Should You Form A Business Cooperative? Consider These 9 Advantages & Disadvantages Before Getting Started

Because employees are directly impacted by the company’s performance and share in its 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 own 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 that are not available to other kinds of businesses.

Equal distribution of ownership in a cooperative also means equal distribution of liability.

In contrast to partnerships, where all partners are fully liable for their own and their partners’ actions, each cooperative owner has only limited liability for company debts, obligations, etc. The liability of the co-op’s member-owners 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. Larger co-ops may be able to may also be able to obtain lower-cost goods and services from suppliers, resulting in an overall lower cost of production by leveraging their size.

Earnings are taxed twice in a traditional corporation — the corporation pays tax on its net earnings, then the shareholders pay taxes on their individual dividends.

The federal tax structure of a cooperative (sub-chapter T of the US 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.

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 into some legal challenges, make sure you are following your state’s business cooperative laws.

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; however, 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 over 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.

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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 of making big decisions as a cooperative, where everyone gets an equal vote in all company decisions, can be equally time-consuming and frustrating.

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.

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, so be sure to do your research.

Once the state has approved your articles of incorporation, you can write your bylaws. These are all 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.

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).

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.

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, and credits and to determine income tax liability. Any cooperative with employees needs an Employer Identification Number (EIN) to file taxes, so be sure to sign up for one before tax season if you haven’t already.

Depending on your financial needs, you may need 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 this process will look different if you convert an established company to a co-op. In addition to incorporating as a cooperative, writing bylaws, etc., you will need to buy out the original owners/founders and then redistribute that money to the co-op.