Notes on coops
Types of corporations
"Cooperative" corporations are one of the many types of corporations that may be established in California. Although there are other cooperative laws (e.g., for housing and agricultural co-ops) in California, this publication is concerned only with the California Consumer Cooperative Corporation Law. In a sense, such law is a legal hybrid of partnership, for-profit corporation, and nonprofit corporation law. Section 12201 of the Consumer Cooperative Corporation Law succinctly states that co-ops "are democratically controlled and are not organized to make a profit for themselves, as such, or for their members, as such, but primarily for their members as patrons." This legal description identifies characteristics that distinguish cooperatives from other forms of business. Each member of a cooperative, no matter how many shares or memberships she or he has purchased, is generally entitled to only one vote. The primary objective of a cooperative is to provide benefits to its members, rather than a return on membersâ€™ capital investment. Unlike the similar nonprofit mutual benefit corporations, however, co-ops may distribute "surplus" to their members. Although consumer and worker cooperatives are rarely tax-exempt, surplus income may be distributed to members in such a way as to minimize corporate taxes.
The California Consumer Cooperative Corporation Law is fairly flexible, partly because it is something of a legal hybrid. On the financial side, a co-op may distribute dividends on shares or memberships (unless the articles of incorporation or bylaws prohibit such dividends) and distribute patronage refunds to its members (based on their relative activity with the co-op). Assuming that certain requirements of the Internal Revenue Code and related Treasury Regulations are met, patronage refunds are income tax-deductible to the co-op, thus often reducing the overall cost of doing business.
Non-profit mutual benefit corporations
Nonprofit "mutual benefit" corporations may be established in California for any lawful purpose. A nonprofit mutual benefit corporation is formed, like all other corporations, by filing articles of incorporation with the Secretary of State. A nonprofit mutual benefit corporation will not qualify for tax-exempt status since its primary goal is to provide direct benefits to individual members. It would also not qualify for favorable tax treatment as a cooperative (i.e., under Subchapter T of the Internal Revenue Code) since a nonprofit mutual benefit corporation is prohibited from making distributions to its members except to redeem memberships and upon dissolution. An organization incorporated as a nonprofit mutual benefit corporation files corporate income tax returns like any regular for-profit corporation unless a specific tax-exempt purpose is established (e.g., a trade association or a power company, under Internal Revenue Code Section 501(c)(6) and (12)).
Non-profit public benefit corporations
Nonprofit "public benefit" corporations are another possible option for organizations operating in California. Such corporations, while usually tax-exempt, face a number of legal constraints (found in both California corporate and federal income tax laws) under which most business-oriented organizations would not want to operate. Capital generation is a particularly salient problem, especially since assets and profits (if any) may not be distributed to members. Still, organizations formed for certain purposes (e.g., educational) possibly meeting tax-exempt criteria may find this "public benefit" status appealing. Because tax-exempt status is usually difficult for most "cooperatively"-run entities to achieve (since individual members instead of the public at large are the intended beneficiaries), nonprofit public benefit corporations are not emphasized in this publication.
Another important advantage for cooperatives is that no "permit" is needed from the California Department of Corporations for the sale of memberships or shares up to $300 per member (if certain legal requirements are met). Unlike nonprofit "mutual benefit" corporations, co-ops may issue unlimited shares of stock (or memberships) to any single member to help generate capital.
California and federal securities laws and regulations impact all the possible entity choices discussed here. Although co-ops incorporated under the California Consumer Cooperative Corporation Law generally have a "special" exemption (up to $300 in nondebt securities per member), securities issues are generally more related to the facts surrounding any particular offering. For smaller organizations, however, California securities regulations in particular have to be recognized and complied with. Other than some summary information provided elsewhere in this publication, securities issues are outside the scope of this discussion
What Is A Security?
A security is a financial instrument representing ownership, a debt agreement, or the rights to ownership. Examples include stocks, bonds, derivatives, and many other types of financial assets. You create a security when you ask people to put money into your business or venture, and you offer them a return. For example, a security could be:
- Selling stock in your business
- Asking people to lend money to your business
- Offering a share of your businessâ€™ profits
- Interests in limited liability companies
Most financing and fundraising options require compliance with securities laws. This is true when the funders are looking for a "return" on their investment.
It is important to know what is or is not a security because when you sell or even offer to sell a security, it needs to either:
- be registered with the U.S. Securities and Exchange Commission and with the state agency where you want to raise money (in California, state registration is called "qualification"); or
- qualify for an exemption from registration. Registration/qualification is an expensive, time-consuming process. If possible, your business should try to find an exemption, which is simpler and less expensive.
Ways to Raise Capital without Securities
Here are examples of ways to raise capital without securities that are well suited to cooperatives. These are copied from here.
- Member Capital Contributions
- If cooperative member will be participating in the management of the business, the membersâ€™ capital contributions are generally not considered a security.
- When people give money without the expectation of receiving anything in return, they are donating. Many entrepreneurs are using so-called crowdfunding websites such as Kickstarter.com and Indiegogo.com to raise money for various enterprises. Entrepreneurs that solicit donations often provide non-monetary rewards to donors.
- Micro Loans
- While traditional banking loans are sometimes difficult for cooperatives to obtain, an alternative is a micro loan. A micro loan is a small, low interest rate loan, supplied through various sources. . Typically, the organizations that provide micro loans are socially conscious about the difficulties that community entrepreneurs face when trying to secure financing. Two examples of micro lenders are Kiva Zip and Working Solutions
- If youâ€™re an existing business and want to expand your business, one possible way to raise funds is to pre-sell gift certificates. For example, you might sell a $150 gift certificate that a customer can redeem at your business, but only charge $100 for the gift certificate. Charging less than the value of the certificate gives the buyer an extra incentive to purchase the gift certificate.
- Loans with Return of Principle Only
- Return of principle only means giving back the money that the funder gave, and not offering a return on the investment. Not offering a return means that the business will not offer anything more than the original investment amount, such as an additional dividend, interest, or appreciation in value. It is important to note that, in California, this is likely considered to be a security, so you should proceed with caution and consult with a lawyer if you choose to utilize this funding method.
- Product Discounts
- Another way to raise capital for your business is to charge a membership fee and offer product discounts in exchange. REI provides an interesting model for product discounts funding. REI is a consumer cooperative that sells memberships to its customers. At the end of the year, REI members receive a "dividend" based on the amount spent at REI during the year. This "dividend" can then be used to shop at REI.
- One unique and sometimes unthought-of way to gain needed resources is to avoid money altogether for certain goods or services your business needs. Bartering, or exchanging services or goods directly, is a means of obtaining resources. If you need to raise money to pay for something such as web design or compostable cups, consider whether you might be able to barter your goods or services to get what you need. This is not a traditional means utilized by businesses when financing their business; however, it can be utilized as an alternative way to obtain much needed resources for your business. However, you should note that bartering may be subject to taxation.
The incorporators should decide on a name of the co-op, which must include the word "cooperative" and some word or abbreviation that will indicate that the co-op is a corporation (e.g., Inc., Incorporated, etc.).
(so we would be e.g: Sudo Room Cooperative Inc. but we don't need to use that name in anything but official tax/financial documents)
The incorporators should next decide who will comprise the initial board of directors. The initial directors, who may also be the incorporators, will serve until directors are elected by the members at the first annual meeting (or by written ballot). Either the articles of incorporation or the bylaws must set the number of directors, or a minimum (not less than three) and maximum number of directors, with the exact number to be fixed by the board or members in a manner provided in the bylaws. Generally, a cooperative should provide for an odd number of directors to help minimize the possibility of tie votes. The bylaws (or articles of incorporation) may set out the eligibility requirements for directors, and most cooperatives would probably want to require directors to be members of the co-op.
The incorporators should also consider who should be selected as the first officers of the co-op, since officers should be designated at the first meeting of the board of directors. The designation of the first corporate secretary is particularly important, since that officer is responsible for maintaining various corporate documents, records, minutes of corporate meetings, etc.
(As with other types of corporation, we need bylaws.)
The bylaws are perhaps the most important corporate document, and this publicationâ€™s sample bylaws and related discussions should be carefully reviewed. Many of the issues facing a newly forming co-op (e.g., membership qualifications, distributions, etc.) will be resolved in the bylaws. In reviewing bylaw issues, some groups decide that they do not want to operate in a co-op format, or in a corporate format. Thus, bylaws should be agreed upon beforeincorporation, wherever possible, to help ensure that a cooperative legal structure is consistent with the goals of the incorporators and that the co-op does not soon have to be "transformed" into another type of organization
Documents that must be given to new members.
It seems like we can set that each member can only own one share (one unit) and that we can set a permanent share price in the articles of incorporation that can only be altered by altering the articles. This is likely what we'd want. If the price is set below $300 for a share, then we don't need to worry about securities requirements.
"A cooperative is not required to issue any shares, or it may issue more than a single class of shares. When more than a single class of memberships or shares is issued, the complexity of either or both of the articles and bylaws, as well as the disclosure document, is increased" from http://www.cccd.coop/files/LegalSourcebookForCaliforniaCooperatives.pdf
The following records must be kept, by law:
- Board meeting minutes
- Accounting records (required for the financial reports)
- Membership records
First meeting of the board
A special "waiver of notice" must be signed by all board members for the first board meeting.
- A small filing fee for filing the articles of incorporation with the secretary of state.
- Other fees?
Articles of incorporation and bylaws
It turns out that almost all of the stuff e.g. Noisebridge has in their articles of incorporation can be put in their bylaws instead. This makes it easier (and cheaper) to change. We should decide if we want this.
The only info that needs to go in the articles of incorporation for e.g. a coop are:
- Article 1: The name of this Corporation is <somename>
- Article 2: This Corporation is a cooperative corporation organized under the California Consumer Cooperative Corporation Law. The purpose of this Corporation is to engage in any lawful act or activity for which a corporation may be organized under such law.
- Article 3. The name and address in the state of California of this Corporationâ€™s initial agent
for service of process is <somename> <someaddress>
- Article 4: The voting rights of each member of the Corporation are equal, and each member is entitled to one vote. The proprietary interests of each member of the Corporation are unequal, and the rules by which the proprietary interests are determined shall be prescribed in the Bylaws of the Corporation.
Article 5: The names and post office addresses of Directors who shall serve until the first annual meeting are: <names>
Examples of co-op bylaws/articles of incorporation
- Ukiah Natural Foods Coop
- Sample bylaws for California worker coop
- Sample legal documents for coops provided by Eddan
- Guide with complete set of sample documents
Power of directors
Comparing the power of directors between the different bylaws / articles of incorporation it is clear that mutual benefit, public benefit and cooperative corporations all have the same problem:
They have a board of directors.
The board of directors have decision-making powers and don't have to go through the members to make critical decision.
We could try to limit the power of the directors, and require member approval through some defined process, but we'd have to deal with the following issues:
- The directors still have a non-neglible amount of liability. Who wants to take on liability without power? That means the members technically can indebt a director (or worse) and the director could do nothing.
- It's not clear if it would be legal to limit director power.
- None of the bylaws / articles of incorporation I've read from other corporations have anything that limits director power. This may be a sign that it's not legal to do so.
It is not clear to me that a California Cooperative is in any way more democratic or non-hierarchical than the kind of structure that Noisebridge has. They both suffer the same flaw of having directors and both have the option for the same safety feature (the membership can remove directors with a vote). (Juul (talk))
This is in Texas, so their articles of incorporation and/or bylaws or not that interesting to us, except to say that they also have a defined hierarchical structure with the directors having ultimate power (link).
A cooperative can become a 501(c)3 provided that its articles of incorporation and bylaws are compatible.
"To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates."
"The organization must not be organized or operated for the benefit of private interests, and no part of a section 501(c)(3) organization's net earnings may inure to the benefit of any private shareholder or individual."
"501(c)(3) organizations are restricted in how much political and legislative (lobbying) activities they may conduct."
- from http://www.irs.gov/Charities-&-Non-Profits/Charitable-Organizations/Exemption-Requirements-Section-501%28c%29%283%29-Organizations
Here is an interview with Mitch Altman about 501(c)3 status.
"The exempt purposes set forth in section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals."