, but not necessarily simpler, business structure.
Kenkel, Phil. “What is Different About Financing a Cooperative?
