Start Up Tip: Forming a Cooperative

A cooperative is a business or organization that is owned and operated for the benefit of those using its services. Profits and earnings generated are distributed among the cooperative members, who are known as user-owners. An elected board of directors typically runs the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative through purchasing shares, although the amount of shares members hold does not affect the weight of their individual votes. Cooperatives are commonly found in healthcare, retail, agriculture, art and restaurant industries.

Forming a Cooperative

Forming a cooperative is different from forming any other business entity. To start, a group of potential members must agree on a common need and a strategy on how to meet that need. An organizing committee then conducts exploratory meetings, surveys, and cost and feasibility analyses before every member agrees with the business plan. Not all cooperatives are incorporated, although many choose to do so. If you decide to incorporate your cooperative, you must complete the following steps:

• File Articles of Incorporation. The articles of incorporation legitimizes your cooperative and includes information such as the name of the cooperative, the business location, purpose, duration of existence, and names of the incorporators, and capital structure. Once the charter members (or the incorporators) file with your state business entity registration office and the articles are approved, you should create bylaws for your cooperative.

• Create Bylaws. While the law does not require bylaws, they do need to comply with state law and are essential to the success of your cooperative. Bylaws list membership requirements, duties, responsibilities and other operational procedures that allow the cooperative to run smoothly. According to most state laws, the majority of your members must adopt articles of incorporation and bylaws. Consult an attorney to verify that your bylaws comply with state laws.

• Create a Membership Application. To recruit members and legally verify that they are part of the cooperative, you must create and issue a membership application. Membership applications include names, signatures from the board of directors, and member rights and benefits.

• Conduct a Charter Member Meeting and Elect Directors. During this meeting, charter members discuss and amend the proposed bylaws. By the end, all of the charter members should vote to adopt the bylaws. If the board of directors were not named in the articles of incorporation, you must designate them during the charter meeting.

• Obtain Licenses and Permits. You must obtain relevant business licenses and permits. Regulations vary by industry, state and locality. Use the Licensing and Permits Tool on the Small Business Administration website to find a list of federal, state and local permits, licenses and registrations you’ll need to run a business.

Cooperative Taxes

A cooperative operates as a corporation and receives a “pass-through” designation from the IRS. More specifically, coops do not pay federal income taxes as a business entity. Rather, the coop members pay federal taxes when they file their personal income tax, paying federal and state incomes tax on the margins earned by the cooperative, with the amount of taxation varying slightly by state. Coops must follow the rules and regulations of the IRS’s Subchapter T Cooperatives tax code to receive this type of tax treatment.

Some coops such as credit unions and rural utility cooperatives are exempt from federal and state taxes due to the nature of their operations.

Advantages of a Cooperative

• Less Taxation. Similar to an LLC, cooperatives that are incorporated normally are not taxed on surplus earnings (or patronage dividends) refunded to members. Members of a coop are only taxed once on their income from the cooperative and not on both the individual and the cooperative level.

• Funding Opportunities. Depending on the type of cooperative you own or participate in, there are a variety of government-sponsored grant programs to help you start.

• Reduce Costs and Improve Products and Services. By leveraging their size, cooperatives can more easily obtain discounts on supplies and other materials and services. Suppliers are more likely to give better products and services because they are working with a customer of more substantial size. Consequently, the members of the cooperative can focus on improving products and services.

• Perpetual Existence. A cooperative structure brings less disruption and more continuity to the business. Unlike other business structures, members in a cooperative can routinely join or leave the business without causing dissolution.

• Democratic Organization. Democracy is a defining element of cooperatives. The democratic structure of a cooperative ensures that it serves its members’ needs. The amount of a member’s monetary investment in the cooperative does not affect the weight of each vote, so no member-owner can dominate the decision-making process. The “one member-one vote” philosophy particularly appeals to smaller investors because they have as much say in the organization as does a larger investor.

Disadvantages of a Cooperative

• Obtaining Capital through Investors. Cooperatives may suffer from slower cash flow since a member’s incentive to contribute depends on how much they use the cooperative’s services and products. While the “one member-one vote” philosophy is appealing to small investors, larger investors may choose to invest their money elsewhere because a larger share investment in the cooperative does not translate to greater decision-making power.

• Lack of Membership and Participation. If members do not fully participate and perform their duties, whether it be voting or carrying out daily operations, then the business cannot operate at full capacity. If a lack of participation becomes an ongoing issue for a cooperative, it could risk losing members.