Understanding Cooperative Terminology

Phil Kenkel

Bill Fitzwater Cooperative Chair

Oklahoma State University

Terms Describing Structure

Centralized Associations: A regional cooperative where the producers are direct members.  Members in a centralized cooperative do business with a local branch which is controlled by the headquarters.

Closed Membership: A structure in which members can join only during the initial membership drive or by purchasing equity from another member.  In closed cooperative equity is often associated with a usage right which requires members to maintain ownership in proportion to use.  Many processing and value added cooperatives operate under the closed membership structure because it allocates capacity among members and ensures the adequate amount of initial investment.

Federated Cooperatives: A structure in which a number of autonomous local cooperatives own a regional cooperative.  Patrons do not hold direct memberships in federated cooperatives; instead the local cooperatives are members of federated cooperatives. Federated cooperatives are controlled entirely by the local associations who receive regional patronage.

Limited Cooperative Associations: A relatively new form of cooperative structure, enabled by separate legislation.  Allows for two classes of members: producer members receiving benefits in proportion to use and investor members receiving benefits in proportion to investment

Local Associations: Refers to a cooperative owned directly by producers operating in a limited geographical area. Historically, local cooperative were single locations but due to growth and mergers many local cooperatives are structured with headquarter location and numerous branches.  A multi-location local cooperative is technically a small centralized cooperative but the term “centralized” is seldom applied to local cooperatives.

Multi-stakeholder Cooperative: A cooperative form that allows for membership and governance by two or more stakeholder groups such as consumer members, producer members, worker members, or general community members.

Nonstock Cooperative: In a nonstock (membership) association, members have membership certificates, often showing that they paid a membership fee. Prior to the Capper Volstead Act of 1922 only agricultural organizations organized without capital stock were granted immunity from anti-trust legislation.  Most nonstock cooperatives are a holdover from that legal situation.

Open Membership: Refers to a structure where any person who meets the bylaw requirements for membership and purchases a share of membership equity can become a member at any time. Most farm supply and commodity marketing cooperatives are open membership

Regional Cooperative: A cooperative operating over a large geographical area.  Regional cooperatives may be structured as federated or centralized.  Regional cooperatives have historically provided economies of scale beyond what is achievable by the local cooperatives in activities such as fertilizer manufacturing, petroleum refining and grain export.

Stock Cooperative: In a stock cooperative, members own common or preferred stock in the cooperative. Most agricultural cooperatives operate as stock cooperatives.

Super Local Cooperatives: A term sometimes used to refer to local cooperatives which due to the number of branch locations and geographic area covered, rival the scale of some regional cooperatives.  Most super local cooperatives are centralized.

Worker Owned: A cooperative that is owned and governed by the firm’s workforce. Even though there is no universally accepted definition of a workers’ cooperative, they can be considered to be businesses that make a product, or offer a service, to sell for profit where the workers are members or worker-owners. Worker-owners work in the business, govern it and manage it. Ownership and decision-making power of a worker cooperative is vested solely with the worker-owners. Worker-owners control the resources of the cooperative and the work process, such as wages or hours of work.

Terms Related to Cooperative Principles

Democratic Control: Cooperatives are owned and controlled by their member-patrons rather than by the investing public. Most agricultural cooperatives operate under a one member-one vote system.  Voting can be proportional to patronage.  However, unlike an investor owned firm, voting rights are not linked to investment.

Duty to Education: Because cooperatives operate under a different financial model, members must understand how their cooperative works and the importance of their own patronage and support. Cooperative members, officers, employees and the general public should receive continuous education in the principles and techniques of cooperation.

ICA Principles:  Guidelines for how cooperatives should operate and put their values into practice developed by the International Cooperative Alliance and most recently revised in 1995.

1. Voluntary and Open Membership. …

2. Democratic Member Control. …

3. Member Economic Participation. …

4. Autonomy and Independence. …

5. Education, Training and Information. …

6. Co-operation among Co-operatives. …

7. Concern for Community

Limited Return on Equity Capital: Cooperatives are permitted under law to pay limited dividends, but their priority is to provide economic benefits to their members.  This is often referred to as “Subordination of capital”.  The Capper Volstead Act and some state statutes specially limit returns on equity to 8%.

Net Income Distributed as Patronage: A cooperative’s net profits usually called net savings, are returned to members in proportion to their use of the cooperative—that is, according to the amount they bought or sold to the cooperative.  The IRS uses the term “patronage dividend” but patronage refund is the preferred term since it is less likely to be confused with the concept of a stock dividend which distributes profits in proportion to ownership.

Rochdale: A set of principles established by a cooperative by a group of weavers, the Rochdale Pioneers in Rochdale England in 1844 in Rochdale, The Rochdale pioneers did not propose a set of principles. However, many years later their rules were studied by others and came to be called the Rochdale Principles. Because the rules evolved over time, they have been summarized differently into 6-12 principles which define how cooperatives ought to operate.  The most common summary is for 12 Rochdale Cooperative Principles:

1. Voting is by members on a democratic (one-member, one-vote) basis.

2. Membership is open.

3. Equity is provided by members.

4. Equity ownership share of individual members is limited.

5. Net income is distributed to members as patronage refunds on a cost basis.

6. Dividends on equity capital are limited.

7. Exchange of goods and services at market prices.

8. Duty to educate.

9. Cash trading only.

10. No unusual risk assumption.

11. Political and religious neutrality.

Terms Describing Non-Agricultural Cooperatives

Direct Charge Retail Cooperative: A closed membership cooperative where members pay a weekly or monthly fee to cover the fixed costs.  Because the fixed costs are covered the cooperative marks up items only enough to cover variable expenses resulting in lower than market prices.

Housing Cooperative: A type of consumer owned cooperative in which the member owns a share of the cooperative corporation with an associated right to occupy a dwelling unit.

Limited Equity Housing Cooperative: A cooperative where the bylaws limit the resale price of membership shares for the purpose of keeping the housing permanently affordable to incoming members.

Market Rate Housing Cooperative: A housing cooperative financed at market interest rates with no restrictions on membership share resale prices.

Terms Used to Classify Agricultural Cooperatives by Function Performed

Bargaining Association: Actually a sub-set of marketing cooperatives, a bargaining cooperative generally does not purchase members’ products but instead negotiates. price and terms of sale.  Many marketing cooperatives implement contracts with their members that cover a given season for specified products.

Marketing Agency in Common: A structure combining and coordinating the marketing activities of multiple cooperatives into a single entity.  Marketing Agencies in Common create scale economies in marketing activities and eliminates duplication of personnel.  A grain marketing alliance would be an example of a marketing agency in common.

Pooling Cooperative: A structure where the crop volumes from members are combined and marketed by the cooperative with each member receiving the average price for the pool for the quality delivered. Pooling cooperative often provide periodic payments in the form of per unit retains with the final payment, which some think of as a patronage refund, distributed when the pool is closed.

Marketing Cooperative: Usually markets member-patrons’ products by purchasing products outright, handling products on a separate account basis, functioning on a commission, bargaining with users for price and conditions of sale, and pooling products according to market preferences.

Service Cooperative: Provides members with services such as credit, insurance, irrigation, electricity, telephone, artificial breeding, cow testing and grazing.

Supply Cooperative: Provides farmer-members with the many inputs (seed, feed, fertilizer, chemicals, etc.) they need for their farming operations. These cooperatives are generally serviced by cooperative wholesalers that assemble the many production supplies and consumer items which the local supply cooperative distributes.

Terms Describing Cooperative Legal Structure

Articles of Incorporation: A set of formal documents filed with a government body to legally document the creation of a corporation. Articles of incorporation must contain pertinent information such as the firm’s name, street address, agent for service of process, and the amount and type of stock to be issued.

Bylaws: The document that serves as the governing body of the organization.  The bylaws can be thought of as the contract between the cooperative and the members.  Changes in the bylaws must typically be approved by the membership.

Board of Directors: A group of individuals elected by the members to act as representatives of the members to monitor the fiscal status of the cooperative, establish polices, formulate strategy and approve major financial commitments.  The number, terms and structure of the board of directors is generally specified in the Articles of Incorporation and/or bylaws.

Charter: In some states the Articles of Incorporation are referred to as the charter.  The term is also used to describe the enabling legislation under which cooperatives are incorporated in the particular state.

Cooperative Corporation: Most cooperatives are legally organized as corporations and are incorporated under separate statues from that of other corporations such as investor owned corporations or not for profit corporations.

Officers: Executive agents of the cooperative responsible for certain duties such as signing documents, keeping meeting minutes and providing notice of meeting.  Officers are generally members of the board of directors

Member: An individual who meets the cooperatives requirement for membership (which often requires the purchase of a share of membership stock) and has the right to vote.

Patron: A term used in a broad sense to refer to a customer or user of a cooperative and in a narrow sense to refer to a user of a cooperative who is eligible to receive a share of profits in the form of patronage refunds.  In most, but not all, cooperative a user must also be a member in order to receive patronage and be a patron.  The IRS code defines patron as: “any person with or for whom the cooperative association does business on a cooperative basis, whether a member or a nonmember of the cooperative

Terms in Cooperative Finance

Allocated Equity: Equity in the cooperative held in the names of specific members. Allocated equity would include membership stock, equity created from equity patronage refunds and preferred stock.

Allocated Patronage: The assignment of the member based earnings of a cooperative to individual members prior to returning the earnings as either a cash or stock patronage refund.

Capital: Durable or long-lasting inputs such as machines, buildings, equipment, land, and vehicles. Capital also means cash needed by the cooperative for day-to-day operations and for financing durable or long-lasting inputs.

Cash Patronage Refund: The net earnings of a cooperative allocated to members on the basis of use and distributed to the patrons in cash. If a cooperative issues a qualified stock patronage refund it must pay 20% of the total patronage refund in cash.  All cash refunds are allocated (assigned to specific members) and qualified (tax deductible to the cooperative and taxable to the member).

Equity Capital: The amount of funds contributed, directly and indirectly by the owners to partially fund the firm’s assets. Equity in a cooperative can be allocated and unallocated and can also be permanent or revolving.

Local Savings: The savings attributable to the individual cooperative before receiving patronage from regional cooperatives.

Margin also called Gross Margin: The income remaining after the cooperative pays for the commodities and inputs which are sold to create total revenue.  In accounting terms Revenue – Cost of Goods Sold = Gross Margin.  Because cooperatives often operate off of fixed per unit margins which do not vary as the commodity or input prices change, managers focus more on margin than on revenue.

Membership Fees: A form of equity capital. They are most common when cooperatives are organized on a nonstock basis, with payment of a membership fee being comparable to purchasing a share of voting stock.

Membership Stock (Voting Stock): Represents the initial investment by the prospective member as part of the membership application. Most cooperative bylaws require the member to hold one share of membership stock in order to have voting privileges. Membership stock is also a source of equity capital. Closed membership cooperatives often raise the majority of their equity through membership stock while the membership investment in open cooperatives may be nominal. Membership stock is typically non-revolving.

Net Savings also referred to as Net Profits:

The remaining revenues after all expenses have been deducted.

Non-cash Distribution also called a Non Cash Patronage Refund: The percentage of allocated patronage refunds distributed as either qualified or nonqualified equity.

Non-Qualified Retained Patronage: Also called nonqualified stock.  A distribution of patronage in a form which is not taxable to the member or tax deductible to the member until the equity is redeemed for cash.  When a cooperative distributes patronage in equity they are simultaneous issuing equity and retained that share of the profits in cash.  A nonqualified distribution can therefore also be thought of as a nonqualified retention although it is the after tax portion that is actually retained.

Patronage Refund: The proceeds of a cooperative (net margin) are returned to members in proportion to their use of the cooperative—that is, they bought or sold to the cooperative. Patron refunds can be paid in a combination of cash and stock.  The IRS uses the term “patronage dividend” but patronage refund is the preferred term since it is less likely to be confused with the concept of a stock dividend which distributes profits in proportion to ownership.

Preferred Stock: Cooperative preferred stock is non-voting, can typically be owned by members and nonmembers and may pay a dividend (often limited to 8%) which may be cumulative or noncumulative.  The term preferred comes from the fact that while the dividend is at the discretion of the board of directors, the cooperative cannot made patronage payments before paying the preferred stock dividend.  Preferred stockholders also have precedence over common stockholders if the cooperative is dissolved.

Per Unit Capital Retain: Equity created by an assessments on each unit of product handled.  Unlike retained patronage, per unit retains are not based on profitability of the cooperative but simply on the volume of commodity handled for the member. For that reason per unit retains are a stable source of equity.  Per unit retains can be in cash or equity.  A cooperative can distribute an equity per unit retain while deducting the amount from the commodity payment to crate equity.  Cash per unit retains are sometimes used to make partial payments for pooled commodities where the final pool price is not yet determined.  Per unit equity retains can be structured as qualified or nonqualified.
Qualified Retained Patronage: Also called qualified stock.  A distribution of patronage in the form of equity that is taxable to the member in the year it is issued and tax deductible to the cooperative in the year issued.  The term “qualified” refers to qualifying for that pass through taxation treatment.  When a cooperative distributes patronage in equity they are simultaneous issuing equity and retained that share of the profits in cash.  A qualified retention can therefore also be thought of as a qualified distribution.

Qualified Written Notice: A written notice which is required by the IRS when the cooperative makes a qualified distribution informing the patron of their allocation and its status as taxable income.

Revenue The funds received by the cooperative from sales, services and other business activities.

Stock Dividends: A distribution of profits based on the amount of equity owned.  In a cooperative dividends are more typical for preferred stock.    Dividends on cooperative stock are often legally limited to not exceed 8%.

Total Savings: Local savings plus savings plus patronage from regional cooperatives in most cases Total Savings is also Equivalent to Total Savings before Patronage and Taxes

Unallocated Retained Earnings: Also called unallocated equity.  Equity in the cooperative that is collectively owned by the members but is not held in specified as to ownership by individual members.  After a member exits the cooperative they lose claim to any interest in the unallocated retained earnings.  Cooperatives often retain nonmember profits as unallocated retained earnings and may or may not channel a portion of member profits to that equity category.  As the name implies unallocated retained earnings is not allocated and is non-revolving.

Written Notice of Allocation: Any capital stock, revolving fund certificate, retain certificate, certificate of indebtedness, letter of advice, or other written notice which discloses to the patron the stated dollar amount allocated to him on the cooperative’s books and which portion if any constitutes a patronage refund.

Terms Used in Discussing Cooperative Taxation

Exempt: Farmer cooperatives which qualify under Sec. 521 are known as “exempt” cooperatives. Like other cooperatives Section 521 cooperatives are only exempt from income taxes to the extent that they pass profits on to their members in the form of qualified patronage.  However they are corporate taxes on dividends paid on stock.  Section 521 cooperatives are required to pay patronage to both members and nonmembers but can also deduct both forms of patronage if it paid in a qualified form.

Non-exempt: Farmer cooperatives which do not qualify under Section 521 or who have not applied for exempt status are known as “non-exempt” cooperatives. They are subject to double taxation (i.e., taxation at both the co-op and patron level) on dividends paid on stock ownership.

Operating on a Cooperative Basis: The basic characteristics required by the Internal Revenue Service for a business to be qualify for tax treatment under Sub Chapter. In general, the firm must be must be democratically controlled by its members, the payment of dividends is restricted, and its net earnings are distributed or allocated to members on the basis of their patronage rather than their stock ownership.

Equal opportunity statement

Patronage Dividend: The term the Internal Revenue Service uses to describe a patronage refund, that is, a distribution of profits based on the amount of business volume with the cooperative

Qualifying Patronage Dividends: Patronage refunds paid in either cash or stock that are tax deductible to the cooperative and taxable income to the member in the year distributed.

Subchapter T: Tefers to Sections 1381 to 1388 of the U.S. Internal Revenue Code that contains most of the provisions for the taxation of businesses “operating on a cooperative basis” and their patrons. Both exempt and nonexempt cooperatives come under the general provisions of Subchapter T.  An important provision of Subchapter T is the ability for cooperatives to deduct profits distributed to their patrons and thus achieve pass through taxation. Subchapter T includes the rules for exempt Farmers Cooperatives organized Under Section 521