Governance and Outside Equity Issues Facing Cooperatives

Agricultural and Food Cooperatives in Rural Development: Implications of Business

Dynamics for the Public Policy

Michael Boland, PhD

Arthur Capper Cooperative Center

Department of Agricultural Economics

Kansas State University

Motivation

• Capper-Volstead Act has served cooperatives well

• Cooperatives used internal earnings to finance growth and revolve allocated equity to members.

• In recent years, this has been insufficient to finance growth due to low profitability and aging membership.

• Outside equity is needed to finance this growth.

Objective

• The objective is to provide examples of well known cooperatives that have changed organizational structure in recent years in an effort to seek outside equity.

Ownership Rights in Co-ops

• Traditional cooperative had these ownership rights– Restricted to producer-members– Residual rights are nontransferable, nonappreciable,

and redeemable– Benefits based on patronage

• Linked to principles of cooperation – Democratic control– Earnings based on patronage– Members provided the equity

Ownership Rights

Restricted to

Member-Patrons

Redeemable

Benefits to

Patrons

Non-Proportional

Member Investm

entTraditional Cooperatives

Proportional Member Investment

Benefits to InvestorsNon-Redeemable

and Transferable

Proportional Investment Cooperatives

Member-Investor Cooperatives

New Generation Cooperatives

Not Restricted to

Member-Patrons

Conversion

Non-Conversion Outside Equity Not in Cooperative

Investor-Oriented Firms

Cooperatives with Capital Seeking Companies

Publicly-Traded Common Stock

Investor-Share Cooperatives

Outside Equity in Cooperative

Source: Chaddad and Cook

Ownership Rights:Restricted to Member-Patrons

• Proportional investment cooperative– Base capital plan which requires members to invest in

proportion to patronage (DFA, Land O’Lakes, CoBank)

• Member investor cooperative– Earnings allocated in proportion to patronage and

equity investment (Fonterra)

• New generation cooperative– Investment equity is aligned with delivery rights (sugar

beet cooperatives, others)

Ownership Rights:Not Restricted to Member-Patrons

• Ownership rights are assigned to investor-oriented firms through – Strategic alliances

• Birds Eye Foods has 59% of its equity owned by Vestar Capital and management

– Trust Funds• Diamond of California formed a limited partnership with an

insurance company

– Subsidiaries• DFA uses a holding company to establish joint ventures

Ownership Rights:Not Restricted to Member-Patrons

• Ownership rights are assigned to investor class of membership– CHS and CoBank have issued preferred stock

Ownership Rights:Not Restricted to Member-Patrons

• Cooperatives demutualize or convert to investor-oriented firms– Public corporations

• Dakota Growers Pasta Company• Calavo Growers

– Limited Liability Companies• South Dakota Soybean Processors • Tall Corn Ethanol Cooperative• Dakota Ethanol• Others have started the process

Outside Equityholders

• Venture capitalists

• Preferred stockholders

• Technology providers

• Local community investors

• Cooperative that supplies commodity

• Others

Public Policy Issue

• Definition of what a cooperative is– Investor and producer classes of membership

• Limited return on membership capital

– 50% of the voting control in hands of producer class

– Different states are redefining what a co-op is– Implications for lenders such as CoBank

Future Issues

• Need for outside equity will continue to grow

• Business model must be sound

• Illiquid and nontransferable equity is an issue– Need for freely traded ownership interests