Agncultural

Cooperative Redemption

Service

Cooperative Guide

InformatIon Report

Number 31
Cooperative Information Report 31

April 1983

Reviewed and Approved for Reprinting 1987, October 1991
Equity Redemption Guide

Jeffrey S. Royer

Gene Ingalsbe

A cooperative is supposed to serve its member-owners, right?

Who owns your cooperative?

Heirs of Bill Jones who died 10 years ago?

Sam White who moved out of State 5 years ago?

Ted Brown who retired last year?

Director Ned Smith who has done 100 percent of his business with the co- op

for 25 years?

Or young Johnny Green who started trading at the cooperative last month?

Do these types of member-owners have the same interests and goals?

Hardly.

Bill Jones’ heirs have been pressing the board to redeem his equity; further,

they’re upset because they don’t have voting rights to affect equity

redemption policies.

Ned Smith believes the cooperative needs a million-dollar feed mill.

Johnny Green and some of his young farmer friends are threatening to quit

the cooperative unless it pays a larger portion of the patronage return in

cash.
How can your cooperative serve such diverse interests and yet survive?

Perhaps it can’t . . . without adopting solid financial planning that includes a

carefully developed and conscientiously followed equity redemption

program.

Redeeming equity is an ownership transfer process to keep the cooperative

financed, owned, and controlled by current member-users. Such a process

should result in a membership whose reasons for using the cooperative are

more similar. And similarity of member interests greatly simplifies a

cooperative’s business strategy and future direction.

Pressures are intensifying to bring about improved programs for retiring

member and patron equities.

Former members or their heirs are voicing increasing frustration over their

inability to get cooperatives to redeem equities allocated many years ago.

That frustration occasionally has been brought before State legislatures and

to Congress. A continuation of equity redemption problems could result in

a legislated mandatory program that could be devastating to many

cooperatives and would greatly reduce cooperatives’ financial flexibility.

An additional reason for redeeming equity stems from research indicating a

relationship between equity redemption and member commitment. A

recent Government study found that 70 percent of farmers surveyed would

increase their patronage if their cooperative improved its equity redemption

program.

FOUR ALTERNATIVES

Equity formation and redemption can be achieved with four types of plans.

Three involve systematic capital formation and redemption as a part of a

cooperative’s financial budgeting process. The fourth redeems equity

according to the member’s particular circumstance.

Revolving Fund

Equities are redeemed in the order they’re allocated. How soon equities are

redeemed is usually left to the discretion of the board of directors and is

subject to the cooperative’s financial condition.

Tables 1 and 2 illustrate how a revolving fund works.

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Table 1 -Revolving fund operation at cooperative level

Year Beginning

equity

Patronage Equity

allocations amount

retained redeemed

Equity

year (9

redeemed

, *******I Dollars - - - - - - - -

1 0 500 0

2 500 500 0

3 1,000 500 0

4 1,500 500 500 I

5 1,500 1,000 1,000 2, 3

6 1,500 500 500 4

Table 2-Revolving fund operation applied to Member A

Year Beginning

equity

Patronage

allocations

retained

Equity

amount

redeemed

Equity

year (4

redeemed

******** Dollars - - - - - - - -

1 0 50 0

2 50 100 0

3 150 150 0

4 300 200 50 1

5 450 200 250 2, 3

6 400 200 200 4

The cooperative’s objective (table 1) is to accumulate allocated equity of

$1,500. Retention begins with $500 in Year 1 and reaches the designated

level by the end of Year 3. Then, as new equities are retained ($500 in

Year 4)) old equities ($500 in Year 1) are redeemed.

In Year 5, the cooperative retains $1,000, perhaps because it realized better

than expected net margins or it deliberately decided to shorten the

revolving period. For whatever reason, by retaining $1,000 in Year 5, it is

now able to redeem equities of $500 each from Years 2 and 3.

Member A (table 2) contributes varying amounts of equity each year

according to use of the cooperative. Beginning Year 4, A’s equity is $300.

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In Year 4 when the cooperative decides to redeem equities from Year 1, A

would get $50. In Year 5 when the cooperative decided to redeem equities

from Years 2 and 3, A would get $250.

Among advantages of this plan:

l It’s easy to understand and to administer.

l It provides an easy method for new members to accumulate equity.

l Equity is held more or less in proportion to pa

revolving period is relati vely short.

tronage as long as the

The basic disadvantage of this plan is the difficulties that may arise if the

revolving period becomes too long. An unexpected need for capital or

unanticipated low margins would force the cooperative to choose between a

cash flow crunch or lengthening the revolving period. The latter might be

the only choice. For whatever reasons, as the revolving period lengthens,

equity becomes less proportional to use. The eventual result often is conflict

among members concerning the cooperative’s financing and equity

redemption policies.

Percentage-of -All-Equities

The cooperat ive redeems a percentage of all eq uities, with members each

rece iving the same percentage of their equiti es regard less of when allocated.

Tables 3 and 4 illustrate how the plan works.

In table 3, the cooperative has $2,000 in allocated equity. After the business

year is over and net margins are allocated according to established policy,

the new total is $2,500. But the board, assessing the coming year,

determines only $2,300 is needed. Consequently, $200 in allocated equity

could be redeemed to members (10 percent of the cooperative’s $2,000 in

allocated equity before the most recent year’s allocation).

Applying the lo-percent redemption to five members is illustrated by

table 4. Note the same percentage is applied regardless of the amount of

equity and how long the equity has been held.

Advantages are:

l Equity redemption decisions can accommodate varied operating

and growth objectives.

decisions
Table 3-Percentage-of-all-equities operation at cooperative level

Dollars

Allocated equity at beginning of year ................................ 2,000

Patronage allocations retained ........................................... +500

Equity available at end of year ............................................ 2,500

Equity required . . . . . . . . . . . . . . . . . . . . . . . . . ..~........................................... 2,300

Equity redeemable (2,500 minus 2,300) ,.,......................... 200*

l 10 percent of allocated equity at beginning of year.

Table 4-Percentage-of-all-equities operation applied to members

Member Beginning

equity

Percent Amount

of equity to be

redeemable redeemed

Do/la rs Dollars

A 750 10 75

B 250 10 25

C 250 10 25

D 500 10 50

E 250 10 25

Total 2,000 10 200

l New members participate immediately in equity redemption.

l The plan works well for cooperatives with stable memberships and little

fluctuation in patronage.

Disadvantages are:

l Redemption ignores the length of time equity has been held and the initial

patronage basis under which it was supplied.

l Transfer of ownership to current members is slowed and, in fact, never

completed without a provision for closing out equity accounts of former k

members.

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Base Capital

Capital needed to run the cooperative is determined annually. Each

member’s equity contribution is also adjusted annually according to

patronage during a base period, usually the past 3 to 10 years.

Underinvested members, those whose equity investments are less than

their capital obligations, continue to invest and may be required to pay an

interest charge on the amount of their underinvestment. Overinvested

m,embers generally are not required to continue investing and may begin to

receive at least partial redemption of excess investment.

Table 5 illustrates operation of the base capital plan.

The six-member cooperative operates on a S-year base period and has

$18,250 member equity. The board has determined the cooperative needs

an additional $250 of equity capital. Each member’s capital obligation is

determined by patronage over the past 5 years. The member’s percentage of

the cooperative’s total business determines the percentage of the member’s

new capital obligation. Comparing the new obligation with the member’s

equity account determines what adjustment, if any, is necessary in the

member’s capital obligation.

In table 5, Member A needs to contribute $350 more. The amount is

determined by dividing A’s patronage ($120,208) by the cooperative’s total

volume ($1,092,796) to determine A’s percent (1 l), which determine’s A’s

capital obligation of $2,035 ($18,500 x .ll>. Because A has only $1,685 in

equity, $350 more is needed. In Member C’s circumstance, a negative

amount of $215 is determined and means that amount could be redeemed.

The burden of redeem ing equity of overinvested members is shared by all

members according to their use ofthe cooperative during the base period.

A variable cash patronage return plan is sometimes used with the base

capital plan. The percentage of the return that’s in cash varies upward from

the required 20 percent according to the member’s base capital obligation

status. An overinvested member would receive a greater percent of the

patronage return in cash than would the underinvested member.

Unless underinvested members are required to meet their capital

obligations immediately, it is impossible to retire all of the overinvested

equities of other members. One gradual approach is to retire a flat percent of

each member’s overinvestment. Another approach is to retire the equities

of the most overinvested members at a faster rate than others.

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Table 5-Five-year base capital plan operation

5-year Share Adjusted

Member Beginning

equity patronage of co-op’s capital Obligation

total business obligation status

_ _ _ - - Dollars - - - - - Percent - - - - - Dollars - - - - -

A 1,685 120,208 11 2,035 +350

6 3,345 207,631 19 3,515 +170

C 2,805 152,991 14 2,590 -215

D 5,515 327,839 30 5,550 +35

E 4,550 284,127 26 4,810 +260

F* 350 - - - -350

Total 18,250 1,092,796 100 18,500 +250

*Inactive member.

Advantages of the base capital plan are:

a With equity requirements determined by patronage, it is the most

equitable plan.

o Equity requirements can be easily altered to meet changing capital needs.

0 Financial planning is easier because equity sources are more predictable.

Disadvantages are:

l Because of its complexity, the plan may be difficult to understand and

administer.

l Frequent turnover in membership and changes in patronage directly

affect the frequency and degree of adjustments in individual member equity

requirements.

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Special

Equity is redeemed in one or more of the following situations: (1) estate

settlement; (2) certain member age; (3) former members who have quit

farming or left the cooperative’s trade area; (4) individuals no longer

patronizing the cooperative; (5) hardship; and (6) redemption requests on

an “on call” basis.

A special plan can be an alternative or supplement to any of the other plans.

Advantages:

l The financial burden on the cooperative is generally small.

l It’s easily understood.

l Equity can be redeemed on a priority basis in the absence of another plan,

when the other plan is not functioning as intended, or the cooperative is

under financial stress.

Disadvantages are:

l Equity is not held in proportion to patronage.

l Financial planning is more difficult

situations that affect redemption.

because of the unpredictable nature of

FEDERATED PARTICIPATION

Patronage returns from federated cooperatives often comprise a large part

of a member cooperative’s net margins. Similarly, investments in federated

cooperatives, primarily from retained patronage allocations, can account for

a large portion of a member cooperative’s assets. Because of the magnitude

of these interrelationships, cash patronage returns and equity redemption

from federated cooperatives can affect the level of cash benefits local

cooperatives return to their members.

Some federated cooperatives have developed specific participation

redemption plans with locals to redeem equities of estates and, in some

cases, of retired farmer-members. When the local cooperative redeems the

equity of a farmer-member, the federated then redeems a portion of its

equity to the local cooperative. As an example: A local has farmer-member

equity of $100,000 of which $20,000 is invested in a federated regional

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cooperative. When the local is faced with redeeming $10,000 held by an

individual member’s estate, $2,000 would come from the regional.

Many federated cooperatives help their member cooperatives with capital

‘budgeting, long-range planning, financial and legal expertise, publications,

and training for directors and managers. Some federated cooperatives may

have model equity redemption plans and can help locals with

implementation.

HOW TO GET A PROGRAM STARTED

Managing the financial affairs of a cooperative is the legal responsibility of

the board of directors. Equity redemption is an integral part of that

responsibility and requires careful study and planning. These guidelines

should help you get a program developed and implemented:

I. Be convinced your cooperative needs an equity redemption program.

You are the key communication link with the membership. Your

conviction, whether you realize it, will show through in discussions about

the program with the membership. This step alone may determine the

failure or success of the capital formation and equity redemption process

and, perhaps ultimately, the future of your cooperative.

2. Know the legal limits of the board’s responsibilities and its power to act.

As a general rule, courts usually defer to the judgment of the board on uses

of member equity. In a few cases, a member has used the court to force a

board to redeem equity. Usually, the reason stemmed from the board’s

failure to balance the interests of current and former members or violated a

cooperative bylaw, article of incorporation, or State statute.

Courts recognize cooperatives need to engage in long-range planning and

that the board must have the responsibility and power to select, adopt, and

carry out business strategies. Courts are usually reluctant to interfere in the

decisionmaking process of cooperatives and substitute their judgment for

that of the board.

Directors are usually expected to act diligently, with skill consistent with

other reasonably prudent directors in similar circumstances, in a manner

encouraging loyalty to the organization, and in the best interests of the

organization yet not favoring one group of members at the expense of

another.

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The board must balance the interests of members who want service and

growth with those who hold large amounts of unredeemed equities.

Additionally, the short-term interests of members wanting immediate

redemption of equities may conflict with the long-term collective interests

of the cooperative. Consequently, decisions on equity redemption must be

made by the board instead of individual members.

3. Seek financial and legal advice.

Though equity redemption policies and decisions are recognized as being

within the jurisdiction of the board, directors should know when they run

the risk of abusing their power. Legal and financial analysis of a particular

situation may be complex. Conclusions and decisions should be made only

after consulting the State incorporation statute, court cases, and the

cooperative’s articles of incorporation, bylaws, marketing contracts, and

equity certificates.

4. Appoint a committee.

Appoint a committee that represents the board, operating management,

and a cross-section of the membership. Give the committee specific

objectives and a timetable for examining the cooperative’s situation and

submitting recommendations. Identify special expertise the committee

should consult. The committee should:

l Become familiar with the cooperative’s financial operation, sources of

capital, and methods of acquiring equity.

l Collect all relevant financial and legal information--including the

cooperative’s articles of incorporation and bylaws, necessary State statutes,

loan agreements, financial statements, and information on equity

redemption programs of other cooperatives in which yours has an

investment.

l Study your cooperative’s longand equity allocation records.

range financial plans, projected cash flows,

l Study alternative plans for equity formation and redemption-evaluating

each according to the cooperative’s ability to redeem equity and its financial

impact on the plans of the cooperative and its members.

l Se lect a plan of presentation to the board -including any related decisions

that need to be made, such as changi ng the bylaws.

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5. Develop a member education plan.

This plan is by far the most important step and usually the most neglected.

Initially, member education about capital formation and equity redemption

must be overwhelmingly thorough and convincing. Additionally, member

education must never cease. Members must be continually informed of the

capital formation and equity redemption status of their cooperative. In

developing an education plan, the board should:

l Seek public relations and communications advice (just as you should seek

financial and legal advice in developing the program).

l Explain the program from the perspective of the member, thus

attempting to answer the member’s basic question: Why is this program

good for me?

l Use multiple approaches- concise brochures, newsletter articles, group

and individual presentations by fellow members, directors, operating

management and staff, and specialists.

l Consider the need to group members during the presentation stagelong-time members with substantial equity, former members, current

members with substantial patronage, young members, and so on.

l Clearly explain why equity redemption is necessarya

l Clearly explain why the selected program was chosen over other

alternatives.

l Make a deliberate effort to generate discussion and encourage feedback,

either openly or confidentially.

l Set a timetable for implementing the plan, including a target date for

member approval.