What’s a cooperative?

There are a lot of different models available to people to set up their businesses, but one of the most underused is the cooperative model. Frankly, I find it odd that so few startups consider using a co-op, given the shift towards people-centric companies, corporate social responsibility, social enterprise, crowdfunding, and the sharing economy. In many ways, co-ops are ideal for these types of ventures, since the primary aim of a cooperative is to benefit its members. It’s up to the members to decide what “benefit” means, so co-ops are often about more than just maximizing profits.

Perhaps unfamiliarity breeds avoidance. The co-operative corporation is an odd beast, and far less common than corporations, partnerships, and proprietorships. A lot of folks don’t even know the co-op exists as an option. Hell, a lot of business lawyers I know have never touched the things, and just gloss it over in the “other” category when talking about business structures. Its weirdness makes it difficult to understand. Co-ops are a mash-up of business and not-for-profit corporations, with partnership-esque decision-making, which are sort of public companies, and report to a separate branch of government than every other business in Ontario.

the-people-dont-know-their-true-power-tc-cartoon-sad-hill-newsIt’s high time we blew the dust off the ol’ girl, and maybe you won’t think co-ops are so weird and scary after all. You might even start to think that your business would do well as a co-op, in which case, we should talk.

There are a LOT of possible variations in co-ops, so I’ll stick to the basics in this article. The goal is to give you an idea of the broad strokes, and I’ll leave the details for later articles. I’m going to talk about:

  • What a co-op is
  • Advantages and disadvantages
  • Types of ownership
  • Types of co-op
  • The basics of financing a co-op, and
  • The basics of decision making

So what is a Co-op Anyway?

Co-operatives are democratically-run businesses governed by those who use their services – their members. Co-ops generally rely on member participation to make the wheels turn. Members pool their money, goods, or services, have a say in decision making, and share in the profits or losses of the co-op’s business. Members can be human people, corporations, and not-for-profits.

cooperative-movementAs we’ll see below, a co-op can be set up with shares, like a business corporation; or without, like a not-for-profit. Co-ops with shares can sell them to members and the general public to raise capital. Co-ops without shares may operate as not-for-profits, and apply for charitable status.

Decision making is one-member, one-vote, so each member has an equal say. Members can be broken down to stakeholder groups, where each group’s votes may be weighted differently, kind of like in a partnership.

Once they reach 35 shareholders or lenders, co-ops become somewhat like a public company, and have to distribute information about the business and its finances to potential investors. The annual financial statements of a co-op must be audited, to ensure that the co-ops accountants are preparing the statements by accounting norms. Ontario co-ops are regulated by the Financial Services Commission of Ontario, rather than the Companies Branch

Advantages

  • Egalitarian – while corporations can allow their stakeholders to participate in ownership through stock option plans and the like, such plans are often carefully controlled to prevent those stakeholders from controlling the company.
  • Democratic – each member has an equal say.
  • Cheaper to set up and run than stock option plans or large partnerships – though the rules governing co-ops can be a bit tedious, many of the rights and responsibilities are written in the law, rather than being custom creations
  • Shared resources – members can get access to more and better equipment or facilities, increased negotiating power when buying/selling, shared marketing costs, etc.
  • Networking and education – members have access to people who face similar challenges, and make contacts up and down the supply chain.
  • Limited liability – a co-op is a “person” in the eyes of the law, which takes on its own liability. Members and shareholders personal assets are protected, and they only stand to lose what they invested.
  • Flexibility – co-ops have a huge array of options on goals, structure, financing, decision-making, and services.
  • Double or triple bottom line – benefits to the members aren’t limited to a share of the profits.

Disadvantages

  • Startup costs – are typically higher than for simple incorporations or partnerships. It takes more legal and accounting work to get ’em off the ground.
  • Offering statements are required to raise money – which takes time and money to prepare, and there are ongoing disclosure requirements.
  • Annual financial statements must be audited – which adds an extra annual operating expense.
  • Decision making can be slow and difficult – especially when there are a lot of members, or stakeholder groups with different interests. Think of how much of a pain in the ass the membership meetings of a condominium can be…
  • Unfamiliarity – because there are relatively few co-ops, compared to other business forms, government and foreign entities may have a hard time wrapping their heads around how to deal with you.

Membership Shares, or Members?

You have two options when incorporating a co-op – ownership through shares, similar to a regular ol’ corporation – or control by members, similar to a not-for-profit corporation. Choosing between the two usually comes down to two things:

  • Whether the co-op’s purpose is to operate like a business and turn a profit, or to provide a service on a break-even or non-profit basis; and
  • How much capital is needed to get started and run the co-op. The greater the need for capital, the more likely it is you’ll lean towards shares.

Consult with your lawyer and accountant before choosing which way you’ll go.

Shares

Shares are just a bunch of rights in the co-op. Most of these rights centre on control (voting), profits (dividends), and ownership (right to a share of the net profit if the business is sold or wound up). Every co-op with share capital must issue at least one type of “membership shares”. Each membership shareholder gets one vote at members’ meetings to do things like electing the directors, setting the rules (bylaws) of the co-op, choosing an auditor, approving annual financial statements, and major business decisions like selling or dissolving the co-op. Different types or membership shares may have slightly different rights.

You also have the option of creating and selling different types of “preference shares” to raise money. Like a regular business corporation, you can get pretty creative with the rights that the preference shareholders have, like priority on dividends, to be bought out or redeemed, to be paid part of the proceeds of liquidation, to receive information, and to receive a portion of the net profits of the co-op each year as a patronage return.

Members

For co-ops without share capital, there are only members, who fill much the same role as membership shareholders, above. The biggest consequence of this type of co-op is that its only financing options are membership fees, loans from members to the co-op, and loans or other debt from outside sources.

Multi-Stakeholder Co-ops

In these bad boys, members are organized into stakeholder groups, depending on what they contribute to the co-op. Each stakeholder group has certain rights as a group, such as appointing directors to the board, or to receive a lower or higher share of the co-op’s profits.

Types

There are four basic types of co-op in Ontario

  • Worker-owned

    Exactly what it sounds like. Only workers can be members of the co-op, and at least 75% of employees of the co-op must be members. An example would be Toronto’s Co-op Cabs, where each taxi license holder is a member of the co-op, and gets a share of the net profits of the company rather than revenues from their specific cab.

  • Consumer

    Businesses, often in retail, which are owned by their customers for their mutual benefit. Resources are pooled to buy in bulk, then the savings are passed on to the members. The most common are credit unions, green energy, insurance, and grocery stores. I’ll lump housing co-ops in here too.

  • Producer

    Producers of a certain product, or a certain category of goods band together to share common expenses like warehousing, equipment, shipping, and marketing. Most people have seen farmers’ co-ops, which often have warehousing and large equipment, as well as buying farm supplies in bulk. Producer co-ops could work for any business from lumber, to crafts, to booze.

  • Multi-stakeholder

    Here, many different groups of interests recognize that they’re all in the same boat, and band together for common gain. These groups could include workers, producers, service providers, consumers, and supporters of a certain cause. Health care and social services are common areas for this form. There’s a big push towards sustainable food co-ops right now, bringing together farmers, land owners, seed banks, grocers, and restauranteurs.

Dolla Dolla Bills Y’all

A co-op model can allow a business to take a fundamentally different path than a regular corporation. The directors of corporations are voted in by shareholders to maximize the value of the shares. Co-ops exist for the benefit of their members, which can far broader than simple monetary gain. That’s not to say that a co-op can’t turn a profit. It’s just up to the members as to how far up the priority list profit falls. The rules on how money comes into and flows out of a co-op are different than regular corporations too.

Money In

Besides profits from the sale of goods, the most common fundraising method is membership fees – an annual fee that members must pay to stay members. In most cases, this isn’t a large sum. Co-ops can also charge fees for use to members or the public – like an hourly rate for use of equipment and facilities, or for sales leads they generate for their members.

money83

Debt Financing

As with any business, a co-op can borrow money, known as debt financing, from a variety of sources. Co-ops can, and often do, require their members to loan money to the co-op, which is common in agricultural co-ops where production is cyclical. They need the cash up front to float the year’s operations, and the loans are paid back when the harvest comes in. They can force members to re-invest profits earned from the previous year as member loans as well.

Co-ops can borrow from banks, government, and other private lenders, same as any other business. They can also apply for government grant funding.

Equity Financing

Co-ops with share capital can raise money by selling preference shares. The magic number is 35, meaning that if there will be 35 or more people who own securities (shares and debt) when the sale is done, the co-op has to file an “offering statement” with the Financial Services Commission. This is similar to, but less demanding than, what a corporation must do before “going public”. The goal of the offering statement is to ensure that the investors know what they’re investing in. The exact requirements vary depending on the co-op, but the result must be a full, true, and plain disclosure which answers any reasonable question an investor may have. There are a few exceptions which mean you don’t have to file one for small numbers of investors, and small amounts raised.

Money Out

Aside from paying operating costs, wages, tax, and debt, there are rules about how the profits of the co-op are paid out. What’s left after operating expenses are paid, but before tax, is called the “surplus”.

A co-op can set aside some or all of its surplus to create a “reserve fund” of retained earnings for its future expenses, and it can pay out the surplus through dividends and patronage returns.

Dividends

Dividends are paid out of a co-op’s after tax income. The member or shareholder is taxed on the dividend (not as regular income), meaning some tax credits are available to them.

The maximum dividend allowed on membership shares is the prime lending rate +2% per year. There’s no cap on dividends to preference shareholders, so the rate of dividend is what’s set out in the Articles of the co-op.

Dividends may be paid in more shares of the co-op as well, which allows the business to reinvest the profits, and increase the equity holdings of the shareholders.

Patronage Return

This posh sounding term is the profit share a member is entitled to based on how much business they’ve done with the co-op. This is the main way in which members receive their profits. Patronage returns are paid out of the pre-tax income of the co-op, and are taxed as income for the member.

Different rules apply to different types of co-op, but the way patronage returns are calculated is set out in the bylaws. Worker co-ops, for example, pay patronage returns based on hours worked, or total compensation paid each year. Producer co-ops may account for the relative profits earned from different products contributed to the co-op (a ton of strawberries may turn a higher profit margin than a ton of potatoes. No offence to potatoes.)

Non-members may also be paid a patronage return, so long as the return for non-members is the same or less than what’s paid to members.

Decision Making

As with a corporation, co-ops have three levels of decision-making – members, directors, and officers.

Members

Each member, or membership shareholder, has one vote at meetings of the members. Members have to attend a meeting in order to vote – they can’t send a proxy to vote in their place.

Most votes are decided by a simple majority of votes, after a resolution has been discussed. The key decision members are called upon to make is to elect the board of directors, or removing them if need be. They also approve audited financial statements, and vote on resolutions proposed by members.

Members have a say in other major decisions, which require a 2/3 majority to pass. These include changing the articles of the co-op, adopting new bylaws, and approving the sale or merger of the co-op.

5% of members can call a meeting, or propose member resolutions. 10% of members can force a directors’ meeting to pass a new bylaw or resolution.

Directors

Elected by the members, the directors have a fiduciary duty to run the co-op in the best interests of the members. All directors must be members of the co-op, and there must be at least three directors on the board. The board is responsible to set the strategic direction of the co-op, and appoint the officers to manage its day-to-day affairs. They vote on things like approving new members, budgets, major contracts, and expansion plans.

Officers

Appointed by the directors, officers oversee operations, and supervise the lower-levels of leadership. Officers are employees of the co-op, and except for the President and chair of the board, they don’t have to be members. The duties of the different offices are listed in the Cooperative Corporations Act. Most co-ops will delegate a certain amount of decision-making power to officers, such as the ability to sign contracts up to a certain amount, to hire and fire employees, and to do the co-op’s banking.

Conclusion

So, there you have it, co-ops in a nutshell. This is by no means a complete guide to co-ops in Ontario, but I hope it proves to be a useful starting point. If you’re looking at starting a business or non-profit, take a good, give co-ops due consideration.

There are a ton of good resources out there for information gathering, including a whole series of guides from the FSCO, and the Ontario Co-operative Association that can help you to get started.

As always, I’m happy to help you birth your cooperative business baby. Reach out.

 

Mike Hook
Intrepid Lawyer
mike@intrepidlaw.ca
@MikeHookLaw

Advertisements

Crowdfunding in Ontario

On May 8, 2014, I presented a webinar for http://www.SmallBusinessSolver.com on the legal ins and outs of crowdfunding in Ontario.

Crowdfunding is a game changer for small business finance. Between $3-5 billion has been raised in crowdfunding efforts worldwide, through over 300 portals. 45 of those portals are available to Canadians. Traditional crowdfunding works by donation or reward.

The latest and greatest is that crowdfunding will soon be available in Ontario to sell equity to the general public. This is going to make selling equity less expensive and simpler to do.

Enjoy!

Selling Shares through Crowdfunding

One of the most important recent developments in financing for small businesses has been the rise of crowdfunding. Crowdfunding is when a bunch of people make small investments in a company through a crowdfunding portal (such as Kickstarter or Indiegogo), in exchange for some sort of reward, like an amount of the product the company makes. The pooled money is used to grow the business. Unfortunately, selling shares – aka “equity” or stock – through crowdfunding has been, and still is mostly illegal in Ontario.

Most small companies are “private issuers”, and “non-reporting companies” – which means that they can’t sell shares to the general public – including crowdfunding. To sell equity to the general public, the corporation has to jump through a whole bunch of regulatory hoops, and make detailed disclosure documents available to investors. Disclosure typically includes an offering memorandum or prospectus, and audited financial statements – which are time consuming and expensive to prepare. There are strict rules about the type and size of offering, what kinds of disclosure must be prepared for prospective shareholders, and who can participate in the offering. All of that, however, is about to change.

The Ontario Securities Commission (“OSC”), the watchdog that regulates the public trade of shares of companies, has just released its proposed rules for a “Crowdfunding Exemption”. They hope to allow small companies to raise capital through crowdfunding without saddling small businesses with expensive disclosure and reporting requirements. The tough part is how to protect investors, and make sure they get enough information to make an informed decision on whether or not to invest.

The Crowdfunding Exemption tries to strike this balance by requiring some limited disclosure from the issuing companies issuing the shares, placing strict regulations on crowdfunding portals, and limiting how much individual investors can contribute. A few of the highlights:

Requirements of Issuing Companies

  • May only raise $1.5 million through crowdsourcing in a calendar year
  • Must be a Canadian company, with its head office in Canada, and a majority of its directors must be resident Canadians
  • May be a public or private company
  • Must disclose the minimum offering amount, and whether or not there is a maximum
  • Offerings must be completed within 90 days
  • Must meet the minimum offering amount, and have the resources to execute its business plan in order to be successful
  • Equity may only be issued in the form of common shares, non-convertible preferred shares, non-convertible debt securities linked only to fixed or floating interest rates, securities convertible into common shares, units of a limited partnership, and flow-through shares under the Income Tax Act
  • May only advertise through a crowdfunding portal, its own website and social media , or with limited marketing materials.

Investor Protection

  • Maximum of $2,500 per investment, and $10,000 per calendar year, per investor
  • At the time of investment, the company must provide an outline of basic information about the company, the fundraising platform, and one year of financial statements
  • Investors must sign an acknowledgement of risk, confirming investment eligibility, and consenting to the possibility that they may lose the entire investment
  • Investors have a two day “cooling off period” to cancel the investment, in case of buyer’s remorse
  • Issuing company must continuously disclose its cash and annual financial statements, and maintain accurate records of the use of crowdfunded money
  • Four month ban on re-selling the shares of a public company, and an indefinite freeze on resale of shares of non-reporting issuers

Crowdfunding Portals

  • Must be registered with the OSC as a restricted dealer, similar to registering as a securities dealer
  • Must do background checks on issuing companies, and their directors, officers, promoters, and control persons
  • Must understand the general structure, features, and risks of securities offered, review and vet information to ensure compliance with the OSC rules, prevent fraud, and provide investor education materials
  • Can’t provide any investment recommendations or endorsements, solicit purchases or sales of securities on behalf of a client of their platform, or invest in or underwrite any issuing company

The OSC proposed rules are open for comment from investors, issuers, and portals until June 18, 2014. It’s expected that the comments will be considered, the rules tweaked, and the Crowdfunding Exemption will come into force shortly afterwards. The most vocal feedback so far has been that the limits on individual investors are too low, and the startup costs for portals to register are too high, and will make it more expensive for their clients. Regardless of the tweaks, equity crowdfunding will be a revolution in small business financing that will make big money available to companies that never would’ve been able to afford to access it before.

If you’re having trouble sleeping at night, you can find a full version of the OSC’s proposed changes as part of the jauntily titled “Introduction of Proposed Prospectus Exemptions and Proposed Reports of Exempt Distribution in Ontario” – at Appendix D – Pages 131-224. It’ll put you right out, I promise.

 

Why does my corporation need a minute book?

In the hustle and bustle of running your business, record keeping often falls by the wayside. Most small business owners put corporate record keeping somewhere below “eating gravel” on their to-do list. The corporation’s minute book is often never even created in the first place, let alone kept up to date, even though the consequences of failing maintain one can be severe, and incredibly expensive.

Why do I have to?

Incorporating brings a lot of benefits – limited liability and tax being the biggest – but also comes with increased responsibility. The government has said, through the laws it has passed, that if you want the good stuff you’ve got to deal with the additional administration that comes with it. Whether you incorporated federally, or in Ontario, you must prepare and maintain corporate records. Trust me, it’s worth a little hassle and expense now to avoid greater hassle and expense later.

So what if I don’t?

Worst case scenario, your corporation could be found guilty of an offence under corporate law, and liable for a fine of up to $25,000.

Aside from the official penalty, there’s a great deal of business risk involved if your books are non-existent or out of date. I’ve often found myself playing CSI: Minute Book, going back several years to piece together the company’s history. It can take a fair bit of time and money to get it all figured out – neither of which small businesses have in spades.

There are a few common situations where your minute book will be in demand:

  • If you’re selling part or all of your company, the buyer will want to see the books as part of their due diligence – so they know exactly what they’re buying. Poor record keeping can drive the purchase price down, and the delay to get your books in order could put the whole sale at risk.
  • Most banks and other lenders will want to see your minute book before lending money to your business. They want to know that its affairs are in order, and the people they’re dealing with are authorized to act for the corporation.
  • Your accountant may want to see the minute book in preparing its tax returns. Without it, she’ll be forced to make assumptions on how to characterize the income, and may end up mis-reporting.
  • The Customs and Revenue Agency is entitled to inspect your books, and may do so as part of an audit of your personal taxes or the corporation’s taxes. This is more common if you’re paying yourself by dividends, or you’ve lent money to the company. The CRA could characterize money coming to you as personal income, tax the hell out of it AND deny the corporation the right to deduct it as an expense. Talk about lose-lose…
  • Shareholders, as owners of the company, have a legal right to inspect the minute book to know what decisions are being made.

OK then, what is it?

A minute book is really just a binder that holds the important documents of your corporation.

If a lawyer incorporated your business, they probably provided you with a minute book to start. If not, then you’ll have to prepare one yourself, including:

  • Certificate of Incorporation;
  • Articles of Incorporation;
  • By-Laws;
  • Consents to Act as Directors;
  • Director and shareholder resolutions
  • Minutes of director and shareholder seetings;
  • Registers of  the officers and directors;
  • Register showing the number of shares issued of each class of shares;
  • Record of the debt obligations of the corporation;
  • Stated Capital – the number of issued and outstanding shares;
  • Documents filed with government departments;
  • Share certificates, if used; and
  • The corporate seal, if used.

Then you’ve got to maintain the minute book, by keeping it up to date as the corporation does its business, including:

  • Resolutions from the annual meetings of shareholders and directors;
    • Electing directors each year;
    • Appointing accountants or auditors for each year;
    • Approving financial statements;
  • Records of loans to or from shareholders
  • Declared dividends;
  • Management bonuses paid;
  • Issuance or transfer of shares;
  • Changes in directors or officers;
  • Changes to how the corporation is run;

Can’t you just do it for me?

What’s tedious and boring to you is an adrenaline-fuelled rollercoaster ride of awesomeness for me. OK, maybe that’s a little extreme, but I’m happy to take the tedium off of your hands.  I can’t emphasize enough that it’s far far far far cheaper, easier, and less stressful to stay on top of this stuff than it is to go back and piece it together in an emergency – like when an investor or potential buyer wants to inspect your books.

Some clients like me to hang on to the record book and keep it updated when things change.  Others want to keep it themselves, and have me send them the updates when they make changes. Either way, this is one of those things that you shouldn’t waste your time doing…

Hey, you just read this blog,
and this is crazy,
but here’s my website,
so call me, maybe.

Mike Hook
Intrepid Lawyer
http://intrepidlaw.ca
@MikeHookLaw