business cooperatives

Business Cooperatives: Should You Form a Business-Cooperative?

When starting your own business, you’ll have more than a few choices regarding what type of structure you choose. Should you be a sole proprietor or have partners? Do you constitute your business as a C-level corporation?

There are many options, but one stands out among the others for its unique properties: the business cooperative. A business cooperative is a unique type of structure where each employee works together for the sake of the business, but while it might sound appealing, there are caveats and restrictions with this option.

To ensure you are making the right choice, this article provides all the details regarding the cooperative structure, how it works, its pros and cons, and the process needed to create one.

What Is a Business Cooperative and How Do They Work?

A cooperative firm, also known as a co-op, is an organization owned and governed by its members, which consume its services and products. Companies like these differ from others in that their members are the ones who create and run them. As such, they are considered charitable organizations. Business cooperatives are essentially employee-owned businesses. Member-owners (also known as members) receive an even share of profits and revenues. Regardless of members’ shares, they all have an equal voice. However, there are many kinds of cooperatives, each with a unique purpose and other company forms similar to cooperatives.

These businesses are quite diverse in terms of scale. Many are small buying clubs run by members of the community. Others are Fortune 500 companies. In the United States, there are approximately 42,000 cooperatives; together, they control assets worth more than $3 trillion, making them a significant contributor to the economy.

Typically, people join cooperatives for the benefits – pooling risk, making large purchases in groups, feeling empowered, and being part of something meaningful.

A large co-op can function similarly to a franchise in that members pay to utilize the company name and resources, but each location is managed separately. For example, ACE Hardware is a retail cooperative whose shares are owned by individual ACE Hardware store owners. Approved ACE outlets may use the ACE products, brand, and distribution methods in exchange for buying shares of company stock.

The democratically elected leaders of a cooperative can also exercise collective bargaining power in their industry if they are large enough. An example of a large agricultural business cooperative is Land O’Lakes Inc., owned by dairy farmers. Thanks to its purchasing power and size, Land O’Lakes has negotiating leverage with its suppliers, which it uses to reduce its production costs.

Business cooperatives can still be beneficial, even on a very small scale. Not all business cooperatives are national brands; most are small companies. A new cooperative might have only a few employees.

Ownership in Cooperatives

Individuals own a prorated portion of a business under normal ownership. Cooperatives are somewhat different. The amount of equity contributed by each member determines the ownership of a cooperative. This ownership structure is unique since it can depend on anything, including how much a member purchases from the cooperative business. This element is what makes cooperatives different from other kinds of businesses.

Take this example: In a regular business, you don’t need to invest in the business to purchase its products. General Motors does not require you to be a shareholder to buy a car from them. The other end of the spectrum is that you don’t have to buy or use the company’s products to own shares. To own Facebook shares, you don’t need a Facebook account. When investing in a cooperative, you must use the cooperative’s products and services. Likewise, you cannot buy the products or use the services of a cooperative unless you are also an investor. This problem appears to be a chicken-and-egg one, but it is typically solved during the co-op’s formation. At that time, it is decided which comes first – purchasing shares or products.

Shares and Control

There is, again, a difference between what a regular business does and how control is exercised. A single vote is given to each share in a regular business. Therefore, investors can buy as many shares as they need to gain a level of control over the company. Cooperatives operate differently. Each member gets one vote, creating equal voting rights. The cooperative business is then run by all members who share the responsibilities.

Consumer vs. Business Cooperative

Although they have the same legal framework, business cooperatives are different from consumer cooperatives. A consumer cooperative’s members are also consumers of its goods or services, contributing to the co-op or occasionally providing work (typically part-time) in exchange for membership.

What are the benefits of joining a consumer cooperative? Having a membership often entitles you to discounts or free services. For example, a food co-op offers high-quality food at a much lower price than Whole Foods. Parents join preschool co-ops so their children can attend for free or at a reduced rate. Community-based cooperatives often provide non-profit services for the community. Some are corporations, while others are not.

Alternatively, business cooperatives provide services to workers. Members of business cooperatives are usually company employees.

Business cooperatives are formed and operate as cooperative corporations. The primary purpose of a company co-op is to make a profit, not to provide a community service. Business co-ops are democratic and often have a socially conscious business culture. Often, owners divide profits equally, with the remainder invested back in the company. Many industries have cooperative enterprises, including manufacturing, agriculture, retail, healthcare, and others.

Differences Between a Business Cooperative and Other Structures

Cooperative businesses are also distinct from conventional corporations (C corporations). Most businesses are owned partly by shareholders who also work for the company. In contrast, cooperatives are owned entirely by their employees, with no employee having more power or ownership than another employee. Cooperative corporations, unlike typical corporations, do not have shareholders who own the majority of the shares (among other differences).

Commercial partnerships differ from co-ops because they have different responsibilities, tax structures, and unequal ownership arrangements. An LLC or a partnership may be a better structure for your business, depending on your objectives. LLCs provide many of the same benefits as co-ops but with fewer restrictions.

Other types of businesses may adopt some characteristics of cooperatives without being cooperatives. For example, Costco and Sam’s Club are similar to co-ops in that members pay a fee to shop there; however, these companies are not co-ops because members do not own them.

Advantages and Disadvantages of Forming a Business Cooperative

Like any other business structure, many benefits and drawbacks come with forming a business cooperative. Here’s a look at both sides of the coin:

Advantages of a Business Cooperative

You’ll find their equality, reduced liability, and tax advantages among the different advantages of business cooperatives. Here’s the full list of benefits:

Equality and Cooperation

Its democratic nature and equality engaged in management are among the most significant advantages of a cooperative company. Members can meet all of their requirements without relying on a single person. Because of their equitable organization style, cooperative businesses are much more stable than standard businesses. The business can function without interference from the members. Whenever a change is required, the entire group must agree on it. In addition, because each member has only one vote, everyone has an equal say in the business regardless of how many shares they own.

Cooperative companies are based on the principle of mutual assistance. Their goal is to help members financially, ethically, and socially. They aim to help members be independent, cooperative, and tolerant.

Cooperative enterprises provide their members with unique economic benefits. In exchange for their support, members of consumer cooperatives receive dividends. These dividends are determined by how much money members spend on cooperative products. Members who are also cooperative employees may receive merchandise discounts.

Reduced Liability

Equitable ownership distribution extends to equal liability distribution in a cooperative. Unlike partnerships, where each partner is fully accountable for their conduct and the conduct of their partners, cooperative owners have only limited accountability for the company’s debts, commitments, and other obligations. As long as a member does not act illegally or negligently, their liability is limited to the amount they invested in the co-op. In addition to limited-liability companies with multiple owners, there are also limited-liability companies with multiple owners.

Cooperatives are their legal entities. It is a legal entity responsible for its debts rather than relying on employees, directors, or shareholders unless fraud or carelessness is involved. Members are only responsible for the amount they have invested.

Tax Advantages

In a typical company, earnings are taxed twice: once on the firm’s net earnings and once on each shareholder’s dividend. Subchapter T of the United States tax code provides that surplus earnings or dividends distributed to members are not taxable. Rather than being taxed twice on their co-op income, co-op owners are only taxed once. Therefore, cooperatives have a lower tax burden than corporations.

To a certain extent, cooperative members are also exempt from income tax. Members will only be taxed on the income they receive from the cooperative, not individually or corporately. A profitable cooperative is taxed just like any other business. Nevertheless, they can reduce their tax liability by rewarding their members with patronage dividends in the form of refunds and discounts on goods and services. Cooperatives can also receive loans and grants from the government.

More Autonomy

In contrast to businesses controlled by investors, cooperatives are owned and controlled by their members. For the workload to be distributed equitably among cooperative members, all cooperative members must be active in the cooperative.

Lower Overhead

Because fewer costs lead to increased profitability, owner-employees are motivated to keep costs down. By leveraging its scale, cooperatives can obtain lower-priced goods and services from suppliers, reducing production costs.

Invested Employees

Employees are more invested in the company they work for because they share in the profits and are affected by the losses. It is more likely that employees who are also owners will put their hearts and souls into the company. As co-op owners, employees can feel like they have a say in the company. Aside from their labor, employees contribute money to the company, which helps fund it.

Disadvantages of a Business Cooperative

As for the drawbacks of starting a business cooperative, you might struggle with funding, the slow decision-making process, and legal restrictions. Here’s a full list of disadvantages:

Issues Securing Funding

Traditionally, startup loans and other forms of capital may be difficult to obtain from traditional lenders due to the financial and liability structure of a cooperative. In addition, co-ops have trouble attracting large investors since a large investor has no more influence over the company than a small investor. Cooperatives may need alternative funding sources, such as launching a crowdfunding campaign or applying for small business subsidies during the initial phase and sometimes beyond.

Large investors are less inclined to invest in cooperative enterprises when obtaining financing. Due to this, they are not very attractive to wealthy investors. They tend to attract smaller investors, while larger investors generally stay away once they realize their investment level does not determine their impact. Banks and other financial organizations can also be difficult to work with when cooperatives attempt to obtain debt financing. Thus, cooperatives are a great choice for people with modest start-up costs.

Slow Decision-Making

What is your experience with group decisions? They can be difficult. Major decisions in a cooperative, where everyone has an equal voice in all company decisions, can be time-consuming and frustrating. By the time the rest of the company decides where to dine, you’re starving.

Traditional businesses can make quick decisions due to their consolidated power. All members of cooperative enterprises are required to participate, which adds to the time commitment. A cooperative may have difficulty making quick decisions in times of need. Everyone’s authority may make deliberations difficult.

Not As Profitable for Founders

In a cooperative, profits are distributed equally among all employees, making this business less profitable for the founders. In a traditional business structure, when the owners/founders have the majority of control and ownership in a company, the owners receive a significantly larger share of the earnings. However, you will likely not pursue personal profit as your primary objective if you decide to start a co-op.

For a firm to succeed, it requires long-term effort. This effort isn’t a problem in typical firms since financial incentives exist. Due to the lack of a financial motive, a cooperative may become inactive if there is no financial motivation.

Legal Restrictions

Depending on where you live and work, you may not be able to incorporate your firm as a co-op. A co-op law exists in every state, but each one is different. Co-ops can only be formed in certain industries, such as agriculture, in certain jurisdictions. In other states, co-ops can be formed in virtually any industry. You must still follow your state’s co-op laws if your state allows you to form a co-op. Ensure you comply with your state’s cooperative regulations before getting into legal trouble.

Management Issues

Most cooperative firms cannot afford professional managers. Co-ops do not recruit professionals unless they are also co-op members, which can eventually cause the co-op to fail due to ineffective administration.

How Do You Form a Cooperative?

Forming a business cooperative involves the following steps:

1. File Articles of Incorporation

Your co-op’s articles of incorporation establish it as a legal entity. The charter members of your company (incorporators/founders) are listed here, along with their names, addresses, and purposes. Your incorporators must file your articles of incorporation with the state business entity registration office.

2. Obtain Business Permits & Licenses

Before legally functioning as a business, you must obtain all local, state, and federal permissions and licenses. Permit and license requirements vary by industry and location.

3. Create Bylaws

After your articles of incorporation have been approved by the state, you can write your bylaws. Here are your cooperative’s rules and regulations, including membership requirements, duties, and general operating procedures. Unless you have already done so, you should consult a lawyer now about how your bylaws should be.

4. Hold Charter Meeting

During this meeting, charter members will adopt bylaws and elect a board of directors (if one was not already created in the articles of incorporation).

5. Recruit More Members

You must expand your cooperative’s membership to be successful. The co-owners and employees of your company will provide labor and capital for the business. Membership applications must include the names and signatures of the board of directors, as well as a description of the rights and advantages of membership.

6. File with the IRS

The IRS still requires you to certify your cooperative’s tax-exempt status (before the end of your fiscal tax year) even though your cooperative is exempt from some taxes. Form 1120-C must be filed by cooperatives to report income, gains, losses, deductions, and credits, and to determine the amount of income tax due. If you haven’t already, you should obtain an Employer Identification Number (EIN) before the end of the year if you have employees.

7. Obtain Additional Financing

You may need additional funding at some point, especially if contributions from your co-op members do not cover your early launch costs. As previously stated, crowdsourcing and startup company grants can be sources of funds for co-op enterprises, and some internet lenders may be able to provide a startup loan as well.

The process for converting an existing corporation to a cooperative will be different. Along with incorporating and developing bylaws, you will need to buy out the original owners/founders.

Nonetheless, the steps to register your business as a co-op may differ slightly from state to state; for additional information on your state’s specific co-op legislation, contact the Secretary of State or State Corporation Commissioner.

Should You Form a Cooperative?

The right choice of business structure will depend on many factors. If you are considering forming a cooperative, you must consider both the benefits and drawbacks. You’ll have a structure with tax advantages, reduced liability, and increased cooperation. However, on the other hand, you’ll receive fewer profits than with other business structures, struggle with securing funding, and find the decision-making process frustrating.

Depending on your industry and location, the choice might have already been made for you due to the legal restrictions for cooperatives. 

Having said all of this, a business cooperative can still be an excellent choice, provided you choose it with full knowledge of what it entails.

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