how cooperatives are changing the landscape of the new economy: what lawyers need to know

HOW COOPERATIVES ARE CHANGING

THE LANDSCAPE OF THE NEW

ECONOMY:

WHAT LAWYERS NEED TO KNOW

PROBLEM STATEMENT Oxfam: 85 richest people as wealthy as poorest half of the world

TONIGHT’S ROADMAP

Introductions and Expectations

Why coops

Examples of impacts of coops at different levels of society/economy- personal to systemic

Basic legal concepts with coops

Role Play

Discussion

WHY COOPERATIVES?

THE COOP PRINCIPLES

1. Voluntary and open membership

2. Democratic member control

3. Members’ economic participation

4. Autonomy and independence

5. Education, training and information

6. Cooperation among coops (inter-cooperation)

7. Concern for community

DISTINCTLY COOPERATIVE:

INDIVIDUAL IMPACT

DISTINCTLY COOPERATIVE:

REGIONAL IMPACT

DISTINCTLY COOPERATIVE:

REGIONAL IMPACT

DISTINCTLY COOPERATIVE:

REGIONAL IMPACT

DISTINCTLY COOPERATIVE:

SOCIAL IMPACT

ORGANIZATIONAL FORMS

Partnerships

General Corporations

Flexible Purpose or Benefit Corporations

Mutual Benefit Corporation

Nonprofit Public Benefit Corporations

_________________________________________

Limited Liability Companies

Corporations

ORGANIZATIONAL FORMS

Partnerships:

• Unlimited liability; Joint and several liability for actions of the partners

• May be a good option for startup, particularly for immigrant or low-income workers

• No $800 annual franchise tax

• Partners are not employees

Corporation

• “C”- Separate person for tax purposes

• “S” – No separate person for tax purposes

Benefit Corporation/Social Purpose Corporation

• Both provide protections for boards of directors to allow them to pursue non-shareholder profit maximization goals; accept tradeoffs that will lower shareholder value.

In CA, and many other states- co-ops are corporations

• Separate person for legal and tax purposes

• Membership structure

How Formed:

• Incorporator files Articles of Incorporation

• Prepare bylaws for cooperative and draft a membership certificate/ disclosure

document

• Hold first board meeting with at least three members

• Adopt bylaws

• Issue memberships to co-op members

COOPERATIVE CORPORATION

KEY GOVERNANCE REQUIREMENTS:

Board of Directors

Officers

Members

Annual Member Meeting

Elections for Board

Bylaws

One-member, one-vote required

CAPITAL STRUCTURE AND

TAX

Capital structure:

• Individual Member Capital Accounts

• Taxed at member level

• Collective Account

• Taxed at entity level

Can qualify for any corporate tax treatment: C, S or T.

Taxation: Subchapter T

• Profits- taxed at entity level (like a corporation)

• Surplus- taxed at member level (like an LLC)

• No self-employment tax on wages

• There may be a self-employment tax on patronage (i.e. surplus)- unresolved question

• In CA, annual minimum tax of $800

EMPLOYMENT LAW ISSUES

Presumption that worker-members are employees

• Must comply with employment law: minimum wage; overtime; workers’ comp; civil

rights, etc.

• Payroll withholding for wages

Can also have non-member employees

SOME ADVANTAGES OF THE

CORPORATE FORM OVER THE

LLC:

Can use the term “cooperative” in its name

Corporate taxation is more stable than partnership taxation

No $800 minimum franchise tax (CA) in first year

Securities exemption for coop memberships up to $300

THE LIMITED LIABILITY

COMPANY

WHY ARE LLCS SO POPULAR?

Flexibility

• Tax

• Employment

• Little formality required

What is an LLC?

• A limited liability entity, but not a separate tax payer

• Separating the incorporated form from tax characteristics

This allows you to have a general partnership, with limited liability, something you

couldn’t achieve with the corporate form.

What does this achieve for worker coops?

HOW FORMED

Similar to a corporation, file Articles of Organization

• Indicate whether the LLC is member-managed or manager-managed

• Note: Most worker coop LLCs are member-managed, not manager-managed

The Most Important Agreement in an LLC is the Operating Agreement

THE OPERATING AGREEMENT

DEFINES:

Purpose as a worker cooperative

Member Rights and Duties

How to become a member

How to leave the co-op

How to govern the coop

How to manage conflicts

What to with the member capital

How to make decisions in the coop

But the Operating Agreement can be amended!

EMPLOYMENT FLEXIBILITY

Worker members of an LLC are not presumed to be employees of it if they behave

as partners

• The test for partner is someone who has managerial control over the business and

their own work.

Implications for undocumented workers:

• IRCA/INA bans employers from “hiring for employment”

• An LLC is not an employer under IRCA, because partners are not hired for

employment

TAX FLEXIBILITY

LLC defaults to partnership taxation

• The basics are that the LLC is not a separate taxpayer, the partners pay the taxes

• This means that all of the LLC property and profits are allocated to the partners, and

the partners must report their allocations on their individual partnership returns

• Tax forms;

• Schedule K-1 – Partner’s Share of Income, Deductions, Credits

• Partners must pay self-employment taxes on their earnings

CAPITAL STRUCTURE

If partnership taxed, then:

It is not a corporation. There is no collective account, all earnings are allocated to

the member accounts.

• This can lead to instability in the co-op.

• Accounting/bookkeeping can be more complicated if you have a lot of members/or

members coming in and out

BUT AN LLC CAN ALSO ELECT

CORPORATE TAXATION

File form 8832

• Tells the IRS that your LLC wants to be taxed as a corporation

Why do this?

• Eligiblity for sub-chapter T treatment

• Ability to pay your worker-members as employees

• Members no longer pay self-employment taxes

• Ability to create a corporate account that is not allocated to the members

OTHER ISSUES:

Cannot use the word “cooperative” in its name

Can convert to a co-op or other corporation

LLC memberships are likely not considered securities if all members are actively

involved in the management (Cal Corps Code 25019, providing for definition of

“security”)

Conclusion: the 2 things to know about

cooperatives:1.Board elected on a one-member, one-vote basis.

Capital ownership doesn’t determine voting power.

2. Profits distributed on the basis of patronage.

Capital ownership doesn’t determine profit share.

GOVERNANCEA Few Things Everyone Should

Know About Governance

Whoa! It’s all about governance!

Every member has one vote…In the election of the board and major decisions

Power

Power

Cooperatives don’t have to be this:

Alvarado Street Bakery

Elects a Board

Arizmendi Bakery

is a Collective

Members

Board

Every Member

is on the

Board

Members

Board Every Member

is on the Board

Cooperative with a small

Board of Directors Collective

Officers don’t necessarily have more power than othersSecretary: Gives notices, tracks membership, keeps minutes, etc.

President: Signs official documents

Treasurer: Keeps accounts

The State of California wants

to know that SOMEONE is

doing this stuff.

Members Elect the Board on a One Member,

One Vote Basis

This means that co-ops

are ultimately

accountable to members,

even if members don’t

call the shots on a day to

day basis.

It helps to remember that there are different realms in

which people exercise control:

1. Worker Owners/Members: Elect the Governing Board and make certain

major decisions.

2. Governing Board: Appoints the Officers and managers; make high level

decisions that steer the company/organization toward its goals.

3. Officers: Corporations generally require President, Secretary, and

Treasurer. These are primarily administrative in nature, and have special

powers if you want them to.

4. Managers: Manage the day-to-day operations.

I’m going to work in an organization where

my voice matters, I have control over my

work, I can use my creativity, build

community, and have fun!

Everyone is behind

the wheel!

Beware of the

Tyranny of StructurelessnessI know

what we

should do!

Rex

Cooperatives often make the mistake of not adopting

clear governance procedures.

Need to be quite specific about stuff like:

•Procedures for meetings

•Procedures for making, reviewing, and adopting proposals

•Process for giving notice and creating agendas

•Spheres of decision-making, management, and operations

•Committees, Circles, Spheres, Managers, etc.

•Composition and election of governing bodies/committees, etc.

•Voting rights

•Procedures for amending governing documents

•Conflict of interest policies

Note that this stuff is partially dictated

by the statute that governs the entity.

Documents can’t look like this:

Give Governance Models Some Legal

TeethNeed to be quite specific about stuff like:

•Procedures for decision-making, AND

•Spheres of decision-making, management, and operations

•Committees, Circles, Spheres, Managers, etc.

•Composition and election of governing bodies/committees, etc.

•Place, time, process for meetings

•Process for giving notice and creating agendas

•Voting rights

•Procedures for amending governing documents

•Conflict of interest policies

Meetings can’t feel like hell.

Get trained. Learn the system. Practice

it. Grow to love it.

Some worker cooperatives are exploring

Holacracy (www.holacracy.org)

1. Distributing Governance Throughout the Organization, rather than

requiring that all decisions flow up the chain of command. Division of the organization into semi-

autonomous circles that are strategically interlocked to ensure communication flows up to a general

circle.

2. Roles: Each person in the organization

fills multiple roles and can move in

and out of the roles somewhat

flexibly, rather than filling a single

position with a single job

description. Within a role, people

have a lot of autonomy.

3. Accountabilities:Each role is accountable to a circle

of people - i.e., they report to that

group on how they are doing with

the tasks required of that role.

Role: Accountable to: Recycling Building Management Circle

Grant Writer Fundraising Circle

Cartoonist Communications Circle

Window Washer Building Management Circle

Legal Advice Legal Services Circle

Happy Hours Fun Circle

4. Highly Structured Meetings!

•Everyone Has a Voice: Most meetings are held by going in a series

of circles, which helps to ensure that everyone has a voice. Everyone

can bring a proposal.

• Keeps Personality Politics at Bay: The high level of structure

keeps personality politics from dominating organizational culture, and

keeps individuals from taking up too much space with too much

talking.

•Different Meeting Process for Different Types of Meetings:

Governance meetings, strategy meetings, and tactical meetings.

5. Proposals Move Things Forward!

• Anyone can bring a proposal. In fact, everything discussed in the context of a

governance meeting is discussed in the context of a proposal.

This allows everyone to follow their passions and inspirations, and also have a

voice in the direction of the organization.

• Proposals are adapted through a structured feedback process.

•Proposals are accepted if no one objects to the proposal on the basis that it moves

the organization backward in its mission or harms the organization.

• Accepted proposals can be revisited and adapted at any time. This allows the

organization to be nimble, experiment, shift course quickly, and adjust to small changes,

all while moving forward.

Let’s encourage hundreds of thousands

of existing businesses to sell to workers

and convert to cooperatives!

Because

GETTING THE GREEN I: BANK

LOANS AND MEMBER

CONTRIBUTIONS

SHOW ME THE MONEY!!

Businesses need money to operate, how do we get

some?

• Overview

• Traditional Businesses and Worker-Cooperatives

• Best Practices

• Alternative Sources of Funding

• Securities Law

TRADITIONAL BUSINESSES

A Traditional Business (non-cooperatively run)

• Typically, the owner would use person savings.

• Over time, the business owner may approach a bank or venture capitalist for additional

funding.

Personal Savings

Loan

Alternatives

Venture Capital

Successful Business

FINANCING A WORKER CO-OP

GENERALLY….

Member contributions/Outside Investors = Equity Financing

Loans = Debt Financing

Member Contributions/Outside

Investors

Loans

Alternative Financing

Successful Worker Cooperative

RAISING MONEY

LOANS – Traditional Lenders

• Banks want to see that you have enough money to cover your debt.

• Trend of Profitability

• Personal Guarantee

• Business Plan

• Size of the Loan

BEST PRACTICES

Preparation

Understanding their Perspective

Attention to Detail

Research

Follow-up/Keep at it!

ALTERNATIVE WAYS TO RAISE $$$

Membership Capital

Donations

Micro Loans

Pre-Selling

Bartering

QUICK

COMPARISONTraditional Sources (Banks and Credit Unions) Alternative Financing (microloans, for example)

Greater Funding

Potentially higher interest rates

May require 2 to 3 years of profitability

May require good credit, collateral, or equity

Less Funding

Potentially lower interest rates

May invest in startups

Credit, collateral, and equity requirements vary by

lender

GETTING THE GREEN II:

SECURITIES LAW

THINGS

TO KNOW

The definition

of security

You cannot

offer or sell a

security

without

registering it

…

… unless you

have an

exemption.

You create a security

when you ask people to

put money into your

business or venture,

and you offer them a

return.

BASIC DEFINITION

SECURITY

Walt Disney Stock Certificate (a security!)

WHY DOES SECURITIES LAW

MATTER

Offering or selling securities must be

registered with the proper authorities

Even ASKING people to invest in

your business could be illegal, unless

you register that security.

SO WHAT ARE YOU DOING THAT IS CREATING

SECURITIES?

Selling Stock

Asking people

to invest money

in your

business

Offering a

share of your

business’s

profits

Member

capital buy-in

HERE ARE A FEW

EXEMPTIONS TO

HELP YOU OUT!

CA LIMITED OFFERING EXEMPTION § 25102(F)

In California

Up to 35 lenders or investors

People with whom you have a

pre-existing relationship

No Advertising

Simple online filing with the CA

Department of Business

Oversight

UNLIMITED # OF ACCREDITED

INVESTORS

Really rich people Directors and Officers

CA COOPERATIVE EQUITY EXEMPTION §25100(R)

A California cooperative can

raise up to $300 from each

member without that

qualifying as a security

Each person must be a

member and have voting

rights

Can’t use a promoter

CROWDFUNDING

CROWDFUNDING

THE CROWDFUND ACT

PROPOSED EXEMPTION

• You can raise up to $1,000,000

• You can invest the larger of $2,000 or 5% of annual income/net

worth

DIRECT PUBLIC OFFERINGS

Can publically advertise

investment opportunities to

the public

Can DIRECTLY sell securities

without a 3rd party intermediary

TO REVIEW!

1. Raising money from friends and family? Use a limited offering.

2. Raising money from directors, officers, managing members, or Mitt Romney? Think accredited investors.

3. Raising $300 from all your voting co-op members? Try the cooperative exemption.

4. Using the internet to raise little bits of money from lots of people? Might use crowdfundingin the future.

5. Don’t fit into an exemption? Don’t forget DPOs.

OUTSIDE INVESTING VS. COOPERATIVE PRINCIPLES

CASE STUDY: EQUAL

EXCHANGE CD

Certificate of Deposits pooled together to guarantee loans to buy coffee, tea, and cocoa from farmer cooperatives at fair prices

Control preserved

Profit returns limited to the interest rate of CD

SECURITIES LAW REVIEW!

1. A security is created when you offer a return when you ask people for money for your business

2. When offering or selling securities, you must register the security unless…

3. There are several exemptions that worker-owned cooperatives can take advantage of to avoid registration of securities.

USE THEM!!