CGIN

All businesses need equity (also called capital); a co-op is no different. This base capital serves as the financial foundation upon which a business is built. It allows the company to purchase inventory, acquire equipment, finance operations, and minimize outside debt. In any business the base capital is provided by the owners. In a co-op, the members are the source of this financial foundation.

Co-ops use member investments to purchase equipment, expand inventory, make improvements and renovations to facilities, pay off debt, pay deposits with suppliers, reduce accounts payable or pay suppliers early to get discounts, and research new services or business opportunities. Member equity gives the co-op base capital. On this foundation, the co-op can then finance its asset base. Member equity also provides a leveraging base for financing additional capital, called debt.

Types of capital and features of member equity
For all types of businesses, there are two basic sources of capital: equity (capital provided by the business and/or its owners) and debt (capital provided by outside sources). Let’s look at the most common sources of capital for retail cooperatives (see also “Methods of Capitalization for Cooperatives”):
Equity financing — capital provided by the business and/or its owners

• Net operating surplus (also known as profit)
• Membership dues or fees
• Membership shares or investments (also known as member equity)

• Outside loans — including capital leases, lines of credit, mortgages, and other debt financing
• Member loans

Member shares, or equity, are investments made by members as the owners of the co-op. These shares form the base capital of the co-op. As such, these shares are also the capital invested at most risk. When established properly, member shares will not be a taxable source of funds for the co-op and will help establish a sense of ownership among members. Shares are refundable to members upon termination.

Without member capital (or with insufficient member capital), a co-op is forced to seek financing from outside sources, such as banks, suppliers and other creditors. Such funding has disadvantages. Supplier credit is limited, and can lead to increased prices on goods. Bank financing is expensive and almost always comes with some restrictions. Bankers are also reluctant to lend money to co-ops that have inadequate financing by their member/owner. Loans might be available but only at high interest rates. If the co-op has an adequate capital base, bankers will be more willing to make loans at reasonable cost and without imposing constraints on the co-op’s operations or goals.

Co-op members provide capital by purchasing shares (just like stock in a publicly traded corporation). Typically, the board of directors sets a required number of shares that members must purchase. The money invested this way is used to finance inventory, purchase equipment, make improvements, etc. Making this investment gives each member the rights and responsibilities of an owner.

Goals and requirements
The goal for a co-op membership program should be three-fold:

• to provide an adequate capital base for the co-op’s current and future financial needs
• to create a sense of ownership among the co-op’s members
• to clarify and solidify the co-op’s structure and operations as a cooperative — consistent with state law and cooperative principles

A successful member capital system must meet the following requirements:

• Costs and benefits to individual members and to the co-op as a whole are balanced between both parties and financially advantageous for each.
• Membership administrative is simple, and records are easy to maintain.
• The required member investment is great enough, when combined with other sources of equity, to provide for the co-op’s financial viability.
• The membership system is not overly complex or sophisticated; it can be easily understood by new and prospective members without lengthy or exhaustive explanations
• Any fees required for special administrative functions ( replacing lost cards, terminating a membership) will be nominal.
• The plan is designed to ensure exemption from securities laws and from taxation (be sure to consult with a knowledgeable attorney about this).
• The system is fundamentally an equitable one that reinforces the concept of members’ ownership of the co-op
• The system is designed to accommodate the variety of basic circumstances presented by the co-op’s current and prospective members

Financial targets
Ensuring that the co-op has an adequate capital base is a key to its long-term survival, especially for the co-op to grow and expand. The following two ratios can provide some guidelines for financial planning.

• Member-share ratio: total member investment divided by total assets
  This ratio shows how much of a co-op’s assets are financed by member investments. A benchmark for the member share ratio is 20 to 30%.

• Member equity ratio:total equity divided by total assets
  This ratio shows how much of a co-op’s assets are financed by the co-op’s total equity (retained earnings and member investments). A benchmark member-equity ratio for an existing business is 40 to 60 percent. For start-ups, experts recommend that 30 to 50 percent of the asset base be provided by the co-op — i.e. from members through equity or member loans or from donations, grants or in-kind contributions.

Overall guidelines for a member equity system

• Shares must be clearly defined as the property of the members. If the co-op allows more than one individual per membership, their shares must be clearly defined as joint (non-dividable) property. The co-op should avoid becoming an arbiter in property disputes.
• The co-op must issue evidence of members’ investment and holding in the co-op. Generally membership cards are sufficient. Some states require co-ops to issue member certificates .
• The co-op should set one reasonable investment requirement of all members — not different levels of investment for individuals, households, seniors, low-income members, etc. Membership requirement and benefits not be changed often as members find such change very unsettling. Avoid referring to “lifetime memberships” since the co-op might sometime need to change its required member investment. Be realistic about the co-op’s future capital needs. Set the share requirement to meet the co-op’s needs for at least 10 years.
• Create several simple payment options for members. Don’t require full payment upon joining, unless you have no other way to finance a start-up. Consider charging an annual processing fee ($3 – 5) for those members who make payments over time. The fee will cover administrative costs and will encourage members to pay in full upon joining.
• It’s reasonable to assess fees for keeping track of memberships. Options include an application fee or fee for processing a request for termination of membership.
• Member shares should be fully redeemable (refundable) upon termination of membership (the co-op will repurchase a members’ shares) However, repurchase of shares should be contingent upon replacement. For example, the co-opt might total new share investment each month and process repurchase requests up to that amount. This system helps the co-op avoid heavy seasonal outflows of capital. For a start-up, it’s most common to state that the co-op will be unable to repurchase shares until at least two years after operations begin.
• Member shares represent an investment in the co-op, like stock in a corporation. However, when established correctly, member shares should not be subject to securities regulations. Make sure that a lawyer familiar with co-op securities laws reviews your bylaws and membership documents.
• Keep the membership system simple, so members will be able to understand it and staff will be able to accurately explain it. Keep administrative systems simple as well.
• New member should be eligible for all member benefits (including voting) as soon as the membership application has been processed and approved.