CI

Co-ops 101

An Introduction to 

Cooperatives

Cooperative 

Information 

Report 55

United States Department of Agriculture
This report provides a comprehensive summary of basic information on the cooperative way of organizing and operating a business. 

It covers the nature and extent of the use of cooperatives, compares 

cooperatives to other business structures, explains the roles various people play in a cooperative, and discusses equity accumulation 

and income taxation. The purpose is to make available, in a single 

report, the information someone would need to acquire a general 

understanding of how cooperatives function.

Keywords: Cooperative, Business, Finance, Structure, Tax

Co-ops 101: An Introduction to Cooperatives

Donald A. Frederick wrote this report in 1997 and revised it in 

2005. This latest revision was completed by James J. Wadsworth 

and E. Eldon Eversull. 

Cooperative Information Report 55

April 1997

Revised November 2012

Publications and information are also available on the RBS website: http://www.rurdev.usda.gov/rbs/pub/NEWPUB.htm

Email: coopinfo@wdc.usda.gov for more information.

The mention of brand-names, trademarks, and company names in 

this publication is for illustrative purposes only, and in no way constitutes endorsement of any commercial enterprise or product.
i

Preface

Welcome to the dynamic world of cooperation—people working 

together to solve common problems and seize exciting opportunities. Cooperatives are business entities that people use to provide 

themselves with goods and services.

This booklet introduces you to the attributes that distinguish a 

cooperative from other ways to organize and conduct a business. 

Its purpose is to help you understand what makes a cooperative 

unique. It contains a great deal of information to absorb. Use it as 

a reference and refer to it when specific problems arise. Over time, 

you will learn more about cooperatives and your experience with 

them should be more rewarding.
ii

Table of Contents

Introduction ---------------------------------------------------- 1

Chapter 1. A Historical Perspective ----------------------------- 3

Chapter 2. Cooperative Principles and Practices ----------------- 9

 Cooperative Principles ------------------------------------ 9

 The User-Benefits Principle---------------------------- 9

 The User-Owner Principle---------------------------- 10

 The User-Control Principle --------------------------- 10

 Related Practices ----------------------------------------- 11

 The Patronage Refund System ------------------------ 11

 Limited Return on Equity Capital -------------------- 13

 Cooperation Among Cooperatives-------------------- 13

Chapter 3. Cooperatives in the Community -------------------- 15

 Commercial Sales and Marketing Cooperatives ----------- 16

 Financial Cooperatives ----------------------------------- 20

 Social and Public Services Cooperatives ------------------ 22

Chapter 4. Benefits of Cooperation ---------------------------- 25

Chapter 5. Business Organizations ----------------------------- 31

 Individually Owned Businesses--------------------------- 31

 Partnerships --------------------------------------------- 32

 General Business Corporations --------------------------- 33

 Limited Liability Company ------------------------------ 35

 Cooperative---------------------------------------------- 36

Chapter 6. Classifying Cooperatives by Structure --------------- 39

 Geographic Territory Served ----------------------------- 39

 Governance System -------------------------------------- 39

 Functions Performed ------------------------------------- 40
iii

Chapter 7. People---------------------------------------------- 45

 Members ------------------------------------------------ 45

 Directors------------------------------------------------- 48

 Officers ---------------------------------------------- 50

 Board Committees ----------------------------------- 51

 Managers ------------------------------------------------ 52

 Employees ----------------------------------------------- 54

Chapter 8. Sources of Equity----------------------------------- 57

 Direct Investment---------------------------------------- 58

 Retained Margins ---------------------------------------- 59

 Per-Unit Capital Retains --------------------------------- 60

 Nonmember/Nonpatronage Earnings -------------------- 61

Chapter 9. Financial and Tax Planning ------------------------- 63

 Cash Refunds -------------------------------------------- 63

 Qualified Retains ---------------------------------------- 64

 Nonqualified Retains------------------------------------- 66

 Unallocated Reserves------------------------------------- 67

Chapter 10. Equity Management ------------------------------ 69

 Revolving Fund Plan------------------------------------- 69

 Special Plans--------------------------------------------- 70

 Base Capital Plan ---------------------------------------- 71

Conclusion ---------------------------------------------------- 72

Notes --------------------------------------------------------- 73
iv

Introduction
1

There is no universally accepted definition of a 

cooperative. In general, a cooperative is a business owned and democratically controlled by the 

people who use its services and whose benefits 

are derived and distributed equitably on the basis 

of use. The user-owners are called members. They 

benefit in two ways from the cooperative, in 

proportion to the use they make of it. First, the 

more they use the cooperative, the more service 

they receive. Second, earnings are allocated to 

members based on the amount of business they 

do with the cooperative.

In many ways, cooperatives resemble other 

businesses. They have similar physical facilities, 

perform similar functions and must follow sound 

business practices. They are usually incorporated 

under state law by filing articles of incorporation, granting them the right to do business. The 

organizers draw up bylaws and other necessary 

legal papers. Members elect a board of directors. 

The board sets policy and hires a manager to run 

the day-to-day operations.

But in some ways, cooperatives are distinctly 

different from other businesses. These differences 

are found in the cooperative’s purpose, its ownership and control, and how benefits are distributed. They are reflected in cooperative principles 

that explain the unique aspects of doing business 

on a cooperative basis.

Photo courtesy Dairy Farmers of America
Chapter 1

A Historical Perspective
3

In one sense, cooperation is probably as old as 

civilization. Early people had to learn to work 

together to meet their common needs, or perish. The Pilgrims who settled at Plymouth, MA, 

jointly cleared fields abandoned by the Indians, 

broke up the soil, and planted and cared for their 

corn. After the harvest, celebrated with the Indians in 1621 with a Thanksgiving feast, the corn 

was shared equally among the settlers.

Legend suggests that the initial structured 

cooperative business in the United States was 

the Philadelphia Contributionship for the Insurance of Houses from Loss by Fire, a mutual 

fire insurance company established in 1752. This 

association’s reputation is likely based on two 

factors. First, Benjamin Franklin was the organizer. Second, the business has been conducted so 

efficiently over the years that it is still operating 

today.

In the early 1800s, cooperative businesses appeared on several fronts. In Britain, cooperatives 

were formed as a tool to deal with the depressed 

economic and social conditions related to the 

struggles with Napoleon and industrialization. In 

the United States, farmers began to process their 

milk into cheese on a cooperative basis in diverse 

places such as Goshen, CT, and Lake Mills, WI. 

Writers sometimes trace the origin of cooperatives from the Rochdale Equitable Pioneers’ 

Society, an urban, consumer cooperative orga-
4

nized in England in 1844. It sold consumer goods such as food and clothing to 

persons unhappy with the merchants in 

the community.

While neither the first nor most successful early cooperative, the Rochdale 

Society developed an active outreach 

program, encouraging and assisting others to form cooperatives. It also prepared 

a written list of practices and policies that 

seemed consistent with success of such 

efforts. This list became one of the first sets 

of cooperative principles, characteristics 

that distinguish cooperatives from noncooperative businesses.

•	 Open membership

•	 One member, one vote

•	 Cash trading

•	 Membership education

•	 Political and religious neutrality

•	 No unusual risk assumption

•	 Limitation on the number of shares 

owned

•	 Limited interest on stock

•	 Goods sold at regular retail prices

•	 Net margins distributed according to patronage

The Grange, founded in 1867, quickly became the major thrust 

behind agricultural and rural cooperatives in America. In 1874, a 

Grange representative went to Europe to gather information about 

cooperatives. In 1875, the Grange published a set of rules for the 

organization of cooperative stores, based on the Rochdale principles.

Local granges organized stores to serve their rural members. 

They sold groceries and clothing as well as general farm supplies, 

hardware and agricultural implements. Granges in the South mar-
5

keted cotton. Those in Iowa operated grain elevators. In Kentucky, 

they sponsored warehouses for receiving and handling tobacco. 

California Granges exported wheat and marketed wool.

As the country recovered from the depression of the 1870s, 

fewer Granges were organized and many cooperatives went out 

of business, but the impact of the Grange cooperative movement 

survives. It demonstrated that the Rochdale type of cooperative, 

which handled goods at prevailing prices and distributed net savings according to use, offered a sound basis for cooperative efforts 

in America.

Cooperation flourished during the three decades from 1890 to 

1920. As many as 14,000 farmer cooperatives were operating by 
6

the end of the period. Cooperative growth was fueled by the wave 

of other farmer movements and farm organizations sweeping the 

country, such as the American Society of Equity, National Farmers Union, and the American Farm Bureau Federation. They were 

engaged in marketing virtually every farm crop and furnishing 

supplies and services to their producer-members. Many of today’s 

major farmer cooperatives were formed during this period.

The following decades have seen farmer cooperatives develop 

their own financial institutions through the Farm Credit System. 

Nonagricultural cooperatives likewise developed the National 

Cooperative Bank. With help from the Rural Electrification 

Administration, rural residents used cooperatives to bring electric 

and telephone services to their towns and farms. The rural electrics 

formed the National Rural Electric Cooperative Finance CorporaPhoto by Neil Crosby/Neil studios, courtesy Tennessee Farmers Cooperative
7

tion (CFC) as a supplemental source of financing.

Some cooperatives have become larger, partially in response to 

growing concentration among their competitors and the firms their 

members must deal with. They have adopted modern management 

techniques and sophisticated processing, distribution and marketing methods.

Today rural and urban residents use cooperatives to acquire consumer services such as housing, credit and other financial services 

(through credit unions), groceries, education and telecommunications. Franchisees, governmental units, hardware and grocery stores, 

florists and numerous other businesses use cooperatives to market 

their products and secure the supplies they need at competitive 

prices.

Cooperatives remain a major component of the food and agriculture industry, but now they are available to help people provide 

services for themselves in virtually all segments of the economy.
Chapter 2

Cooperative Principles 

and Practices
9

Cooperative Principles

Various writers over the past century have analyzed and observed the application of cooperative principles. Although slight differences in 

terminology appear on the various lists, three 

principles emerge as being widely recognized and 

practiced.

These principles are more than just good practices, policies or common sense. They distinguish 

a cooperative from other kinds of business. They 

are also recognized in State and Federal statutes and regulations as criteria for a business to 

qualify as a cooperative.

The User-Benefits Principle

Members unite in a cooperative to get services 

otherwise not available, to get quality supplies at 

the right time, to have access to markets or for 

other mutually beneficial reasons. Acting together gives members the advantage of economies 

of size and bargaining power. They benefit from 

having these services available, in proportion to 

the use they make of them.

Members also benefit by sharing the earnings 

on business conducted on a cooperative basis. 

When cooperatives generate margins from efficient operations and add value to products, these 

earnings are returned to members in proportion 

to their use of the cooperative. Without the cooperative, these funds would go to other middlemen or processors.
10

The User-Owner Principle

The people who use a cooperative own it. As they own the assets, 

the members have the obligation to provide financing in accordance with use to keep the cooperative in business and permit it 

to grow. Accumulating adequate equity is a major challenge facing 

many cooperatives. How this task is accomplished is discussed later.

The User-Control Principle

As owners, a cooperative’s members control its activities. This 

control is exercised through voting at annual and other member-
11

ship meetings, and indirectly through those 

members elected to the board of directors. 

Members, in most instances, have one vote 

regardless of the amount of equity they own 

or how much they patronize the organization.

In some instances, high-volume users may 

receive one or more additional votes based on 

their patronage. Equitable voting is assured, 

often by limiting the number of additional 

votes any one member can cast. This protects 

the democratic control of the membership as 

a whole.

Only members can vote to elect directors and to approve proposed major legal and 

structural changes to the organization. The 

member-users select leaders and have the authority to make sure the cooperative provides 

the services they want. This keeps the cooperative focused on serving the members, rather 

than earning profits for outside investors or 

other objectives.

Related Practices

Certain business practices have developed 

that implement and facilitate these basic 

principles. They further differentiate a cooperative from other forms of doing business.

The Patronage Refund System

While cooperatives strive to return earnings to members, this can’t 

be done on a transaction-by-transaction basis. Rather, cooperatives 

usually charge market prices for supplies and services furnished to 

members and competitive prices for products delivered for further 

processing and marketing. Normally, this allows them to generate sufficient income to cover costs and meet continuing needs for 

operating capital.
12

After the fiscal year is over, a cooperative computes its earnings 

on business conducted on a cooperative basis. Those earnings are 

returned to the patrons — as cash and/or equity allocations — on 

the basis of how much business each patron did with the cooperative during the year. These distributions are called patronage refunds.

For example, if a cooperative has earnings from business conducted on a cooperative basis of $20,000 for the year, and Ms. 

Jones does 2 percent of the business with the cooperative, she 

receives a patronage refund of $400 ($20,000 x .02).

This allows the cooperative to return margins to members on an 

annual basis, consistent with standard accounting conventions and 
13

without regard to how much was earned on 

each transaction.

Limited Return on Equity Capital

Members form a cooperative to get a service—source of supplies, market for products 

or performance of specialized functions—not 

a monetary return on capital investment.

Many cooperatives don’t pay any dividends 

on capital. Others pay a modest return, in line 

with state and federal statutes that bar substantial payments.

Limiting returns on equity supports the 

principle of distributing benefits proportional 

to use. It also discourages outsiders from trying to wrest control of a cooperative from its 

members and operate it as a profit-generating 

concern for the benefit of stockholders.

Cooperation Among Cooperatives

Many cooperatives, especially local associations, are too small to gather the resources 

needed to provide all the services their members want. By working with other cooperatives—through federated cooperatives, joint 

ventures, marketing agencies in common, and informal networks—

they pool personnel and other assets to provide such services and 

programs on a collaborative basis at lower cost.

This permits members of local cooperatives to participate in 

owning and managing fertilizer plants, food manufacturing facilities, power plants, national financial institutions, wholesale grocery 

and hardware distribution programs, and so forth. Benefits flow 

back through the local cooperatives to the individual members. 

These principles and practices have survived and flourished 

through 150 years of continuous evolution in the business world. 

They remain the foundation that supports the distinctive cooperative method of doing business.
Chapter 3

Cooperatives in the 

Community
15

Cooperatives are meeting people’s needs in all 

sectors of American life. A study by the University of Wisconsin reports that 29,285 cooperatives 

directly serve almost 351 million members in the 

United States (many people belong to more than 

one cooperative). These cooperatives have more 

than 2.1 million employees and generate revenue 

of nearly $653 billion. 

Table 3.1 provides a breakdown of the numTable 3.1—U.S. Cooperatives by Sector*

Number Revenue

($millions)

Employees

Commercial Sales 

and Marketing

3,463 201,207 422,505

Social and Public 

Services

11,311 7,525 424,505

Financial Services 9,964 394,363 1,133,353

Utilities 4,546 49,408 162,873

 Total 29,284 652,903 2,143,236

*Commercial sales and marketing: farm supply and marketing; biofuels; grocery and 

consumer goods retail; arts and crafts and entertainment.

Social and public services: housing; healthcare; daycare; transportation; education.

Financial services: credit unions; farm credit; mutual insurance.

Utilities: electric; telephone; water.

Source: Research on the Economic Impact of Cooperatives (June 2009, University 

of Wisconsin Center for Cooperatives). The tables that follow in this chapter are from 

that study as well.
16

ber of cooperative businesses by sector, their revenue and number 

of employees. The 11,000 Social and Public Services cooperatives 

represent the biggest co-op sector in terms of number of firms. 

Financial Services rank second, followed by Utilities, and Commercial Sales and Marketing. Ranked by revenue and number of 

employees, the Financial Services sector is largest, with $394.4 billion in revenue and 1.1 million employees.

Commercial Sales and Marketing Coooperatives

Focusing on the Commercial Sales and Marketing sector, table 

3.2 shows farm supply and marketing cooperatives are the largest 

group with more than 2,500 co-ops (although more recent USDA 

data shows that number has declined to 2,285, due primarily to 

mergers). These co-ops employ more than 183,000 individuals. 

Of these farmer co-ops, 1,222 primarily marketed farm products; 

935 primarily handled farm production supplies; and 128 provided 

services related to marketing or purchasing activities.

Marketing cooperatives handle, process and sell cotton, dairy 

products, fruits and vegetables, grains and oilseeds, livestock and 

poultry, nuts, rice, sugar and other agricultural commodities. Farm 

supply cooperatives provide producers with farm chemicals, feed, 

fertilizer, petroleum products, seed and other inputs. Farm service 

Number Assets

($millions)

Revenue 

($millions)

Employees 

(thousands)

Memberships 

(thousands)

Farm Supply 

and Marketing

2,547 44,394 119,074 147.80 2,484

Biofuels 39 2,750 4,231 1.75 20

Grocery 290 323 865 13.60 487

Arts and Crafts 305 34 32 0.83 16

Other (retail 

and service 

cooperatives)

282 13,338 51,391 102 3,075

 Total 3,463 60,839 175,593 265.78 6,082

Table 3.2—Commercial Sales and Marketing Cooperatives
17

cooperatives operate cotton gins, provide trucking and artificial 

insemination services, and store and dry products.

In 2011, farmer cooperatives had more than 2.2 million members (many farmers belong to more than one cooperative) and 

generated a total gross business volume of $213.4 billion. Total net 

earnings (adjusted for losses) were $5 billion. Combined assets of 

the group totaled $78.5 billion and liabilities were $50.6 billion, 

leaving member equity of $27.9 billion. 

There are 290 U.S. grocery cooperatives with revenue of $865 

million and 13,000 employees. Many of these grocery cooperatives and other independent grocery stores are served by cooperative grocery wholesalers that provide them with the advantages of 

group buying power and brand names, helping them better compete with large grocery chains and discount stores.

 The nation’s 305 arts and crafts cooperatives have annual revenue of $32 million. They have 16,000 members and employ 830 

people. These cooperatives are used by artists and craftspeople to 

market their products and maximize sales income. They are also 

used to obtain studio space and other specialized supplies or services. 

There are 282 other retail and service cooperatives, including 

restaurant supply purchasing co-ops, which save money and provide quality products for franchisees of such noted fast-food chains 
18

as KFC (Kentucky Fried Chicken), Dunkin’ Donuts, Arby’s, Taco 

Bell, Burger King, Popeye’s and Church’s. Besides their bottomline impact, purchasing cooperatives also offer another, less tangible 

benefit: they help to build trust among franchisers and franchisees, 

particularly on pricing issues.

 Cooperatively owned hardware wholesalers supply virtually all 

of the independent hardware stores in the United States. As huge 

warehouse store chains spread across the nation, the independents 

are relying more and more on Cotter and Company (True Value), 

Ace Hardware and other cooperatives for products, promotions and 

education services to remain viable businesses.

Cooperatives are leaders in other major industries including 

outdoor goods and services (Recreational Equipment Inc./REI), 

lodging (Best Western), carpeting (Carpet One), insurance, natural 

foods, hospital and pharmacy supply, electric and building supplies, 

and collegiate bookstores.

Utility Cooperatives

Another important cooperative activity in rural areas is furnishing 

electric power. The nation’s 929 rural electric cooperatives provide 

electricity to 12 percent of the nation’s population by serving 40 
19

million people in 47 States, including 17 million businesses, homes, 

schools, churches, farms, irrigation systems and other establishments. Sixty-five of these are called generation and transmission 

cooperatives (G&Ts) because they generate and transmit electricity to meet the power needs of other cooperatives that distribute 

electricity to homes, farms and businesses. Electric cooperatives 

own assets of $92 billion, own and maintain 2.4 million miles (43 

percent) of America’s electric distribution lines and employ 65,000 

people.

Telecommunications services to rural areas are also provided by 

cooperatives. More than 1.2 million people in 31 States are served 

by 255 telephone cooperatives. These cooperatives provide local 

telephone exchange services, long distance telephone operations, 

direct broadcast satellite, wireless, TV, mobile radios, cellular and 

key systems, and Internet access.

Water cooperatives are another type of utility cooperative. There 

are more than 3,300 water co-ops serving almost 2 million people. 

Table 3.3—Utility Cooperatives

Number Assets 

($millions)

Revenue 

($millions)

Employees 

(thousands)

Memberships 

(thousands)

Rural Electric 

Cooperatives

929 111,786 34,275.00 67.29 16,652

Generation 

and Transmission

65 42,490 2,246.00 11.16 854

Distribution 846 69,296 32,029.00 55.09 15,798

Rural Telephones255 5,116 1,520.841 2.61 964

Water Cooperatives3,352 2,240 1,703.00 39.26 2,066

Cooperatives 

and Mutuals

2,228 1,401 350.00 39.05 1,753

Associations 1,122 839 253 0.21 312

 Total 4,546 105,034 61,086 119 19,692
20

Most water cooperatives are small in terms of number of people 

served. 

Financial Cooperatives

There are 8,334 credit unions in the United States, serving about 

92 million consumers. Of these, 5,036 are federally chartered credit 

unions holding $418 billion in assets; another 3,157 credit unions 

are State chartered, holding $336 billion in assets. Building on 

their core services of member savings accounts and consumer loans 

and home mortgages, credit unions now offer additional services to 

their members, including credit cards, automated teller machines, 

tax-deferred retirement accounts and certificates of deposit.

Created in 1916, the cooperative Farm Credit System is the nation’s oldest and largest financial cooperative. It provides real estate 

loans, operating financing, leasing, facility and equipment financing, real estate appraisals and crop insurance to nearly 500,000 

farmer, small-town resident and cooperative borrowers nationwide. 

Through 90 local Farm Credit associations and five Farm Credit 

banks, the Farm Credit System provides more than $160 billion in 

credit and related services to its members.

Table 3.4—Financial Services Cooperatives

Number Assets 

($millions)

Revenue 

($millions)

Employees 

(thousands)

Memberships 

(thousands)

Credit 

Unions

8,334 760,971 40,218 236.55 91,537

Farm Credit 

System

104 186,451 11,884 11.17 401

Mutual 

Insurance

1,497 842,340 140,038 122.17 232,969

Cooperative 

Finance

43 1,072,196 72,691 6.25 27.891

 Total 6,627 2,861,958 264,831 376.14 324,935
21

A major element of the Farm Credit System is CoBank, ACB. 

This bank has a loan volume of more than $42 billion. Loans are 

made to farmer and rural utility cooperatives and water and communications providers. CoBank has become an important financier 

of exports of U.S. farm products as it broadens its role of making 

credit available to enhance farm and rural income.

Since 1969, the National Rural Utilities Cooperative Finance 

Corporation (CFC) has been a valuable source of financing for 

rural electric and telephone cooperatives. CFC supplements funding provided by USDA’s Rural Utilities Service and provides business services to its borrowers. Together, CFC and its affiliates – the 

National Cooperative Services Corporation (NCSC) and the Rural 

Telephone Finance Cooperative (RTFC) – provide financing to 

1,520 member organizations and affiliates in 49 States, the District 

of Columbia and two territories. CFC total gross loans and guarantees stand at $20.5 billion.

National Cooperative Bank (NCB) has become an important 

financial institution for America’s housing, business and consumer 

cooperatives. Chartered by Congress in 1978 and private since 
22

1982, NCB, with $1.6 billion in assets, has originated more than 

$2.4 billion in loans to nearly 1,000 cooperatives throughout the 

country. NCB has become a leader in providing development funding for new, non-agricultural cooperatives and in devising methods 

of attracting outside capital to leverage its investments.

Social and Public Services Cooperatives

There are 11,311 social and public services cooperatives in the 

United States, with most of these being housing cooperatives; 

childcare cooperatives are the next most numerous type. It is 

estimated that the 9,471 housing cooperatives represent 1 million 

units of housing, with nearly 600,000 of the units in New York 

City. New units are being developed in many other areas, including senior citizen communities, manufactured housing courts, 

low-income housing complexes and student housing near college 

campuses.

There are 305 healthcare cooperatives with assets of $1.1 billion. 

These cooperatives serve millions of Americans. Health mainteTable 3.5—Social and Public Services

 

Number Assets

($millions)

Revenue 

($millions)

Employees 

(thousands)

Memberships 

(thousands)

Healthcare 305 1,109 3,290 73.18 961.22

Childcare 1,096 45 868.17 - -

Housing 9,471 - - - -

Transportation49 68 290 0.50 29.08

Education 390 428 692 9.75 14.80

 Total 11,311 1,650 4,358 91.60 1,005
23

nance organizations (HMOs) serve more than 1 million people 

coast to coast. In a number of major cities – including Seattle, 

Minneapolis, Memphis, Sacramento, Salt Lake City and Detroit 

– companies have formed cooperative health alliances to purchase 

health care for their employees.

Childcare cooperatives help meet the needs of families where 

the parents are employed and want affordable, supportive care for 

their young children while working. These centers can be organized 

by parents on their own, by a single employer or by a consortium of 

businesses providing a single center for the group. There are 1,096 

U.S. childcare cooperatives used by more than 50,000 families. 

Finally, there are 49 transportation and 390 education cooperatives providing services to Americans across the nation. 
Chapter 4

Benefits of Cooperation
25

People buy stock in a non-cooperative business 

to make money on their investment. The more of 

the company you own, the more benefits (stock 

appreciation and dividends) you will realize if the 

business succeeds.

The benefits of being a cooperative member 

differ in two ways. First, the advantages are more 

numerous. Second, they are distributed on the 

basis of how much use you make of the cooperative, rather than your equity stake. Here are some 

benefits of cooperative membership and how 

they relate to use.

1. Access to quality supplies and services at reasonable 

cost.

By banding together and purchasing business 

supplies and services as a group, individuals offset 

the market power advantage of firms providing those supplies. You can gain access to volume discounts and negotiate from a position of 

greater strength for better delivery terms, credit 

terms, and other arrangements. Suppliers will be 

more willing to discuss customizing products and 

services to meet your specifications if the purchasing group provides them sufficient volume to 

justify the extra time and expense.

The larger the group purchasing supplies and 

services through the cooperative, the greater the 

potential for savings. And the more each indi-
26

vidual member uses the supply operation, the more he or she may 

save over doing business elsewhere.

Another option for cooperative members is to manufacture their 

own supplies and hire experts directly to provide essential services. This gives members even more reliable sources of supply and 

greater control over the types of products available, the cost, and 

the quality of the services received.

2. Increased clout in the marketplace.

Marketing on a cooperative basis, like purchasing supplies and 

services, permits members to combine their strength while maintaining their status as independent business people. They can lower 
27

distribution costs, conduct joint product promotion, and develop 

the ability to deliver their products in the amounts and types that 

will attract better offers from purchasers.

A special Federal law, the Capper-Volstead Act, provides a limited exemption from antitrust liability for marketing agricultural 

products on a cooperative basis. Under this law, farmers can agree 

on the prices they will accept for their products and other terms of 

sale.

Through cooperative marketing, members can share information 

and negotiate with buyers from a position of greater strength and 

security. They can also develop processing facilities by themselves or 

as part of a joint venture with other cooperative or non-cooperative 

firms.

A cooperative can also serve as a 

vehicle for people selling goods and 

services to work with their customers 

to promote industry research, reduce 

regulatory burdens, and develop markets for their products. The cooperative 

can help create a “win-win” situation 

for the entire industry, a business environment where both producers and 

buyers have more income.

3. Share in the earnings. 

Some people talk about noncooperative firms operating “for profit” while 

cooperatives operate “at cost.” This isn’t 

totally accurate. Most cooperatives 

generate earnings. They differ from 

non-cooperative firms in how they allocate and distribute their earnings.

A non-cooperative firm retains its 

earnings for its own account, or perhaps pays part of them out to shareholders as dividends, based on the 

amount of stock each investor owns. 
28

In a cooperative, earnings are usually allocated 

among the members on the basis of the amount 

of business each did with the cooperative during 

the year. Remember the example of a cooperative 

that has net earnings of $20,000 during the year 

and conducts 2 percent of its business with Ms. 

Jones. She is allocated $400 of those earnings 

($20,000 x .02).

Typically, Ms. Jones would receive her allocation, called a patronage refund, partly in cash and 

the remainder as an addition to her equity account in the cooperative. Permitting their cooperative to accumulate retained patronage refunds 

is a relatively easy and painless way for members 

to help finance activities and growth. Also, if 

certain rules in the Internal Revenue Code are 

followed, the cooperative may deduct both the 

cash payouts and the retained patronage refunds 

from its taxable income. This makes cooperative 

earnings particularly valuable.

4. Political action.

Growers, small business owners, and other rural 

residents have to realize that no one gives you a favorable law or 

regulatory ruling just because you think you deserve it. You have to 

build your case and argue your point convincingly.

A cooperative gives people a means to organize for effective 

political action. They can meet to develop priorities and strategies. 

They can send representatives to meet with legislators and regulators. These persons will have more influence because they will be 

speaking for many, not just for themselves.

They can also form coalitions with other groups having similar 

views on issues. The larger the voice calling for a specific action, the 

more likely that the system will respond with the policy you desire.

Co-op leaders file up the steps of the Eisenhower Executive 

Office Building to meet with White House officials. 

Photo courtesy National Cooperative Business Association
29

5. Local economy enhanced and protected.

 Having its businesses owned and controlled on a cooperative 

basis helps your entire community. Cooperatives generate jobs and 

salaries for local residents. They pay taxes that help finance schools, 

hospitals, and other community services.

When a business is a cooperative, your town is less likely to lose 

those jobs and taxes. A business owned by one person, or a subsidiary of a big company, can easily be moved to another community. 

When many local people share the ownership of a cooperative, no 

individual or company can take it from your area or simply close it. 

Only the membership as a whole can make such decisions.
Chapter 5

Business Organizations
31

In the United States, historically there are three 

basic categories of private business firms—individually owned, partnerships and corporations. 

Cooperatives are a type of corporation. Recently, 

most States have approved a new business structure, the limited liability company. This section 

explains the similarities and differences between 

cooperatives and the other business forms.

Individually Owned Businesses

The individually owned business is the oldest and 

most common form. One person owns, controls 

and conducts the business. Characteristics of 

individually owned businesses include:

•	 Control. The owner is responsible for management, makes all the major operational 

decisions and sets the business policies.

•	 Capital. The owner supplies the equity and 

is responsible for all debts.

•	 Earnings. Profits belong to the owner.

•	 Taxes. Profits are taxed once, as income of 

the owner.

•	 Life. The life of the individually owned 

business is tied to the one owner. It continues until the owner sells the business, 

retires or dies. At that point the business is 

either taken over by a new owner or discontinued.
32

Many farms are operated as individually 

owned businesses. Other examples of business 

commonly operated by an individual owner 

include service stations, hardware stores, restaurants, flower shops and dry cleaners.

Partnerships

Partnerships consist of two or more people 

who jointly own, control and operate a business. The responsibilities of each are usually 

based on a partnership agreement. Characteristics of partnerships include:

•	 Control. Partners usually share management and make policy decisions by mutual agreement or majority vote. Some 

agreements provide for senior partners 

whose votes may carry greater degrees 

of weight.

•	 Capital. Partners provide the equity capital. Usually, each 

partner is personally liable, up to the value of all the property 

he or she owns (both within and outside the partnership), 

for the debts of the partnership. Some partnerships have 

“limited” partners, who relinquish any voice in managing the 

business in exchange for a limit on their personal liability.

•	 Earnings. Profits (or losses) are shared by the partners in accordance with the terms of the partnership agreement. This 

is usually determined by the amount of capital invested and 

the nature of the work performed by each partner.

•	 Taxes. Earnings are taxed once, as income of the partners.

•	 Life. The life of the partnership as a business is determined 

by the partners, but if one dies or leaves the organization, it 

often must be dissolved and a new partnership formed.

Dairy farmer-owned cooperatives produce a wide variety 

of value-added foods, including cheese. 
33

Some farms are owned and operated on a partnership basis. 

Other examples include law and accounting firms, insurance and 

real estate companies. Partnerships may operate an auto repair firm, 

store and any other business.

General Business Corporations

Most businesses that have more than a small number of owners are 

organized as corporations. Corporations are legal entities, authorized by law to act much like an individual person. A corporation 

has the right to provide services, own property, borrow money, 

enter into contracts and is liable for its own debts.

A general business corporation operates as a profit-making 

enterprise for its investors, who are also referred to as stockholders. 
34

Most of the major corporations in America 

operate as general business corporations. Their 

characteristics include:

•	 Control. Management is controlled by a 

board of directors and officers who are 

elected by the stockholders. Each stockholder usually has as many votes as the 

number of shares of voting stock he/

she owns. Business decisions and policy 

are made by the board and officers. The 

directors have no obligation to use the 

firm’s products or services and may have 

no contact with the firm outside of 

board meetings.

•	 Capital. Equity is raised by selling shares 

of stock to investors for their profitmaking potential. The corporation is 

responsible for its own debts. If the 

business fails, each owner of stock can 

lose only the amount invested.

•	 Earnings. Profits are distributed to stockholders as dividends according to the 

number of shares of stock owned or 

used to expand the business. The timing and amount of such 

dividend distributions are decided by the board of directors.

•	 Taxes. Earnings are taxed twice, as income of the corporation 

when earned and as income of the stockholders when distributed as dividends.

•	 Life. A corporation enjoys a continuing existence, regardless 

of changes that may occur in the ranks of its shareholder 

owners.

Examples of investor-oriented corporations are large department stores, chain grocery stores, regional banks, automobile 

manufacturers and much of the communications industry.

Photo courtesy CoBank
35

Limited Liability Company

A new form of business gaining widespread attention is the limited 

liability company (LLC). It combines the single-tax treatment of a 

partnership and the limited personal liability of owners of a corporation. Characteristics of an LLC include:

•	 Control. The owners, called members as in a cooperative, may 

share management and make policy decisions by mutual 

agreement or majority vote, or turn the management over to 

nonmembers. The operating agreement among the members 

determines voting rights of each member.
36

•	 Capital. Members usually provide the equity capital. Liability 

of the members is usually limited to their investment in the 

corporation.

•	 Earnings. Profits (or losses) are shared by the members in 

accordance with the terms of the operating agreement. This 

is usually based on the amount of capital invested and the 

nature of the work performed by each member.

•	 Taxes. The Treasury Department assumes an LLC wants to 

be taxed as a partnership. However, an LLC has the option 

to elect to be taxed as a general business corporation.

•	 Life. An LLC may have a perpetual existence, or the members may chose to be governed by the partnership rules.

The LLC is still developing as a business structure. It is already 

proving a useful vehicle for organizing joint ventures among established corporations, including those involving cooperative and 

noncooperative firms. Whether it can be used to organize a number of individuals, who may want the flexibility to join and leave 

the venture at will, is undetermined at this time.

Cooperative

A cooperative corporation is also a state-chartered business. organized and operating under its laws. Attributes of cooperative 

corporations include:

•	 Control. Management is controlled by a board of directors 

who are elected by the members. One unique feature of a 

cooperative is that each member usually has only one vote in 

selecting directors, regardless of the amount of equity that 

member has in the cooperative. Another is that all or most of 

the directors must be members of the cooperative. Thus, the 

leaders are regular users of the firm’s products or services.

•	 Capital. Equity comes from the members, rather than outside investors. It is obtained by direct contributions through 

membership fees or sale of stock, by agreement with members to withhold a portion of net income based on patronage, 
37

or through retention of a portion of sales proceeds for each 

unit of product marketed. If a cooperative fails, the liability 

of each member is limited to the amount he/she has invested.

•	 Earnings. Earnings (or losses) on business conducted on a 

cooperative basis, often called margins, are allocated to the 

members on the basis of the use they made of the cooperative during the year, not on the basis of equity held. The allocations may be distributed in cash or retained as additional 

equity. Members usually receive a combination of cash and 

an allocation of equity.

•	 Taxes. Earnings from business with members are taxed once, 

either as income of the corporation when earned or as income of the members when allocated to them.

•	 Life. A cooperative usually has a perpetual existence. Members can routinely join or resign without disrupting ongoing 

operations.

Examples of businesses that operate as cooperatives include 

agricultural marketing, purchasing and service organizations; credit 

unions; health care providers and multi-unit housing facilities.
Chapter 6

Classifying Cooperatives 

by Structure
39

Cooperatives are described by a number of classification schemes. The more important ways to 

categorize them are based on the geographical 

territory served, the governance system and the 

functions they perform.

Geographic Territory Served

One factor determining cooperative structure 

is the size of the area served. Cooperatives are 

loosely categorized as “local” or “regional.”

Local cooperatives typically operate within a 

single State, often within one or two counties. 

They usually have only one or two facilities from 

which to serve members.

Regional cooperatives usually serve an entire State 

or a number of States. They can have operations 

that are nationwide or cover major portions of 

the United States. Some regional cooperatives 

also have international operations with sales and 

members in more than one country. 

Governance System

Cooperatives can also be classified based on 

membership structure, as “centralized,” “federated” or “mixed.”
40

Centralized cooperatives have individuals 

and business entities (including partnerships and family corporations) as members. Virtually all locals are centralized. 

Regional cooperatives may also be centralized.

A centralized cooperative has one central office, one board of directors elected by its 

members, and a manager (or chief executive officer) who supervises all operations. Business may 

be conducted through numerous branch stores or 

offices staffed by employees responsible to the central 

management team.

Federated cooperatives have other cooperatives as their 

members. Each member of a federated is a separate cooperative that owns a membership share entitling it to voting 

rights in the affairs of the federated. Local cooperatives commonly form federated regional cooperatives to perform activities too complex and expensive for them to do individually, 

such as manufacturing production supplies, tapping major financial 

markets and marketing on a national or international scale. 

Each local cooperative member of a federated cooperative typically has its own board of directors, manager, employees and facilities to serve its members. The federated has its own hired management and staff and a board of directors elected by and representing 

its member cooperatives.

Mixed cooperatives have both individuals and other cooperatives as 

members. Individuals have voting rights and the cooperatives usually do also.

Functions Performed

Cooperatives may perform one or more of three core functions: 

marketing products, purchasing supplies and providing services.
41

Marketing cooperatives help members maximize 

the return they receive for crops and goods they produce. Most cooperative marketing activity involves either agricultural products or producers in related industries, such as forestry, 

aquaculture and horticulture. New marketing ventures are developing in such diverse industries as handicrafts, professional services 

and information technology.

Some marketing cooperatives limit their activity to negotiating 

prices and terms of sale with buyers. Dairy farmers and producers 

of fruits, nuts and vegetables grown for processing are primary users of these cooperatives, often called bargaining associations.

Other marketing associations assemble member production 

Many marketing cooperative brand names are familair 

sights on grocery market shelves
42

into large quantities for sale to further processors, wholesalers or 

retailers. This first-handler role is common for cooperatives of grain 

growers and producers of fruits and vegetables for the fresh produce market.

Other such associations add further value to member production 

by processing or manufacturing member products into other more 

valuable products. These may serve as ingredients in further-processed products or be sold to institutional buyers and restaurants 

for their direct use, to grocery chains for resale as private-label 

products, or to companies for resale under their private brand. Cooperatives that process dairy products, fruits, vegetables, grains, fish 

and lumber exemplify these value-added processing activities.

Some co-ops put member products right on the grocery store 

shelf under their own brand name. Land O’Lakes dairy foods, 

Sunkist citrus, Ocean Spray cranberries and beverages, Blue Diamond almonds and Welch’s grape jelly and juices are examples of 

cooperatives with established brands.

Marketing cooperatives enable members to extend control of 

their products – and realize additional margins – through processing, distribution and sale.

Purchasing cooperatives were first used by farmers to gain access to 

affordable, quality production supplies such as feed, fuel, fertilizer 

and seed. These early efforts often became businesses having fulltime managers and warehouses to handle other production supplies and services such as farm chemicals, animal health products, 

fencing, building supplies, construction contracting, automotive 

accessories, etc.

Many local purchasing cooperatives have affiliated with other 

such organizations, often through regional federated cooperatives. 

These efforts reduce member costs and strengthen their purchasing 

power through direct ownership of large-scale facilities, such as petroleum refineries and feed mills. Today, many non-farm businesses 

have developed supply purchasing cooperatives to gain access to the 

same volume discounts and quality-control assurances long available to farmers. These include hardware stores, independent grocery 

stores and fast-food restaurant franchisees. Many have developed 
43

private labels, such as Shurfine Foods, or recognized brand names 

such as Ace Hardware, True Value and Servistar.

Service cooperatives were also developed to serve farmers. Some of 

these services are farm-specific, such as recommending and applying fertilizer, lime, or pesticides; cotton ginning; animal feed 

processing; and crop harvesting. Others are general in nature, such 

as credit through the Farm Credit System, electricity through rural 

electric cooperatives and communications service through rural 

telephone cooperatives.

Non-agricultural service cooperatives are also flourishing. Credit 

unions and the National Cooperative Bank provide credit on a 

cooperative basis to non-farm individuals and cooperatives. School 

systems, health care providers and insurance buyers are among the 

general public segments making use of service cooperatives. 
Chapter 7

People
45

Because a cooperative is owned and controlled by 

the people who use its services, the various persons affiliated with a cooperative must work even 

more closely together than in a noncooperative 

firm. Customer service and satisfaction are the 

driving forces behind a cooperative, not maximizing bottom-line return to investors. These take on 

a highly personal tone when the owners and directors, in their role as users, have regular contact 

with management and staff.

Cooperatives depend on a coordinated team 

consisting of four elements — members-owners, 

board of directors, the manager and other responsible employees. Each part of the team has 

its own distinctive duties. Success is based on 

intelligent and active cooperation and each group 

carrying its load.

Members

Members are the foundation of the cooperative. 

They organized it. Their needs are the reason for 

its existence. Their support, through patronage 

and capital investment, keeps it economically 

healthy. And their changing requirements shape 

the cooperative’s future.

Statutory law and the basic legal documents of 

a cooperative — articles of incorporation, bylaws, 

and contracts between the cooperative and its 

members — give the members the tools to con-
46

trol the cooperative and the duty to use those tools for their mutual 

benefit. Legal rights and responsibilities of cooperative members 

normally include:

•	 To adopt and amend the articles of incorporation and bylaws.

•	 To elect and, if necessary, remove directors.

•	 To decide whether to dissolve, merge or consolidate the 

cooperative or form a joint venture with other cooperative or 

noncooperative firms.

•	 To make sure officers, directors and other agents comply 

with laws applicable to the cooperative and with its articles 

of incorporation, bylaws and membership contracts.

Members also have general responsibilities toward their cooperative. Unlike the passive investor in a general business corporation, 

the member-owner-user of a cooperative must patronize and guide 

the venture for it to succeed. Employees and advisers need to understand these member obligations and help members fulfill them. 
47

1. Patronize the cooperative. Members must make a conscious decision to be committed to the cooperative, even when short-term 

prices or services may be better 

elsewhere. If members don’t want 

to use the cooperative, the need 

for it must be reexamined.

2. Be informed about the cooperative. 

To carry out their other duties, 

members must know what the 

cooperative is about; what it can 

do for them; its purpose, objectives, policies; and the issues it 

faces. They can obtain information through annual meetings, 

reports and newsletters, and from 

talking to the manager, staff, 

directors and other members. To 

effectively exercise their right of ownership, a member needs a good 

understanding of the present situation and projected future operations.

3. Be conscientious when selecting and evaluating directors. Although 

the cooperative is a user-owner, democratically controlled form of 

business, members can’t make all the decisions directly. They select 

from among their peers individuals with the best judgment and 

business management skills to represent them in management affairs as the cooperative’s board of directors. Loyalty, integrity, the 

ability to make wise business decisions and willingness to serve are 

necessary characteristics for board members.

4. Provide necessary capital. Members must provide the equity financing their cooperative needs for acquiring inventory, facilities, 

services and working capital. This is done initially through the 

purchase of stock or a membership. It continues by permitting the 

cooperative to retain a portion of the earnings allocated to each 

member and through the collection of per-unit retains from checks 

to members for the proceeds of sale from marketing member products.
48

If the cooperative loses money, members have the same obligation to share those losses as they do the earnings.

5. Evaluate performance of the cooperative. Members should examine 

the annual report and observe whether the cooperative is meeting 

their needs. If they are dissatisfied with cooperative performance, 

they should share their concerns with the directors. They should 

also express support for things the cooperative is doing well. Directors can’t effectively represent the members if they don’t know the 

members’ true feelings.

Directors

Directors in a cooperative occupy a key position between members 

and hired management. They are both users of its services and representatives of other members who depend on those same services.

Acting as a group, directors set the objectives for the cooperative 

and make decisions that set the course the cooperative will follow 

in achieving those objectives. These broad managerial decisions 

include:

•	 Hire a competent manager, determine the salary, outline the 

duties and authority of the position and formally review his/

her performance at least annually.

•	 Adopt broad, general policies to guide the manager. Topics 

covered might include credit limits to patrons, expenditures 

that need prior board approval and general personnel regulations.

•	 Develop and adopt long-range business strategies.

•	 Require written monthly financial reports and operating 

statements for board meetings to be informed of adverse as 

well as favorable operations.

•	 Direct the manager to prepare, before the close of each year, 

an operating budget for the next fiscal year for board approval. This budget should estimate the volume of sales and 

gross income of various items to be handled, the expenses 

by account classifications and the net income expected. This 

constitutes necessary forward planning by the board and 
49

management. The budget should be reviewed at intervals 

throughout the year to determine the trends of the business.

•	 Employ a qualified auditor to make an independent audit at 

least once each year to determine the accuracy of the financial records. An audit is the primary method the board uses 

to verify the financial condition of the cooperative. Many 

successful cooperatives also use the audit report to evaluate 

the effectiveness of the policies and budget, performance of 

the manager and gain insight into the effect of past decisions 

and the need for new ones.

•	 With the aid of the manager, plan and conduct the annual 

meeting to keep the membership informed about the status 

of their business, including operations, finances and policies.

•	 Determine the patronage refund allocation and per-unit 

retain level. Factors to consider include legal requirements, 

member needs and desires for cash refunds, the desirability 

of retiring old equities, and current and future capital needs.

•	 Assure competent legal counsel is available.

•	 Keep a complete record of the board’s actions.
50

•	 A cooperative director should not expect to receive special 

favors from the manager or employees, and a director does 

not:

* Act independently on matters that should be decided by 

the entire board. Individual directors have no authority 

outside of board meetings.

* Represent special interests, factions or political entities. 

Directors are elected to oversee the business activities of 

the cooperative, not serve as an agent of these groups.

In carrying out their responsibilities, directors serve much like 

trustees, charged with a legal obligation to protect the assets of the 

members. Directors who act outside the parameters of the law or 

don’t exercise due care in their 

decisionmaking can be personally liable for the harm they 

cause the members, the cooperative or third parties.

Officers

The board usually elects the 

cooperative’s officers shortly 

after the annual membership 

meeting. Each officer has specific duties as detailed in the 

cooperative’s bylaws.

•	 The president presides at 

all meetings and watches 

over the association’s affairs, serving as the main 

communication link 

between hired management and the other 

directors and members.

•	 The vice president, in 

the absence or disability 
51

of the president, performs the duties of the president.

•	 The secretary keeps a complete record of all meetings of the 

board of directors and general membership and also is the 

official custodian of the cooperative’s seal, bylaws, and membership records.

•	 The treasurer oversees the bookkeeping and accounts to ensure accuracy and proper handling and also is responsible for 

presenting periodic financial reports.

•	

Board Committees

The board’s work may be divided among special or permanent 

committees, each dealing with a phase of the association’s operations, such as finance, purchasing, merchandising, and others.
52

Each committee 

studies the problems 

in its particular field 

and makes recommendations to the 

board of directors. 

In some instances, 

committees may be 

given certain powers 

to act for the board, 

subject to review by 

the entire board.

Large associations may select an 

executive committee 

to perform general 

management and 

oversight duties as 

authorized by the 

board.

Managers

Success of a cooperative largely depends 

on good board/ 

manager relationships. The working relationship between board 

and general manager requires respect and an understanding of each 

other’s responsibilities.

The board of directors decides what the cooperative will do; the 

general manager and immediate staff decide how it can best be 

done—subject to board review—so as to achieve the basic objective 

of serving members effectively.

The manager is selected by the board and accountable to it for 

his/her actions. The manager should therefore not be a part of the 

board. The manager should, however, attend all board meetings and 

be an active, nonvoting participant.
53

The manager controls the ongoing activity of the cooperative. 

Responsibilities of the general manager include:

•	 Supervise and coordinate, under board direction, the business activities of the co-op by managing the people, capital, 

and physical resources.

•	 Hire, train, supervise, and set compensation for employees. 

The manager also needs to review their performance and 

train, reassign, or replace those employees not meeting acceptable performance levels.

•	 Oversee the detailed operations of the cooperative, within 

policies established by the board of directors, such as purchasing inventory and selling commodities, maintaining the 

general appearance of the co-op, and making sure employees 

respond to member needs.

•	 Maintain, and revise as necessary, an adequate bookkeeping 

and accounting system; develop for board approval a financial budget annually; prepare proper financial reports regularly for board review; and present a report of the cooperative’s operational highlights to the membership at the annual 

meeting.

•	 Furnish information needed for long-range planning. This 

will bring matters, such as fixed asset additions or revisions, 

to the board’s attention for review.

•	 Represent the cooperative and portray a positive image to 

members and others in the community.

•	 Encourage membership and active patronage.

•	 Communicate developments at the cooperative to members.

•	 Keep current on local, State, and Federal legislative and 

regulatory developments affecting cooperatives.

Employees

In many ways, working for a cooperative is similar to doing the 

same job at a noncooperative firm. But special features of a cooperative—the role of the member-owner as user and the emphasis on 

service over bottom-line numbers—place unique obligations on the 

employees.
54

1. Understand the purpose and objectives of the cooperative. Employees 

need to know how cooperatives are different from other methods 

of doing business. By understanding cooperative purposes, objectives, operations and their role as employees, they can help improve 

member relations, the cooperative’s image and the general public’s 

understanding of cooperatives.

2. Fully perform duties. In many cooperatives, like other business 

firms, the largest operating expense is for personnel. While the 
55

cooperative has responsibility for recruiting and providing training, the employee is 

responsible for using these opportunities to 

provide the best possible service to members.

3. Understand the relationship to member-owners. 

All employees have a responsibility to maintain a high level of customer satisfaction 

and good relations between the cooperative 

organization and its member-users. Immediate feedback from members should be encouraged to keep the manager informed of 

problems, needs and customer satisfaction.

The employee role is particularly important in larger cooperatives. The only cooperative employees that members may encounter regularly, from annual meeting to annual 

meeting, may be the individual pumping the 

gas, the cashier, the person answering the 

telephone, the truck driver picking up their 

milk or delivering a product. To the average 

member, they are the voice of the cooperative.

4. Favorably represent the cooperative. Employees help build the cooperative’s image as 

they serve members and the community—

both on and off the cooperative’s premises. 

Employees should keep the premises clean and attractive; make 

sure equipment and service tools are operating; serve members 

pleasantly, promptly, and in the order promised and take an extra 

step to give members satisfactory service.

Employees, like their manager, can be community boosters by 

taking part in religious, school or community affairs. Their efforts 

can positively affect the cooperative image held by members, the 

general public and other businesses.

Photo courtesy Burnett Dairy Cooperative
Chapter 8

Source of Equity
57

One of the greatest challenges facing cooperatives 

is raising equity capital. Because cooperatives pass 

earnings through to users on a patronage basis, 

they cannot attract equity from outside sources to 

the same extent as investor-owned businesses.

Cooperatives are not alone. Sole proprietorships, partnerships and closely held corporations 

face similar problems acquiring equity. Their 

equity capital usually is provided by the owners or 

acquired via retained earnings.

Only a single tax is placed on their income, to 

help overcome the capital accumulation problem. 

Earnings of investor-owned corporations are subject to taxation twice, once at the corporate level 

when earned and again at the ownership level if 

and when distributed as dividends. Owner(s) of 

a sole proprietorship, partnership, limited liability company or cooperative can generally reduce 

tax liability at the firm level if they meet specific 

Internal Revenue Code (Code) requirements. A 

greater portion of income is therefore available 

for reinvestment in the business.

The three primary ways members provide 

equity to their cooperative are direct investment, 

retained margins, and per-unit capital retains. 

Cooperatives may also acquire equity by retaining 

earnings on nonmember, nonpatronage business. 

This section explains the nature of each source of 

equity.
58

Direct Investment

Direct investment refers to cash purchases of membership certificates, common and preferred stock or other forms of equity.

Most cooperatives require a member to make a direct payment 

when joining the cooperative. In return, the member receives a 

membership certificate in a nonstock cooperative or a share of 

common stock in a stock cooperative. The certificate or share of 

stock usually conveys to the owner the right to vote on matters 

submitted for decision to the cooperative membership and the 

owner is generally referred to as a member of the cooperative.

Direct investment by members is often a minor source of equity 

to a cooperative. Most cooperatives are trying to retain current 

members and attract more members and member business. And 

members generally prefer the cooperative to generate its own equity, rather than solicit checks from them. Thus the cost of a membership certificate or share of common stock is usually modest. 

Equity that evidences membership usually does not pay a dividend, 

if for no other reason than the administrative expense of issuing a 

large number of small checks.

Traditionally, direct investment can be a major source of equity 

in two instances. Direct investment is often the primary means for 

a new cooperative to acquire equity capital. Once the cooperative is 

functioning, it then can accumulate additional equity from operating funds in the form of retained earnings or per-unit retains.

Some cooperatives also acquire equity by selling nonvoting stock 

or equity certificates to members and nonmembers. This nonvoting 

equity usually pays a limited dividend as an inducement for persons 

to invest in the cooperative.

Transferable Delivery Rights

A resurgence in cooperative value-added processing of commodities is being fueled by a system of direct investment, called transferable delivery rights. Members who wish to share in the benefits 

from the value-added processing are required to provide necessary 

up-front capital by purchasing long-term delivery rights in the 

cooperative. These delivery rights entitle and obligate the member 

to deliver to the cooperative all of the production from specified 
59

acreage or specific quantities of product (so many tons or bushels). 

The purchase of delivery rights assures members of a long-term 

“home” for their production and provides an opportunity to share 

in the benefits of value-added processing based on their patronage.

Membership is generally limited to producers who purchase 

delivery rights and the cooperative only sells enough delivery rights 

to secure the quantity of product it can process efficiently and 

resell at a profit. The delivery rights are typically represented by 

non-dividend bearing, non-voting preferred stock. The preferred 

stock (and thus the right to deliver product to the cooperative) are 

transferable by the member to other producers, subject to approval 

by the cooperative’s board of directors. If the cooperative is successful, the only way other producers can participate is to purchase 

delivery rights from current members. Thus, members may enjoy an 

additional benefit, a gain on the sale of their preferred stock tied to 

their delivery rights.

Generally, the tax treatment of direct investments in a cooperative follows the same rules as a direct investment in an investorowned corporation. The payment to the cooperative is a nontaxable 

event. While the value of cooperative equity is usually constant, any 

gain or loss realized by the equity holder is generally a capital gain 

or loss.

Cooperative earnings used to pay dividends on equity are usually 

subject to taxation at both the cooperative and the recipient levels. 

An exception is dividends paid by farmer cooperatives that qualify 

for so-called “exempt” status under Code section 521. These cooperatives are allowed to deduct dividends paid on stock, so they are 

only taxed once, at the recipient level.

Retained Margins

While cooperatives are sometimes described as businesses that 

operate “at cost,” few if any can do so on a day-to-day basis. Rather, 

cooperatives seek to generate income that exceeds expenses on an 

ongoing basis. Then, usually after the close of the fiscal year, they 

return earnings from business conducted on a cooperative basis to 

the persons responsible for the business generating those earnings, 

who are called patrons.
60

These returns, based on the amount of business each patron 

does with the cooperative during the year, are called “patronage 

dividends” in the Code. This report refers to them as “patronage 

refunds,” the term used in cooperative literature. This reduces the 

likelihood such refunds will be confused with traditional dividends, 

which are based on stock ownership rather than the amount of 

business conducted with the firm.

The board usually determines how the earnings will be distributed. All of the earnings may be returned to the patrons as cash 

patronage refunds. Or the directors may decide to have the cooperative retain some or all of the patronage refunds as an equity 

investment in the cooperative. Single tax treatment is available only 

for patronage-sourced earnings that are returned to the patrons as 

cash or “other property,” or retained under procedures set out in the 

Code.

Qualifying for the single tax treatment provided in the Code is 

discretionary, not mandatory. Earnings not allocated to patrons are 

treated just as profits of an investor-owned firm. They are taxable 

income to the cooperative when earned and taxed a second time to 

the recipients when distributed by the cooperative.

Per-Unit Capital Retains

Cooperatives that market products produced by their members 

have a third means of acquiring equity capital, per-unit capital 

retains. These are capital investments based on either the number 

of physical units handled by the cooperative or on a percentage of 

sales revenue. Per-unit retains are deducted from sales proceeds due 

the members from the cooperative.

As with patronage refunds, per-unit capital retains returned to 

patrons as cash or retained by the cooperative, under rules in the 

Code, are only subjected to a single income tax.

And again, single tax treatment is discretionary. A cooperative 

may place some or all of these retains into an unallocated reserve, 

thereby forfeiting access to single tax treatment.

People sometimes blur the distinction between patronage refunds and per-unit capital retains. Patronage refunds are based on 
61

the earnings of the cooperative; per-unit retains on the volume or 

value of business done with the cooperative. Thus, a cooperative can 

acquire capital, even in a year of limited margins or a loss, through 

the use of per-unit capital retains.

Nonmember/Nonpatronage Earnings

Non-tax laws, such as the Capper-Volstead Act and State cooperative incorporation statutes, frequently require affected cooperatives 

to do a majority of their business with members. This still leaves 

those associations free to do up to 49 percent of their business with 

nonmembers on a noncooperative basis.

Earnings on this business are usually not eligible for single tax 

treatment. But the after-tax earnings can be used to build the equity base of the cooperative to improve its balance sheet and finance 

services it provides to members. Again, an exception is made for 

section 521 cooperatives, which may deduct nonpatronage income 

distributed to patrons on a patronage basis.
Chapter 9

Financial and Tax 

Planning
63

As the following flow chart illustrates, cooperatives have flexibility in designing an equity 

accumulation program to meet their individual 

needs. An understanding of the alternatives and 

their tax treatment is especially important when 

allocating patronage-based sources of equity, 

retained margins, and per-unit retains.

Direct investments usually are made to purchase membership equity, the membership certificate or a share of common voting stock.

Nonpatronage income is likewise usually 

placed into a single type of account, an unallocated reserve.

Patronage-based sources of equity can be used 

for at least four purposes: cash refunds, qualified retained patronage allocations, nonqualified 

retained patronage allocations and unallocated 

reserves.

Cash Refunds

Cooperatives can distribute their margins and 

per-unit capital retains as cash refunds to the 

patrons. Cash distributions are generally tax 

deductible by the cooperative in the year earned 

and taxable income to the recipient in the year of 

receipt. Cash refunds do not add to the equity of 

the cooperative, but provide an immediate additional return to the patron on his or her use of 

the cooperative.
64

Qualified Retains

Cooperatives can retain margins and per-unit capital retains and 

allocate the retained funds to equity accounts of the patrons, based 

on the amount of business each patron did with the cooperative 

during the year. If the cooperative follows the rules in the Code to 

“qualify” the equity, the cooperative deducts the amount of the allocations from its taxable income in the year the margins and retains 

were realized.

Patrons include the amount allocated in their taxable income 

in the year they receive a required written notice of the allocation. 

The retained funds become an equity investment by the patron in 

the cooperative. An example illustrates how this works for a typical 

agricultural marketing cooperative.

The cooperative pays the producer $600 for his/her crop at the 

time of delivery. It costs the cooperative $300 to market the crop. 

The cooperative sells the crop for $1,000.

The resulting margin of $100 is returned to the patron as a 

patronage refund. Thus the patron receives a total payment of $700 

for the crop, a $600 advance at the time of delivery and a $100 

patronage refund.

When the cooperative figures its taxable income, it is allowed to 

deduct the initial payment for the crop ($600), its other expenses of 

Table 9.1—Tax Treatment of Cooperative and Patron Qualified Retained Equity

Cooperative Patron 

Expenses Income

Crop $600 Crop $600 

Other $300 

Total $900 

Income $1000 

Margin $100 Refund $100

Taxable Income 0 Taxable Income $700
65

Direct 

Investment Margins Per-Unit Retains

NonPatronage

Income

Stock or 

Membership 

Certificate

Cash 

Refund

Qualified

Investment

Qualified

Investment

NonQualified

Investment

NonQualified

Investment

Unallocated

Reserve

Unallocated

Reserve

Unallocated

Reserve

Sources and Types of Equity

Sources

of Equity

Types

of Equity

marketing the crop ($300), and the patronage refund ($100). Thus, 

it ends up with no taxable income. The patron includes both the 

initial payment ($600) and the patronage refund ($100) in taxable 

income, for a total of $700.

The Code requires at least 20 percent of a qualified patronage 

refund be paid in cash. But the cooperative can still retain up to 

80 percent of its margins without having to pay a tax (at the co-op 

level) on any of the patronage refund. There is no 20-percent cash 

distribution requirement for qualified per-unit retains, so a cooperative can keep the entire amount free of tax liability at the co-op 

level.
66

The patron must report the entire $100 refund as taxable income, even though $20 or less may have been paid in cash.

The redemption of qualified equity is a tax-free event for both 

the cooperative and the patron, since the tax was paid by the member when the patronage refund was received.

The tax treatment of qualified retained equity is similar to the 

pass-through procedures that provide single tax treatment for partnerships and other single-tax corporations. But, cooperatives have 

additional flexibility not generally available to other passthrough 

entities.

Nonqualified Retains

Cooperatives may delay the pass-through of the tax obligation 

from the cooperative to the patron without jeopardizing single tax 

treatment of those moneys.

Any patronage-based allocation not meeting the requirements 

of the Code to be “qualified,” has “nonqualified” status. When a 

nonqualified allocation is made, the cooperative pays corporate income taxes on the funds retained. The patron has no tax obligation 

on these funds in the year of allocation.

When nonqualified retained equity is redeemed, the cooperative 

Table 9.2—Tax Treatment of Cooperative and Patron 

Nonqualified Retained Equity

Cooperative Patron 

Expenses Income

Crop $600 Crop $600 

Other $300 

Total $900 

Income $1000 

Margin $100 Refund $100

Taxable Income $100 Taxable Income $600
67

receives a tax benefit based on the tax paid at the time of allocation. 

The patron is taxed on the funds received.

If the cooperative in the earlier example issues its patronage 

refunds as nonqualified written notices of allocation, it would have 

taxable income of $100, the amount of the margin. The patron’s 

taxable income would have been $600, the payment for the crop.

At some later time, when the nonqualified notice is redeemed, 

the cooperative would deduct the $100 (or receive a credit under 

certain circumstances). The patron would report it as income in the 

year the cash payment was received.

Thus the single tax treatment of cooperatives doing business 

with or for members is complete and consistent with that accorded 

other single-tax entities. Income is ultimately taxed once, at the 

level of the owner-user of the business.

Nonqualified allocations have particular appeal to cooperatives 

with member-patrons in high marginal tax brackets. If the cooperative uses qualified allocations, it must make substantial cash 

payouts or high income patrons may suffer a negative cash flow on 

the margins they generate. This occurs when the total tax owed on 

the allocation (Federal and State) exceeds the amount of cash paid 

out as part of the distribution.

By using nonqualified allocations, no tax is due from patrons 

until the allocation is redeemed. Also, there is no 20-percent cash 

payout rule for nonqualified allocations.

Unallocated Reserves

Cooperatives can treat margins just as noncooperative firms treat 

earnings, by putting them into an unallocated reserve and paying 

corporate income tax. Under this approach, single tax treatment is 

forfeited. If the funds are later distributed, the recipients must pay 

a second income tax.

Cooperatives are free to use a combination of cash payouts, 

unallocated reserves, and qualified and nonqualified allocations. 

This makes it possible for the leadership to develop a program that 

reflects the best interests of the membership.
Chapter 10

Equity Management
69

Another practice unique to cooperatives is the 

regular redemption of outstanding equity. Capital 

contributions from continuing patrons build as 

time passes. But the level of patronage will fall 

for some members, and others will likely cease 

using the cooperative at all. A program of redeeming patronage-based equities on a regular 

basis matches the responsibility of financing the 

cooperative to current use of its services.

Two methods of redeeming member equity 

have achieved general acceptance: the “revolving fund plan” and “special plans.” Although the 

systems are often viewed as unrelated, they may, 

in fact, operate together.

Revolving Fund Plan

“Revolving fund financing” refers to systems in 

which patrons make annual capital contributions, 

typically through retained patronage refunds or 

per-unit retain allocations. The cooperative, in 

turn, redeems earlier capital contributions on a 

regular basis. Redemption is usually on a first-in, 

first-out basis. The cooperative determines what 

its total capital requirements are and the excess is 

redeemed each year, the earliest or “oldest” equity 

being revolved out first.

A revolving fund plan is frequently described 

as “systematic” if older equities are retired on a 

regular basis, usually a given number of years 

after they were issued. In a systematic plan, member investment is related to recent and current 

use. Newer members usually add equity to their 

account during their early years in the cooperative.
70

The accounts of established members are adjusted each year to 

better reflect current patronage. They make new investments based 

on current year’s patronage and have their earliest year’s equity 

redeemed. The accounts of former members are commonly paid 

off during the life of the revolving cycle, usually beginning the year 

after they cease patronizing the cooperative. 

Redemption is normally dependent on a board of directors 

determination that funds for revolvement are available. This ensures 

that there is room for flexibility if the situation warrants it. For 

instance, if there is a shortfall in new equity or a need to increase 

the cooperative’s total equity, equity requirements can be met by 

lengthening the revolving cycle (the cooperative keeps equity for a 

longer period of time).

This tactic should be used sparingly, as it deviates from the 

objective of having current users finance the cooperative. Also, it 

can create member relations problems if the members have the 

expectation that their oldest equities will be redeemed on a fixed 

schedule, sometimes without regard for the cooperative’s financial 

condition.

Special Plans

A special plan is one in which a specific event or condition, such 

as a member’s death, triggers equity redemption. The most common events covered are death, retirement or reaching a specified 

age. Once the condition is verified, the member’s equity may be 

returned at once or over a prescribed number of years.

Special plans are often popular with members, who see redemption of their equity investments supplementing retirement income 

or their estates. But special plans can complicate financial planning 

for the cooperative. One problem is forecasting how much equity 

will be redeemed in a given year.

Another difficulty is dealing fairly with members who are partnerships or corporations and whose business activity or life may 

continue well beyond that of individual partners or shareholders. 

One approach is for the association to redeem that portion of the 

member firm’s equity equal to the ownership interest in the firm 
71

of the person meeting the special redemption condition. Then the 

firm would be expected to make up the difference just as if it had 

been underinvested by the amount of the redemption.

Special plans are sometimes combined with revolving fund or 

base capital plans. 

Base Capital Plan

A “base capital plan” is a special equity capital management plan. 

It focuses directly on the current proportion of capital a patron 

should have in the cooperative at a particular time, based on the 

degree of use.

Development of the base capital plan involves several steps. 

1. The cooperative determines its total equity capital needs. 

2. The equity capital needs are allocated among patrons based 

on the proportion of the cooperative’s business each patron 

did with the cooperative during a base period, typically the 

past 3 to 7 years.

3. Each year the cooperative’s equity requirements are reviewed 

and adjusted as the board of directors finds appropriate. 

Each patron’s share of the equity requirement is also adjusted 

to reflect (a) any change in the total requirement of the 

cooperative and (b) any change in the patron’s proportional 

share in the new base period.

4. Under invested patrons must add to their equity account, 

usually through the current year’s retained patronage refunds 

or per-unit retains, or by direct contribution.

5. Fully invested and overinvested patrons generally are paid a 

cash rebate of current year’s patronage refunds and per-unit 

retain allocations. Overinvested patrons may receive an additional payment in redemption of their excess share of the 

equity.

The proportional share of former patrons will fall each year, 

reaching zero at the end of the base period beginning the first year 

after they cease patronizing the cooperative.
72

Conclusion

Cooperation is a very old concept, with the potential for a very 

bright future. That potential will only be realized if the people with 

an interest in cooperatives make the effort to make them work. 

Reading and studying this booklet, and others like it, is an important first step. But that alone won’t make you an expert. Learning 

about cooperatives can be a life-long process.

As the world changes, so must cooperatives if they want to 

survive and prosper. Members, directors, managers, employees and 

advisers must all seek out and take advantage of continuing educational opportunities.
Notes

Chapter 1 — This section is based primarily on chapters 1 and 2 of 

Farmers, Cooperatives, and USDA: A History of Agricultural Cooperative Service, Agricultural Information Bulletin 621 (USDA 

1991).

Chapter 2 — One should note that there are other useful generic 

principles, practices, and “good ideas” that are used as necessary 

guiding forces for cooperatives. For instance, the International Cooperative Alliance (ICA) recognizes seven cooperative principles 

in its Statement on the Cooperative Identity. Those principles are 

in many ways similar to the principles and practices that have been 

explained in this chapter. The Statement on the Cooperative Identity can be found at: http://www.ica.coop/coop/principles.htm. 

Chapter 3 — Most of the material in this chapter is derived from 

Research on the Economic Impact of Cooperatives, conducted by 

the University of Wisconsin Center for Cooperatives (http://reic.

uwcc.wisc.edu/).

Chapter 4 — This section was written originally for Do Yourself a 

Favor: Join a Cooperative, RBS Cooperative Information Report 

54 (USDA 1996).

Chapter 7 — This chapter reflects material originally published in 

Understanding Cooperatives, a series of circulars that can be used 

individually or collectively for teaching people about cooperatives. 

RBS Cooperative Information Report 45, sections 4-6 (USDA 

2011).

Chapter 8 — Much of the last 3 chapters were first drafted for 

Income Tax Treatment of Cooperatives: Background, RBS Cooperative Information Report 44, part 1 (USDA 2005), the first in a 

technical series of reports on Federal income taxation of cooperatives.

73
United States Department of Agriculture

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obtaining services from USDA, participating in a USDA program, or 

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To file a complaint of discrimination, complete, sign and mail a program 

discrimination complaint form, available at any USDA office location or 

online at www.ascr.usda.gov, or write to:

USDA

Office of the Assistant Secretary for Civil Rights

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Washington, D.C. 20250-9410

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should contact USDA’s TARGET Center at (202) 720-2600 (voice and 

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