Cooperatives need to pursue debt capital from members through the creation of member loan programs and member loan drives.
The purpose of this article is to suggest some of the basic principles and organizing strategies that underlie a successful cooperative member loan program. However, this article is in no way an offering of or a substitute for legal advice. Due in part to federal and state securities regulations, establishing a member loan program should be done only after careful planning under the supervision of qualified legal counsel.
Historically and presently, cooperatives have been chronically undercapitalized. A cooperative often originates as a volunteer, grass-roots organization dedicated to meeting the needs of its members. If it is initially successful, it will often grow to a larger size, but still be undercapitalized. It may lack the financial resources to fund both its current operation and its future growth.
In the world of finance, all potential sources of capital are in the form of either debt or equity. While the cooperative structure contributes to limitations in sourcing capital (cooperatives are not publicly traded corporations, and banks are sometimes reluctant to lend to cooperatives), the cooperative structure also facilitates a great opportunity for acquiring capital in the form of equity and debt from our member-owners.
As with any business, the owners are responsible for providing initial and ongoing capital, preferably as equity (no interest expense) and, if not, as debt. Many cooperatives have developed member equity programs as a way to supplement and build equity in addition to that coming through retained earnings (operating profits). The member equity programs attract a relatively small amount of capital over time, but from many people -- all the members. For example, 1000 members at $100 each = $100,000 raised over 3 years.
Food cooperatives are undercapitalized in the face of mounting competition. Member equity programs need to be further developed, and equity caps need to be lifted or removed altogether. In addition, and equally important, food cooperatives need to pursue debt capital from members through the creation of member loan programs and member loan drives. For example, 100 members at an average of $3000 each = $300,000 raised in three months.
While member loan drives are often carried out in conjunction with expansion projects, they can, with limitations, also be viewed as an ongoing and/or rolling source of capital. The remainder of this article, however, will focus primarily on member loan drives as part of an expansion project.
In an expansion project, we suggest that the owner's contribution be at least 30% of the total project cost. If cash reserves and additional member equity fall short of that 30%, the most effective source of capital will likely be member loans. An expansion project with a budget of $1,800,000 should have an owner's contribution of at least $540,000. Assuming cash reserves and additional member equity total $240,000, that would leave $300,000 to be raised in member loans.
A member loan program plays a critical and valuable role in an expansion/relocation project. It is an appropriate way to test your members' support of the co-op and its plan. It is an effective strategy for bringing your members further into the project as serious stakeholders. If successful, the member loan drive is a strong statement of member support to convey to your banks. Member loans, properly structured, will definitely help you leverage additional financing.
Perhaps the greatest benefit of a member loan program is the level of accountability that it often introduces into the cooperative. In accepting a member loan, the leadership of the cooperative (board and management) is taking on the serious responsibility of paying back a loan to a member. While lender and vendor debt is also serious and requires responsible action, loans from your members underscore that accountability.
In contrast to a member equity drive, a member loan drive can raise a larger amount of money from a smaller number of people in a shorter period of time. A member loan program effectively complements a member equity program. The interest expense for a member loan will typically be less than a bank loan, and the payment terms normally provide for full payment at the due date, rather than principal payments beginning in the first month.
Basic terms and parameters
Once again, seek appropriate legal advice in planning a member loan drive. Subject to legal review, establish the basic parameters and policies for your member loan program. These include:
- Minimum size loan: We suggest $1,000 or $1,500. You will have a much more difficult time reaching your goal if you accept loans of less than $1,000. They are also generally not worth administering over the loan term.
- Term (length): We suggest 4, 5, and 6 years with approximately one-third in each category. Member loans of a shorter term may be of concern to your bank, since the bank will want to make sure their loan is being comfortably repaid prior to the repayment of member loans. Spreading the maturity dates over 3 years avoids having to pay back all member loans at one time.
- Interest rate: We suggest setting a rate ceiling (simple interest, 5-6% in today's market) and offering loans from up to that ceiling. Have it be negotiable between the co-op and each member, essentially allowing the member to choose an interest rate within that range. This makes it simpler for the member to make a decision to lend to the co-op. The interest rate should not be set at a high rate that could be viewed as speculative; this attracts the wrong kind of investor.
- Payment of principal and interest: We suggest that the principal be paid in full at the end of the term. We also suggest either having all interest paid out at the end of the term when the principal is repaid (thus accruing the interest annually and adding it to the principal) or offering a choice of annual payment of simple interest.
- Unsecured and subordinated: It is important to understand that member loans are typically unsecured and subordinated to primary and secondary debt. And it is important that your members understand those concepts, including how subordination really will work in your specific instance. Members need to understand that there is a level of risk in making a member loan.
Your co-op may be initiating or changing its member equity program. If possible, do not launch your member loan drive at the same time you are launching a member equity drive. It will be too confusing for your members, and they will choose the lesser of two options.
Plan a member loan drive so that it is ready to begin at the appropriate time, whether that be at the point or just prior to when you secure your new site, or at a time when you are trying to build member support for expansion in general (not site specific).
It typically takes 4-6 weeks to plan and fully organize the member loan drive and get it to the point of launching. Once begun, the drive should be completed within a few weeks, assuming it is launched at an appropriate time of the year (e.g., not between November 15 and January 6) and that it is properly conducted. If the member loan drive is extended beyond 6 weeks, it becomes increasingly more difficult to reach your goal.
An important part of planning is to set a clear goal for how much you wish to raise in member loans. Have the goal be achievable. This will likely take a lot of thought and discussion; initially you might think you can only raise $30,000, while your project may require that you raise $300,000. As you examine the situation and find out what other similar size co-ops have been able to raise, you will likely gain confidence with the larger number.
Once you have set the goal, determine what you wish to promote as the "average size loan," as a way of communicating to your members and stretching their thinking. It is important not to communicate only the minimum loan size.
When you set a goal for the average loan size, you will know how many loans you are likely to need. At an average size of $3,000 a total of 100 loans = $300,000. But planning includes the following: Does your legal counsel advise that you limit the number of loans you can accept? Will you have the capacity to secure and administer 100 loans? Maybe 60 loans is more realistic for your co-op. If so, the average size will need be $5,000. Is that realistic for your co-op? If not, you may need to lower your goal.
Co-ops who have had a member loan program in the past and repaid all the loans will be much better positioned to have a large member loan drive. We are seeing examples of co-ops raising 10 times the amount they raised in their earlier member loan drive of 5 or 10 years ago.
A key indicator of success for your member loan program is the commitment level of your board. To what extent will your board support the member loan program in a tangible and visible way? Not every board member should be expected to make a member loan, but your board as a whole should be expected to lend approximately 10% of the total needed. It is important to test the waters by seeking your board members' commitment before launching the member loan drive. In our experience, if your board members (as a group) choose not to participate in the member loan program, you will not be successful in reaching your total goal for the member loan program.
Preparing your documents
The best proven approach to raising member loans involves creating a target list of names (4 names for every loan needed) from the membership list and sending out a personalized one page letter, followed by a phone call. This should not be done by a large committee, but rather by a small committed group with selling skills. It is best to have one or two people call the target list as a follow-up to the mailing. The full strategic guidelines for doing this are beyond the scope of this article, and it is suggested that you seek appropriate consultation in addition to legal advice.
Planning out your documents in advance is critical, and includes:
- co-op stationery and envelopes;
- one page letter, with an envelope hand addressed with an attractive stamp mailed to the target list (promising a follow-up phone call within a week);
- one page letter to the full membership with address labels and an attractive stamp, (but not promising a follow-up phone call);
- brochure that broadly explains the member loan program and is included in both mailings;
- member loan information packet that is provided to those members who have an interest in the member loan program;
- promissory note and subordination agreement.
It is critical to train your phone callers. These people need to be credible in your community, consistent with their messages, comfortable in asking people for money, and able to clearly explain the member loan program. Find the best one or two callers in your co-op's community.
Monitor progress and celebrate
As the drive is launched, carefully tally and assess your progress each day. Send out thank you notes to those who have committed and to those who have made their loan and signed the papers. If you aren't getting adequate results (at least 1 favorable response out of 4 calls), reassess and adjust your strategy before it is too late. If necessary, be prepared to send out a second mailing within 14 days to the target list (and maybe the full membership), indicating your progress and making another appeal. Show your progress on a graphic thermometer or chart in the store. Update it regularly. For those members who are enthusiastic about your expansion project and member loan drive, request their email address and send regular email updates to them as another way to build excitement.
Collect the member loans in a timely manner following the verbal commitments. Even under the best of circumstances, at least 10% of those commitments will not translate into loans.
An intensive member loan drive can be fully completed within six weeks. Provide for a time to celebrate, and acknowledge all of your volunteers and your members who have made a loan. The process and results of a successful member loan drive will contribute immensely to your co-op's future.