Cooperative Capital and Member Equity Systems: The Heart of Cooperatives
This section presents material intended to help readers active in the leadership of their cooperative to design and argue for an improved member equity system. Four co-ops are briefly surveyed regarding their practices in this area, along with an essay reviewing the need for such capital and of desirable characteristics of member equity systems.
Member equity and its multiple links to the rest of the cooperative are worth examining closely, for this is an area in which co-ops still have much to learn. Practices among cooperatives vary widely, and along with examples of healthy cooperative businesses with strong and growing member equity systems, there are many instances of neglect of the role of member capital or of inconsistent and irrational organizational practices.
If capital is the lifeblood of a business, a co-op's member equity system may indicate whether that business is anemic or full of vitality. Yet member equity usually is less evident and less promoted than other features of the cooperative. Even where there are growing sales and a satisfied membership, there may be a serious capital problem. Frequently we find that members are owners in name only, with but a token investment in the co-op. There may be little sense of identity as owners of a business, and little attention given to whether the cooperative is building equity.
Despite this frequently low visibility, we can see in member equity systems the locus of several fundamental features of cooperative business. The cooperative mission, the member's link to the co-op, the cooperative's ability to sustain operations serving the members -- all these are manifested in the structure and practice of member equity systems.
Analogously, the cashier is the locus of several fundamental features of a retail operation. Store income, the movement of inventory, essential operating data, and customer relations all are generated or manifested at the checkout counter.
Of course, just as store operations are more than cashier/customer transactions, a cooperative is more than its member equity system. But while the co-op in all its aspects always is something larger and more complex, equity programs do compress into the co-op/member relationship a great deal of what makes the cooperative.
Mind your mission
Take, for example, member equity and its relation to cooperative mission. A broad but essential mission or purpose for cooperatives, I would argue, is the redistribution of wealth (or capital) and the democratic control of wealth. Cooperatives pool assets to support organized services to members; members, by meeting their required contribution toward those pooled assets, obtain and may exercise voting privileges and patronage related privileges. The co-op is structured to control capital by limiting interest paid on member investments, and by distributing earnings according to the level of patronage or production rather than according to the level of investment. Growth in assets supports improved services and increases the amount of cooperatively owned and controlled capital.
But how are cooperative assets to be financed? Assets needed to establish and maintain business services must be financed in some fashion. Recall the balance sheet equation: Assets = Liabilities + Capital. This reminds us, as you can remind your members in marketing an equity program, that the co-op's assets are financed either by external (debt) capital or by internal (owner) capital. (The debt to equity ratio -- total liabilities over total equity -- is an expression of the relative use of these two sources of capital and a common measure of solvency.) A challenge to the co-op leadership is to tap into the tremendous potential that the membership has for strengthening the owner equity side of the equation.
New Leaf Market
Based on a conversation with general manager Carol Wilkinson:
The member equity program is two years old. We instituted it at a point when we were nearly bankrupt and needed the capital to move forward. With the board having thought through the proposal, most members supported it. Of th former members, half rejoined right away, and now we are back to the previous level -- but with many new people.
Initially, some people seemed to have trouble understanding that the new program called for a one time, refundable investment, and we had to work on the best way to convey that message. Of the old members who renewed under the new system, almost half chose to be in the $100 or $200 investment class. Presently, the majority of members are in the $25 class.
At the beginning of the program, because we were in such bad shape, we didn't want the members to be concerned that we would lose their equity through store operations. The initial investments were put into a trust fund not available to the store until $25,000 had been built up and the store had demonstrated viability; both goals were achieved. The funds are being used, but remain targeted for capitalization, primarily equipment and other fixed assets. This capital is not available for operations, although management can borrow against it for a specified short term basis.
- Different colored cards help cashiers identify the proper discount.
- The co-op's membership form asks for a beneficiary name, and the co-op is often so designated by the new member.
- The co-op avoids perpetual records of obsolete memberships through a clause that revolves the amount to the co-op after two years of inactivity in the member account.
Oryana Food Cooperative
Traverse City, Michigan
Based on a conversation with general manager Alan Green:
The co-op has had an equity program for about half of its 17 years. The present three-tiered system has been in place for three years.
In the past, we used member deposits to support operations. But we no longer do that, and by policy require otherwise. Now, store operations must be supporterd by sales and margin on sales. We set aside member deposits, essentially in escrow; presently it is in a money market account. It is used only with board approval and has always been used for capital improvements.
This has been a very good shift for us and an important one. People feel really good about their investment in the co-op and the way it is being handled. The member deposit system has improved our balance sheet also. The steady inflow of member capital lets us finance more assets with equity rather than short term liabilities.
One question the board and management and the membership will soon have to explore is whether the capital program is sufficient to carry us through the kinds of major projects we're looking at: The co-op must expand and relocate its retail operation; we have committed to doing this by the end of 1991. In addition, the co-op has a food service division with a soy products wholesale distribution operation, and we want to expand that. Will the present member equity program give the co-op enough capital to leverage more from commercial sources? At current rates, the co-op will have accumulated member deposits in escrow of about $200,000 within two years.
The co-op leadership is aware of a need to revolve member capital. We are considering changing the present unlimited term of annual member deposits to one with an early return of the deposits -- but this will not be attempted until after the above improvements have been accomplished.
North Coast Cooperative
Based on a conversation with membership marketing director Karen Zimbelman:
Along with the cooperative, North Coast's membership continues to grow, and so does the number of members, now about 750, with their $200 "fare share" fully invested. And despite a low initial requirement for membership, the average amount invested is $72. This is double the average investment by members five years ago.
Although North Coast is in some ways undercapitalized and is very highly leveraged at present, we have accomplished a lot -- and member investments have a lot to do with that: a growing and profitable cooperative operating three full line natural foods grocery stores and a regional distributor. The equity program also has had a very positive impact in building the idea of the cooperative as a place to invest.
In addition, we've found that giving dividends helps promote understanding by everyone of the membership as an essential source of capital for the co-op. We're showing that we would rather pay interest to the members than to a bank. And since unlimited investment is allowed and encouraged and earns interest, it leads to some large investments by individual members. In the fiscal year ending March 31, 1989, North Coast raised $78,000 in investments by individual members.
On the down side, the North Coast member equity system is complex and requires a sophisticated selling job. There is much misunderstanding about the different types of shares, and one-on-one explanation is often needed. Other drawbacks are that dividends are paid after taxes (unlike interest expenses paid, which are deductible). And the co-op's methods require annual filing with the California Department of Corporations for review for possible consumer fraud -- more work for us, but actually a positive safeguard for the members as consumers and investors.
Based on a conversation with general manager Gail Graham:
Member reaction to the member equity program has been good. Unfortunately, the program has suffered mainly from lack of applied resources. We just finished our first year in an expanded store; adjustments in operations and other needs have taken precedence. In addition, the member coordinator position has not been adequately filled until recently. Prior to that, there was much negative member relations generated by inconsistent or otherwise improper practices around the newsletter, discounts, billings, etc. Our new person is cleaning everything up nicely. Notices are going out, and renewals and new memberships are rolling in. Our basic handout has been rewritten, and cashiers are being trained -- they continue to be very effective membership recruiters. A recent survey told us that members continue to spend more money per trip at the store than nonmembers. We realize we very much need to build and solidify our membership base.
[continued from above]
A cooperative which promotes the role of member equity in fulfilling its mission and requires member capital contributions is taking advantage of a very important opportunity. As a co-op generates increasing amounts of capital, it is in a stronger position to leverage additional debt capital, if needed, from external sources. Prudent financial management can magnify, through such borrowing, the impact of member investments. At the same time, in general there is relatively less need for debt capital, and more financial security, as owner equity increases.
Mind your members
Member equity systems also are closely linked to the member relations aspects of cooperative enterprise. Why join the co-op? How does one do so? What is the purpose of the cooperative? What services and benefits does membership offer? A successful member equity system is inseparable from education about the cooperative, and a member capital progam must "fit" with the rest of the business and organizational culture of the co-op. The aim in such a system should be nothing less than that membership be understood and supported by most of the shoppers. Corollary to the goal of increasing the level of member equity over time, a cooperative should strive for an increasing level of member sales, avoiding long term major reliance on non-members.
If customers and potential members don't understand or support a program for member equity, something is amiss. Properly planned and presented, member equity can be the piece linking the individual service needs with the business resources that enable the co-op to meet those needs. Do your members think of themselves as owners of the business? Successful retail cooperative enterprise usually includes a member equity system which provides the business with the substance of ownership and provides the members with the pride and opportunities of ownership.
Mind your store
To highlight a final way (last but far from least!) in which member equity is integral to the cooperative: the capital infusion it provides is needed to sustain the business over the long term. The concentration of resources that creates the co-op also must provide for replacement of aging fixed assets, future expansion, revolving of past investments, and other costs that neither result from daily operations nor are covered by the margin from operations.
In the grocery industry generally, the margin of earnings from independent retail operations is seldom adequate for meeting long term capital needs, and this appears to hold also for higher margin natural foods and specialty stores. If there is pressure to meet all of a retail's capital needs through operating profits, the results probably will be higher prices and/or lower wages. In store operations, these two are the most important factors that determine the income statement's bottom line, which carries over to the owner equity section of the balance sheet.
In addition to overreliance on net earnings as a source of capital, another common pitfall among food co-ops should be noted: giving an inflated return on the individual member's investment through excessive price discounts. For example, assuming store prices are roughly competitive with those in the rest of its market, giving a 5 percent discount on all purchases in return for $20 annually will provide most individual shoppers with a return on their investment of more than 200 percent!
In reducing or even eliminating the net margin from member sales, overdiscounting encourages reliance on non-member sales and is an obstacle to growth in total equity. Such practices also ignore the cost to the cooperative of other, borrowed capital. And overdiscounting may prevent the cooperative from using capital investments to do anything more than cover operating expenses and to supplement the margin from non-discounted sales. Certainly the co-op should look to its members for capital, and explain to them the need for such capital -- but not pay them at a rate far greater than the co-op would pay to another lender!
(This discussion of return to the individual member is a different matter than the co-op's overall return on investment [ROl], a measure of business performance calculated by dividing total equity into net earnings; or the return on assets [ROA], calculated by dividing total assets into net earnings. For figures and comments on ROI and ROA ratios among co-op retails, see the Retail Operations Survey.)
Tired assets, undernourished capital?
In its effect on operations, a lack of owner equity may cause serious difficulties, both in the short term and long term. It may result in the cooperative having both inadequate assets and overreliance on debt financing.
With weak or inadequate assets, you will find:
- a lack of cash -- leading to loss of purchase discounts, minimal reserves, and overdraft problems;
- a lack of inventory;
- an inability to maintain and invest in equipment and facilities.
As a consequence of these conditions, operations profits are diminished or losses increases, which further depletes capital.
With overreliance on debt financing, you will find:
- high accounts payable and problems with creditors;
- high other liabilities, the risk of penalty charges, and higher interest charges (debt service);
- an inability to leverage additional financing when needed, particularly when the lending institution cannot be shown that the owners are making a significant investment themselves.
As noted earlier in discussing discounts to members, their capital contributions should not be used to cover losses or operating expenses in general. These expenses should be covered by operating income. Such misuse of member capital may occur both in the case of member fees, which to the member becomes just another expense, as well as in situations where member equity is devalued as a result of negative retained earnings.
Note futher that member loans to the co-op are an additional source of capital and can be an important complement to required member investments. But often such loans from members are misused by covering for the absence of a member equity system. In addition to the advantages discussed above, required member investments can be the most stable and least costly source of capital for the cooperative. And if the member equity program is well planned and marketed, it will also generate additional capital through loans from some of the members.
You need Dr. Equity!
Certainly the benefits and potential problems outlined here underscore the need for skilled management of the cooperative's finances and of its entire operations. But even more, they should remind us of the need for sound planning for meeting the co-op's capital needs.
In examining your co-op's member equity system, or designing a new one, consider the following desirable characteristics of a model program:
The member equity system is easy to understand and explain. It is neither so complex nor calls for so large an investment that it is a serious barrier to marketing co-op membership.
It's simple. The system can be administered -- for new members, numerous transactions, accounting, payment schedules maintained, etc. -- without extraordinary difficulties.
It fits. Member equity requirements are appropriate for the members and the type of co-op, and the marketing of the program is integrated with the co-op's larger efforts in marketing, member relations and member education.
It's legal. The equity system reflects an awareness of statutory and regulatory limitations on raising capital for the business, and is consistent with the co-op's articles of incorporation and bylaws.
It's effective. The member equity system provides its share of the cooperative's capital needs: leveraging additional debt as needed; sustaining renewal and expansion of the co-op's capital base, not using it for operating expenses; allowing for periodic return of earlier investments. In addition, membership in the cooperative provides discounts and/or dividends which realistically reflect the cost of capital and which allow for net earnings from operations to contribute toward building capital. The member equity system is rationalized to encourage both the co-op and the customers to continue building member sales as well as member capital.