Member Investment Shares- A Capital-Raising Strategy For California Cooperatives

Unlike investor-driven business structures, co-ops in California faced constraints in offering their member-owners the ability to make significant capital investments. Where investor-oriented firms attract financing through the sale of shares, with the promise of a financial return, cooperatives favor limited returns on investment.  This makes member investment, as a method of financing, relatively rare. Additionally, until January 2015 the California cooperative statute did not provide a clear mechanism for offering investment shares to Co-op members.

However, recent changes in California cooperative law and ongoing low interest rates make member financing a much more attractive strategy. Lower expectations of return on investment in general mean that a cooperative investment share can be competitive with other investments while still conforming to the traditional cooperative principle of limited financial returns. Additionally, the cooperative investment share structure provides several other tangible benefits to the cooperative and its membership. Potential problems in governance and operations can be addressed through carefully drafted bylaws and other safeguards.

Benefits of Member Investment

Build a strong equity position.

The main benefit in financing through member investment shares is that the cooperative is able to develop a stronger equity, as opposed to debt, position on its balance sheet. Member investment in the cooperative is not a loan from membership to the cooperative, instead the investment flows to the equity side of the balance sheet, making the cooperative’s financial position stronger. In contrast to a member loan program, member investments position the cooperative attractively to other lenders should the cooperative need to raise additional capital from traditional sources.

Keep dividends local.

A second benefit of member financing through investment shares is that it keeps the investment in the community. Rather than paying interest to a remote lender, as the cooperative would do with borrowed capital, dividends paid on member investment shares are paid to members, people who usually live in the local community. This multiplies the benefit as members can spend their dividend locally as well.

Deepen the members’ involvement in their coop.

A third benefit of member financing through investment shares is that members' relationships with their cooperative deepen as members make a financial commitment. Where they have financed the development of their cooperative, members become more involved in the governance of the organization and are more likely to patronize it.

Build a long-term commitment.

Finally, deepening members’ involvement makes the cooperative more sustainable in the long term. Where initial coop members form a cooperative to address a need, or a problem (e.g.: access to organic food, a stable job, or increased economic leverage), the cooperative may face a challenge to maintain ongoing relevance and members' enthusiasm once the initial problem has been solved and as the founders mature. For example, some of our more-established natural food cooperative clients have succeeded in completely changing the natural foods market and providing members with access to a vast array of previously unavailable products. Now, however, members have multiple natural foods options, including Whole Foods and Trader Joes. These potential competitors do not have the financial constraints of a cooperative in raising capital and can implement pricing strategies across multiple locations to create extreme price competition on a given cooperative location.

In order to stay relevant, and address the competition, the cooperative should consider additional investment from its members.  Where the members have made a substantial financial commitment to the cooperative as a business, member involvement with the cooperative's longer term financial viability increases. And it is this type of involvement that maintains "founder's enthusiasm" as the cooperative matures.

Addressing Potential Issues

Member investment is not without its risks, however. First, permitting member investors to vote their shares, as is the norm with investor-oriented firms, threatens the cooperative’s democratic one-member, one-vote structure.  Second, a member’s expectation of a return might create a tension with the other non-financial benefits of membership.  For example, consumers join a natural foods store because they want access to high-quality food and transparent pricing.  However, when a member is both an investor and a consumer, there is an inherent tension between the members’ primary and secondary benefits.  Is she primarily using the coop’s services for access to good food, or as a passive investment opportunity?

These two issues have the potential to endanger the cooperative’s original reason for existence.  Fortunately, cooperatives can employ various strategies to insure adherence to cooperative principles while enjoying the benefits of member financing. 

Most significantly, the cooperative should maintain a policy and practice of one member-one vote, regardless of the level of financial investment by any single member. Some cooperatives also insulate board members who have a financial investment from participating in certain decisions. Additionally, the cooperative should carefully structure any non-member investment to limit non-member participation to extreme circumstances such as demutualization.

The decision to invest in the cooperative for a financial return must always be recognized as a secondary benefit. The cooperative should always limit the return a member can receive on their capital investment. The cooperative should always attempt to pay investment dividends out of non-member sourced income to avoid any reduction in patronage distributions.

Financing a cooperative by member investment sustains the organization in furthering its goals and its financial health. Careful planning and adherence to cooperative principles of democratic control, one member-one vote and limited return on investment will insure that desire for financial returns don't overwhelm the original cooperative mission.

Member Investment Mechanics

Member investment shares are regulated securities. Where a member invests more than $1000.00 in the cooperative, the cooperative must qualify to sell the shares in the State of California through California’s Department of Business Oversight. It must also register with the SEC to sell the shares, unless it qualifies for an exemption.

How our law firm can help

Tuttle Law Group specializes in preferred share financing for California cooperatives. We have assisted our clients in developing significant member investment programs.
This is an advertisement. Past results are not a guarantee of future success. 
For more information on using preferred shares in your cooperative, contact us here

 

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