Applying USDA Programs to Assist Worker Ownership

Bruce J. ReynoldsUSDA/Rural Development/Cooperative Programs bruce.reynolds@wdc.usda.gov

2009 ACE InstituteMinneapolis, MNJuly 19, 2009

Presentation Topics:

1. Background on USDA programs of potential application to worker ownership

2. Business & Industry (B&I) loan guarantees for financing business conversions

3. Research programs – type-comparative topics:

– cooperative sustainability

Cooper worker cooperatives of Minneapolis, 1864-1929

● About 800 coopers, with the majority belonging to worker cooperatives, of which there were at least seven

● Richard T. Ely stated in 1887: “The Minneapolis coopers are of as much significance as the Rochdale pioneers….” (cited in Knapp, 1969)

A slight digression –

● A major U.S. worker cooperative sector, comparable to the Northwest plywood cooperatives in the latter part of the 20th century

Background of USDA Programs for Business Development

● 1913 – start of research programs on farmer cooperatives

● New Deal Era

● Post WW II - Farmers Home Administration –

- Farmer Cooperative Service

● 1960’s – rural development emphasis

● 1990’s establishment of Rural Development Mission Area: non-agricultural cooperatives Research on the Economic Impact of Cooperatives (REIC)

Research on the Economic Impact of Cooperatives

─ University of Wisconsin Center for Cooperatives, 2009

Survey data cover 2006-07

Business & Industry (B&I) loan guarantees for financing business conversions

● Loss of small businesses in rural America, as family owners retire without heirs willing to take over.

● Succession Planning

● Conversion to worker ownership, cooperative or ESOP

● Two conversions to 100% owned ESOPs in Pennsylvania with assistance of B&I loan guarantees.

Rural businesses in selected rangesof employment size, 2004

Employees 5 - 9 10 - 19 20 - 99 100 - 499 Row totals

West 19,492 11,612 11,306 5,628 48,038Central 37,003 21,472 22,188 11,923 92,586East 23,947 13,734 12,741 7,544 57,966

Rural U.S.* 80,442 46,818 46,235 25,095 198,590Source: Small Business Administration

* Total for selected ranges.

Limitations of the Current B&I Program

● Requirement that a guarantee completes the ownership conversion so that no proceeds from a loan would go to the “selling owners” who are still maintaining partial ownership during a transition period.

● “Complete-change-of-ownership” financing is more relevant for worker cooperatives than ESOPs wanting to do gradual 1042 rollovers.● An employee profit-sharing plan over prior years can reduce the size of loan for a complete conversion.

● B&I requirement of complete ownership conversion poses a problem for establishing a cooperative where original owners become short-term members while they share their know-how and have their equity redeemed.

Proposed New B&I Loan Guarantee Regulations

Federal Register, December 17, 2008 / Vol. 73, No. 243, p. 76788, 5001.103(c) Unauthorized projects and purposes.(4) Distribution or payment to an individual owner, partner, stockholder, or beneficiary of the borrower or the immediate family of such an individual when such individual will retain any portion of the ownership of the borrower, unless the Agency has determined that the distribution or payment is a part of the transfer of ownership within:(i) The immediate family; or(ii) An Employee owned Cooperative.

● Comments from the lenders were extremely negative on this provision.

Research programs type-comparative topics: Some general observations on sustainability

● Succession planning by family-owners is critical in rural communities to prevent businesses from buy-outs by competitors wanting to consolidate.

● Cooperatives, especially worker and farmer, have a “succession” (sustainability) challenge in how they manage the financing of operations and returns to members.

Problems for long-term sustainability of cooperatives:

● A “horizon problem” identified for the Yugoslav social or common property-type worker cooperatives. Members had no rights to retained earnings, and hence, lacked incentives to invest in projects with long-term benefits (Furubotn & Pejovich, 1970).

● U.S. agricultural economists, accountants, lawyers, applied the horizon problem to farmer cooperatives. These co-ops while paying patronage refunds, do not give members adequate property rights to be residual claimants for their contribution to the value of the enterprise, hence, diminishing their incentive to contribute investment for long-term gains.

● New Generation Cooperatives (NGCs)

● Some similarities in the use of transferable shares in the Northwest plywood cooperatives.

● Transferable shares reduces underinvestment problems but a 2nd problem emerges when transferring appreciated shares that have become unaffordable to new members.

● A 3rd problem is high percentages of unallocated retains invites investor ownership ─ a situation exacerbated by nonmembers, closed membership.

Solutions for long-term sustainability of cooperatives:

● A passion for building a business, a legacy, and succession without a hidden agenda for an exit strategy.

● Managing total equity with solvency targets (Barton) targeted limits on unallocated retains proportionality in ownership and redemption with base capital or percent-of-all equities

● ESOP member shares evaluation is similar to Fonterra’s handling of member, transferrable equity (the New Zealand Dairy Cooperative).

─ Diminish incentives for sell-outs with a rollover of payments for member contributions to the cooperative’s NAV (proposes a five year cycle).

─ When a member leaves, retires, or dies; membership rights terminate while NAV rights are claimed.

● Ellerman’s analysis of the Mondragon internal capital account:

─ Membership rights include voting and annual surplus dividend, while the other type of rights involve a gradual distribution of members’ contributions to the cooperative’s Net Asset Value (NAV), recorded in the internal capital account.

─ Financing the NAV allocations with external debt financing (perpetuities backed by cooperative banks, traded in mutual funds).

Selected References

Baarda, James R. 2006. Current Issues in Cooperative Finance and Governance. USDA/RD/Cooperative Programs.Baldwin, Sidney. 1968. Poverty and Politics: The Rise and Decline of the Farm Security Administration. Chapel Hill: University of North Carolina Press.Barton, David. 2004. A Comparison of Traditional and Newly Emerging Forms of Cooperative Capitalization. NCERA 210. www.agecon.k-state.edu/accc/ncera210/default.htm -------- 2008. 11th Annual Farmer Cooperative Conference. UWCC.Clawson, Marion. 1978. Resettlement Experience on Nine Selected Resettlement Projects. Agricultural History 52: 1-92.Ellerman, David P. 1990. The Democratic Worker-Owned Firm. London: Urwin Hyman Ltd.Furubotn, E. & Pejovich S. 1970. Property rights and the Behavior of the Firm in a Socialist State: The Example of Yugoslavia. Zeitschrift fur Nationalokonmoie. 30: 431-454.Knapp, Joseph G. 1969. The Rise of American Cooperative Enterprise: 1620-1920. Danville, IL: Interstate Publishers.---------- . 1973. The Advance of American Cooperative Enterprise: 1920-1945. Danville, IL: Interstate Publishers.Reynolds, Bruce. 2007. Worker-owned/ ESOPs can help preserve business in rural America. Rural Cooperatives. USDA/Rural Development. Sep/Oct: 28-31.-----------. 2009. Building a Bridge for Ownership Succession. Rural Cooperatives. USDA/Rural Development. Jan/Feb: 10-12. Shaw, Albert. 1888. Cooperation in a Western City. History of Cooperation in the United States. H.B. Adams (editor). Baltimore: John Hopkins University.