Should You Form A Business Cooperative? Consider These 9 Advantages & Disadvantages Before Getting Started
A business cooperative, also called a “worker cooperative” or just a “co-op,” is a type of business that offers some special advantages—namely, the advantages of group ownership. Though it has some commonalities with other business types, including business partnerships and traditional corporations, a business co-op is its own animal with its own unique legal structure. A cooperative is not the most conventional business type and can only work for certain types of businesses. Read on to learn more about whether this unique business model could work for your new or existing business.
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What Is A Business Cooperative & How Does It Work?
Essentially, a business cooperative is an employee-owned business. Every member of the cooperative has an equal voice, regardless of how many shares they own. Profits and earnings are divided equally among the members (also called “member-owners”). However, it’s important to know that there are different types of co-ops with different goals, and that there are other business types that resemble co-ops.
How Business Co-ops Differ From Consumer Co-ops
A business cooperative is not to be confused with a consumer cooperative, though the legal structure may be the same. With a consumer co-op, members of the co-op are also consumers of the co-ops good or services, paying into the co-op or sometimes volunteering their labor (usually part-time) in exchange for membership.
Why join a consumer co-op? Membership typically gets you a free service or lower prices for a service. For example, a food co-op typically offers high-quality food at much lower prices than you’d pay at, say, Whole Foods. A parent joins a preschool co-op so that their children can attend the school for free or at a discounted rate. Consumer co-ops typically not-for-profit, community-based services. They may or may not be incorporated as businesses.
Business cooperatives, on the other hand, serve workers. The member-owners of a business cooperative are typically full-time corporate employees.
While business co-ops are democratic by nature and often have a socially conscious business ethos, the main goal of a business co-op is not to provide a community service, but to make a profit. Typically a percentage of profits are distributed equally among owners, while the rest is reinvested in the company. There are co-op businesses in retail, agriculture, healthcare, manufacturing, and other industries. Business cooperatives are incorporated and do business as cooperative corporations.
Business Cooperatives VS Other Business Structures
A cooperative corporation is also not to be confused with a regular corporation (C corp). Though many corporations are partly owned by shareholders who also work for the company, a cooperative, by contrast, is 100% owned by its employees, with no owner having any more control or ownership of the company than any other owner. Unlike a traditional corporation, a cooperative corporation has no executives who hold the majority of shares (among other differences).
Co-ops are also different from business partnerships, which have different liability structures and tax structures, and can involve unequal ownership arrangements. Learn more about the different types of business structures if you’re not sure which one is right for your company. Depending on your goals, a more appropriate business structure might be a partnership or even a limited liability company (LLC), which has a lot of the same benefits of a co-op but with fewer restrictions.
Other business types may borrow some features of co-ops without being true co-ops. For example, Costco and Sam’s Club resemble co-ops in that members pay a fee in order to shop there; however, these businesses are not true co-ops because they are not member-owned.
Business Cooperatives On A Large Scale
Very large business co-ops can operate much like franchises—in that members pay to use the company name and resources, but each individual business location is more or less independently managed. ACE Hardware, whose shares are all owned by individual ACE Hardware store owners, is an example of a retail cooperative. In exchange for purchasing shares of company stock, approved ACE outlets become part owners of the company and can use the ACE name, products, and distribution channels.
A business cooperative can also function sort of like a union, in that its democratically-elected leaders can exert collective bargaining power in their industry if the co-op is large enough. Land O’Lakes Inc., owned by dairy farmers, is an example of a large-scale agricultural business cooperative. Due to its large size and purchasing power, Land O’Lakes has a lot of negotiating power from its suppliers (of trucks, farming equipment, etc.), which it uses to lower its cost of production.
But not all business cooperatives are nationwide brands; most are actually small businesses. A new co-op might only have a handful of employees. There are still benefits to forming business cooperative, even on a very small scale.
The Advantages Of Owning A Business Cooperative
Incorporating your business as a co-op can provide great benefits and establish your organization as a really special entity where workers love their job — with low operating costs to boot. Read on to learn about the benefits of owning a business cooperative.
Because employees are directly impacted by the company’s performance and share in the company’s successes and losses, they are more invested in the company they work for. Employees are more likely to pour their hearts and souls into a company when they are also owners. Having an equal voice in the company, as co-op owners do, can also inspire more motivated workers. In addition to their labor, employees invest their money into the company, which helps fund the business.
Cooperatives may be eligible to receive certain business grants from the federal government and other entities.
Equal distribution of ownership in a cooperative also means equal distribution of liability. In contrast to partnerships where all partners are fully liable for both their own and their partners’ actions, each owner of a cooperative has only limited liability for company debts, obligations, etc. The liability of the co-op’s members is limited only to the extent of their investment in the co-op, provided that they were not engaged in illegal or negligent activities. (LLCs, which can also have multiple owners, also have limited-liability benefits.)
Owner-employees are more motivated to keep costs down, because lower costs ultimately increase the company’s profitability. By leveraging their large size, co-ops may also be able to obtain lower-cost goods and services from suppliers, resulting in an overall lower cost of production.
Earnings are taxed twice in a traditional corporation—the corporation pays tax on their net earnings and then the shareholders pay taxes on their individual dividends. The federal tax structure of a cooperative—subchapter T of the U.S. tax code—is such that these entities are not taxed on the surplus earnings/dividends they redistribute to members. Co-op owners are only taxed once on their personal co-op income, and not at the co-op level. Thus, a cooperative has a reduced tax burden compared to regular corporations.
The Disadvantages Of Owning A Business Cooperative
A cooperative business model is also not without its downsides. Before you decide to incorporate as a cooperative, make sure you are okay with the following caveats of forming a co-op:
Depending on where you live and work, you may not be allowed to incorporate your business as a co-op. Every state has a co-op law, but they are all different. Some states have very restrictive co-op laws, only allowing co-ops in certain industries, such as agriculture, to incorporate. Other states allow co-op businesses in almost any industry. If your state allows you to form a co-op business, you will still have to adhere to your state’s co-op laws. Before you get yourself in some legal challenges, make sure you are following your state’s business cooperative laws.
Not As Profitable For Founders
Because a cooperative’s earnings and profits are distributed equally among all employees, this type of business is not nearly as profitable for the company’s founders. This doesn’t mean that all cooperative employees are paid equal wages, but in a conventional business structure where the owners/founders have the majority of control and ownership in a company, those owners stand to take a much bigger chunk of the profits. Then again, if you’re considering forming a co-op, there is a good chance that personal profit is not your primary goal.
Finding startup loans and other types of funding through traditional lenders may be difficult due to a cooperative’s financial and liability structure. Co-ops also struggle to attract large investors, since a large investor will not have any more control in the company than a small investor. During the startup phase and sometimes beyond, co-ops may have to get creative with other funding sources, such as launching a crowdfunding campaign or applying for small business grants.
Have you ever tried to make a decision as a large group? It can be pretty challenging! By the time the entire group decides where to eat, you are out of your mind with hunger. The process to make big decisions as a cooperative, where everyone gets an equal vote in all company decisions, can be equally time-consuming and frustrating.
How To Form Your Co-op
The following are the main steps you need to take to form a business co-op. However, the steps to register your business as a co-op vary somewhat from state to state; check with your state’s Secretary of State or State Corporation Commissioner for more information regarding your state’s specific co-op laws.
1. File Articles of Incorporation
The articles of incorporation is a document that makes your co-op an official business. This document includes your company’s name, location, purpose, financial structure, and the names of your charter members (incorporators/founders). Your incorporators must file the articles of incorporation with your state business entity registration office.
2. Obtain Business Permits & Licenses
You will need to obtain all local, state, and federal permits and licenses before you can operate as a legal business. These requirements will vary based on your industry and location.
3. Create Bylaws
Once your articles of incorporation have been approved by the state, you can write your bylaws. These are all of the rules and procedures for your cooperative and include membership requirements and duties, as well as general operational procedures for your co-op. Your bylaws must comply with state law, so you may need to consult with an attorney at this time if you haven’t already.
4. Hold Charter Meeting
During this meeting, charter members will adopt the bylaws and elect a board of directors (if the board wasn’t already established in the articles of incorporation).
5. Recruit More Members
To make your co-op a success, it needs to grow its membership. These are the employees and co-owners of your company who will supply the capital and labor. The application members use to join the company needs to include names and signatures from the board of directors, as well as a description of the member rights and benefits.
6. File With The IRS
Even though you are exempt from certain taxes as a cooperative, you will still need to file with the IRS (before the end of your fiscal tax year) to validate your organization’s tax-exempt status. In particular, most cooperatives will need to file Form 1120-C to report income, gains, losses, deductions, credits, and to determine your income tax liability. Any cooperative with employees needs need an Employer Identification Number (EIN) to file taxes, so be sure to sign up for one before tax-time if you haven’t already.
7. Obtain Additional Financing
Depending on your financial needs, you may need to obtain additional financing at some point, especially if contributions from co-op members are not sufficient to cover all your initial startup expenses. As mentioned, crowdfunding and startup business grants are a couple of potential ways co-op startups get capital, and certain online lenders might be willing to extend you a startup loan as well.
Note that if you are converting an established company to a co-op, this process will look different. In addition to incorporating as a cooperative, writing bylaws, etc., you will also need to buy out the original owners/founders and then redistribute that money to the co-op.
A business cooperative can be the perfect business structure for certain organizations, particularly those with a democratic business ethos. A strong corporate culture and reduced costs are just two of the many benefits that cooperative businesses enjoy. However, co-ops are also limited in certain ways, and are not appropriate for every business type.
Don’t think a co-op is right for you? Take a look at our business structures explainer to learn about other business structures and their pros and cons.