How To Form a Co-Operative
Table of Contents
- Introduction
- Section 1. The Basics Of Co-Operatives
- Types of Co-operatives
- Comparison of the Co-operative and
Corporate Business Structure
- Section 2. Forming A Co-Operative
- Section 3. Operating The Co-Operative
- Appendix 1. Steps In Forming A Co-Operative
- Appendix 2. Developing The Business
Plan Of A New Co-Operative
Introduction
Co-operatives have existed in Ontario for more than 150 years. Co-operatives
have been formed to meet the needs of various business sectors and communities
in rural Ontario. The co-operative business structure is only one of a
number of structures that businesses can use.
This Factsheet is designed to help business owners and rural communities
understand the co-operative structure and determine if it is a suitable
structure for their situation.
New Generation Co-operatives are a variation on the traditional
co-op structure. They have been successfully used in a variety of
situations, most notably where agricultural producers wish to gain
ownership in value-added and further processing activities. For
information on New Generation co-operatives refer to the Factsheet
New Generation Co-operatives
Order No. 02-017.
Section 1. The Basics Of Co-Operatives
What Is A Co-Op?
A co-operative is a business organization owned by the members who use
the services of the co-operative. Control rests equally with all members
and surplus earnings are shared by members in proportion to the degree
they use the services.
Basic Principles Of A Co-Operative
All co-operatives are guided by the same general principles as stated
by the International Co-operative Alliance. These principles are:
Voluntary And Open Membership —Co-operatives are
voluntary organizations, open to all persons able to use their services
and willing to accept the responsibilities of membership.
Democratic Member Control — Co-operatives are democratic
organizations controlled by their members, who actively participate in
setting their policies and making decisions.
Member Economic Participation — Members contribute
equitably to, and democratically control, the capital of their co-operative.
At least part of that capital is usually the common property of the co-operative.
Autonomy and Independence — Co-operatives are autonomous
organizations controlled by their members. If they enter into agreements
with other organizations, including governments, or raise capital from
external sources, they do so on terms that ensure democratic control by
their members and maintain their co-operative autonomy.
Education, Training and Information — Co-operatives
provide education and training for their members, elected representatives,
managers and employees so they can contribute effectively to the development
of their co-operatives.
Co-operation Among Co-operatives — Co-operatives
serve their members most effectively, and strengthen the co-operative
movement by working together through local, national, regional, and international
structures.
Concern For Community — Co-operatives work for
the sustainable development of their communities through policies approved
by their members.
Types Of Co-Operatives
Co-ops exist in almost every sector of the economy. See the various types
of co-operatives listed below:
Profit Verses Non-Profit Co-Operatives
Co-operatives can be formed as either for profit or not for profit co-operatives.
In both cases the goal of the co-operative is to operate profitably, however,
the surplus revenues are handled differently in these two types of co-operatives.
- For-Profit Co-operatives: surpluses of the
enterprise, after payment of dividends on shares and interest
on loans, are distributed at the discretion of the directors among
the members in proportion to their business transactions with
the co-operative during the fiscal year.
- Not-For-Profit Co-operatives: operating surpluses
of the enterprise are not distributed to the members and must
be returned to the co-operative's general reserve. The co-op can
use these funds to improve services to members, distribute them
to other non-profit co-operatives or give them to charity.
Types of Co-operatives
Producer Co-operatives
- Some co-operatives process and/or market, their members'
products and services directly.
- Others may also sell the input necessary to their members'
economic activities (such as agricultural supply co-operatives).
- Owned by members who either purchase their inputs or supply
the products and services they market.
- Examples: Agricultural processing and marketing, farm supply,
crafts, livestock and crops, seed cleaning, pooling of equipment
Service Co-operatives
- They provide services to their members (individuals or corporations).
- They are owned by the users of the services.
- They can range in size from small day care centres to large
housing co-operatives.
- Examples: Community development, electricity,
natural gas housing, day care centres and nurseries, health
care, transportation and communication, tourism
Financial Co-operatives
- These co-operatives offer financial, loan or investment
services, and insurance services to their members.
- They are owned by user members or by subscribers to insurance.
- Examples: Caisses populaires, credit unions, insurance co-operatives,
mutual companies.
Multi-Stakeholder Co-operatives
- The membership of these co-operatives is made of different
categories of members who share a common interest in the organization;
i.e. clients, workers, investors, community organizations
etc
- Examples: Home care services, health services,
community services
Consumer Co-operatives
- They provide their members with goods for their personal
use.
- They are owned by the consumers of the goods sold by the
co-operative.
- Examples: Food, natural food, school supplies (stationery,
school supplies, computers and software), hardware, clothing
Worker Co-operatives
- The purpose of these co-operatives is to provide their members
with work by operating an enterprise. They may be found in
all economic sectors.
- These co-operatives are owned by their employee members.
They are mainly part of the small or medium sized enterprise
sector.
- Examples: Agri-food, natural food, manufacture
and sale of clothing, communications and marketing, industrial
production and manufacturing, home nursing services
Listed below is a comparison
of the features of the for profit and not for profit co-operative
and corporation business structures.
Organizational Structure
A co-operative has 4 key groups of people:
Members
Members, as owner-users, are the reason the co-op is organized.
They justify its continued existence through their patronage,
capital investment, and participation in decision making. The
members are represented in the co-op by the Board of Directors.
The Board of Directors
The Board of Directors is a policy-making body elected by the
members, who represent the members by overseeing the co-op’s
business affairs. Usually 7–9 members (minimum 3) are elected
to provide leadership. Directors, as trustees, establish policy,
report to members and give direction to the co-op’s hired
management, generally without getting involved with the day-to-day
operations.
Members of the board are held accountable for their actions
by provincial and federal laws applying to businesses and by
the by-laws of their co-op. For larger co-ops the board of directors
also retains an independent auditor to evaluate the co-op’s
financial condition. They may also appoint committees for such
continuing concerns as property, finance or member relations,
education or appoint ad hoc committees for fund raising or special
projects. The board is directly responsible for hiring the manager
but delegates the responsibility for choosing co-op staff to
the management.
Management
Management supervises and co-ordinates the day-to-day operations
of the co-op and are supervised by the board of directors.
Comparison of
the Co-operative and Corporate Business Structure
Co-operatives - For-profit
Purpose
- Service and saving for members.
Co-operatives - Not-profit
Purpose
- For social, cultural and economic needs of members.
Corporations and Investor Owned Business - For profit Corporation
Purpose
- Profit for shareholders on investment of time or money.
Corporations and Investor Owned Business - Non-profit Corporation
Purpose
- Social and cultural activities other than personal financial
gain.
Co-operatives - For-profit
Ownership - By Members
- The share is listed in the member's name.
- Unless otherwise stated in the Articles, co-op shares may
not increase in value and may only be redeemed by the co-operative
at their par value.
Co-operatives - Non-profit
Ownership - By Members
Corporations and Investor Owned Business - For-profit Corporation
Ownership - By shareholders
- Generally, a share carries no name.
- Unless registered, it belongs to the bearer.
- A common share may increase in value. A shareholder may
sell his or her shares to another person at an agreed upon
price.
- Some classes of shares can have additional rights.
Corporations and Investor Owned Business - Non-profit Corporation
Ownership - By members
- There is no ownership.
- Members are accepted when they agree to pay annual dues
conferring member status, or a one-time membership fee.
- As the bylaws permit, anyone may become a member, whether
or not they use or benefit from the services provided by the
organization, as long as they support the purpose of the organization.
Co-operatives - For-profit
Control (voting)
- One member, one vote, no proxy voting.
- A member is entitled to only one vote at a general meeting,
regardless of the number of shares he or she holds.
- Certain co-operatives with a large and dispersed membership
may introduce delegate structure for representing members
(e.g. Delegates representing multiple members from a geographic
district).
Co-operatives - Not-profit
Control (voting)
- One member, one vote, no proxy voting.
- Same as For-Profit.
Corporations and Investor Owned Business - For-profit
Corporation
Control (voting)
- The number of voting shares held per shareholder.
- The number of votes a shareholder is entitled to at a general
meeting is equivalent to the number of shares held in the
company.
- A shareholder may obtain a proxy to vote for other shareholders.
Corporations and Investor Owned Business - Non-profit
Corporation
Control (voting)
- One member, one vote unless otherwise specified in the articles
or by-laws.
- Delegates or proxies may be used depending on the governing
legislation.
Co-operatives - For-profit
Liability
- Members limited to share subscription.
- Directors can be liable.
Co-operatives - Non-profit
Liability
- Members limited to membership amount.
- Directors can be liable.
Corporations and Investor Owned Business - For-profit
Corporation
Liability
- Shareholders limited to share subscription.
- Directors can be liable.
Corporations and Investor Owned Business - Non-profit Corporation
Liability
- Limited to the investment.
- Directors can be liable.
Co-operatives - For-profit
Distribution of Surplus or Earnings
- To members in proportion to use of service. Allocated, but
members may choose to reinvest.
- Surpluses may be paid into the reserve or to members in
the form of patronage returns proportional to the business
done by each member with the co-operative or as dividends.
- Dividends on membership shares are limited to a maximum
of 2% above prime; preference shares have no maximum.
- Premiums paid on the redemption of preference shares have
a maximum of 10% compounded per year.
Co-operatives - Non-profit
Distribution of Surplus or Earnings
- Surplus remains in co-op.
- Surplus goes to another non-profit group at time of dissolution.
Corporations and Investor Owned Business - For-profit
Corporation
Distribution of Surplus or Earnings
- Dividends paid on shares. Rate set by board of directors.
- There is no limit on share dividend.
- Profits may be distributed in the form of dividends according
to the provisions for each class of shares, or reinvested
in the company.
- The value of shares reflect the net value of the corporation.
- Shareholders may dispose of all of the assets of the business
in accordance with certain legislative provisions.
Corporations and Investor Owned Business - Non-profit Corporation
Distribution of Surplus or Earnings
- Surplus remains in corporation.
- Surplus goes to the membership or to another charitable
organization at time of dissolution.
- Surpluses do not belong to individual members but to the
organization.
- They may, therefore, not be redistributed among the members
but must be returned in full to the indivisible general reserve
of the organization
Co-operatives - For-profit
Initiation of Policies
- Board of directors, members and management.
Co-operatives - Non-profit
Initiation of Policies
- Board of directors, members and management.
Corporations and Investor Owned Business - For-profit
Corporation
Initiation of Policies
- Board of directors, shareholders and management.
Corporations and Investor Owned Business - Non-profit
Corporation
Initiation of Policies
- Board of directors, members and management.
Staff of the Co-operative
Staff of the co-operative report to management. They should
be well informed about co-operative's activities and able to
explain them to both members and non-members.
A Federated System
Larger, more complex co-operatives may have a centralized or
federated structure. A centralized structure is sometimes referred
to as the delegate system. For example, the structure of the
Saskatchewan Wheat Pool is divided into twelve districts. Each
district has a number of sub-districts. The members in a sub-district
nominate and elect a district delegate. The delegates in a district
elect a director to represent the district on the central board.
A federated system allows related but autonomous co-ops to
join together to form secondary co-ops which service their businesses.
The Credit Union Central of Ontario is a federation of Ontario
credit unions. It is a central depository for surplus credit
union funds. Members of the autonomous co-ops elect delegates
to the federation, delegates then meet in districts to elect
directors of the federation.
Section 2. Forming A Co-Operative
The process of forming a co-op is not very different from that
of any other form of business venture. There is the planning
process and the technical details of setting up the structure.
The development of a fully operating business from an initial
idea requires strong organizational and communication skills
and a comprehensive business plan. See Appendix
1 for a complete checklist of the planning process.
The following steps outline the order of events that are typical
in the formation of a co-operative.
Initial Idea and Key Organizers — An
idea for the co-op is usually formed by a key group of individuals
who see a business opportunity or a solution to a problem.
Selection of a Steering Committee — Select
a steering committee from the initial group and from those willing
to fund the feasibility study.
Conduct a Feasibility Study — Plan the
scope of a feasibility study, including areas of study and the
amount of budget required. Evaluate the feasibility of the business
idea carefully before proceeding. The feasibility study determines
the most efficient plant size, which determines the amount of
product the plant can accept. Funding for the feasibility study
can be raised by the organizers and potential members or possibly
through an economic development agency.
Such a study not only determines the economical viability of
the venture but also outlines the market advantages of a member-owned
processing co-operative if any. If the feasibility study is
positive this builds enthusiasm among the steering committee
for the project the organizers can proceed to the next step.
Selecting an Interim Board — If the feasibility
study is positive and the decision made to proceed with forming
a co-operative, dissolve the steering committee and set up an
interim board. Elect a chairman and explore funding sources
to complete the business plan. The interim board can decide
if it is appropriate to recruit a chief executive officer.
Incorporating the Co-operative — The
timing of incorporation depends on a number of factors including
the need to enter into legal agreements such as Confidentiality
Agreements, Letters of Intent, supply agreements, funding agreements
with governments. Incorporate as soon as there is potential
exposure to liability.
Developing the Business Plan and the Legal Organization
of the Co-operative — The business plan
outlines the goals and objectives of the co-operative and the
steps to reach those goals. The board uses this information,
along with the business plan, to promote the co-operative and
provides a basis for filing an offering statement with the Financial
Services Commission of Ontario, where required. (see Financing
the Co-operative.) This must be done before the sale of
shares can take place. For details about what to include in
a business plan see Appendix 2.
Information on feasibility and preparing business plans is
available from OMAFRA, local Business Enterprise Centres and
private consultants.
Preparing an Offering Statement — Co-operatives
wishing to raise more than $200,000, issue shares to more than
25 members or issue shares with a value of more than $1,000
per member are generally required to file an offering statement
(similar to a prospectus) with the Financial Services Commission
of Ontario (FSCO).
Conducting a Fund Raising Campaign —
Once the legal and filing requirements are in place and the
business plan finished, the board can launch a funding campaign.
A key element in forming a co-operative is the involvement
of potential co-op members. This ensures a variety of input
to the plan and encourages members to develop ownership and
commitment to the co-op.
Incorporating The Co-Operative
The following information regarding the Co-operative Corporation
Act and the legal structure of a co-operative is general information
and should not replace competent legal advice.
The Co-operative Corporations Act is administered by
the Financial Services Commission of Ontario.
A co-operative requires at least 5 persons to incorporate.
The exception to this is worker co-operatives that require only
3 people. These incorporators may be individuals who are at
least 18 years old, or they can be corporations, including other
co-operatives.
The following is a summary of some of the more important requirements
of the Act; however it should not be used in place of
the Act. A schedule of fees for incorporation is available from
the Financial Services Commission of Ontario.
The Act requires that a co-op corporation must carry
on an enterprise that is organized, operated and administered
under the following principles:
Each member or delegate has only one vote.
In a business corporation, the number of votes a shareholder
has depends on the number of shares owned in the company. In
a co-op corporation, each member has only one vote regardless
of the amount invested in the co-op.
No member or delegate may vote by proxy. This
serves as a check against the accumulation of power by one or
more members.
Interest on loan capital and dividends on share capital
are limited. Interest on member loan capital and dividends
on share capital are limited to a cap of prime rate plus 2%
as fixed by the Co-operative Corporations Act. An exception
is made for preferred shares in that the dividend rate has no
limit and can be determined by the co-operative.
Articles of Incorporation
- To incorporate a co-op in Ontario, you must file Articles
of Incorporation with the Financial Services Commission of
Ontario (FSCO). The Articles of Incorporation, along with
the Co-operative Corporations Act, provide the basic
legal framework for your co-op. They outline its purpose and
how it will be financed. They can be seen as the "constitution"
of your co-operative. The articles of incorporation include:
- the name and location of the co-operative, names, addresses,
and signatures of the Incorporators
- the number of directors of the co-operative;
- how the co-op finances itself: by accepting loans, selling
debentures, or charging membership fees;
- the share structure of the co-operative
- any special restrictions or provisions which apply to the
co-operative.
Choosing a Name
A co-op’s legal name must contain the word Co-operative
(or Co-op) and must end with either the word corporation or
incorporated. Co-op corporations that have share capital may
also choose to use the term limited. It is illegal in Ontario
to use the word co-operative in connection with the name of
an enterprise unless the group is incorporated under the Co-operative
Corporations Act.
Once the proposed name has been chosen, hire a private search
house to ensure no other group is using the same name. The search
house will supply a NUANS report which you submit to the Ministry
of Finance. A list of the private search houses in Ontario is
available from the Ministry of Finance.
To incorporate a co-operative you need to send the following documents
to the Financial Services Commission of Ontario:
- proof of a Newly Updated Automated Name Search, or NUANS
report
- a cheque or money order for $15 to reserve the name chosen.
(This is in addition to the incorporation fee noted below.)
- Articles of incorporation (2 original copies) (distinct
forms for co-operative with share capital (form 1) and co-operative
without share capital (form 2)
- consent to act as first directors (if your co-operative
has directors who are not incorporators)
- a cheque or money order for $155 to incorporate a non-profit
co-operative, or $335 for other co-operatives.
You may wish to send a draft version of your Articles of Incorporation
to the Financial Services Commission of Ontario for an opinion.
Obtain the forms required from the Commission. When this process
is complete, a certificate of incorporation will be issued by
the Commission, which shows your co-operative is legally incorporated.
Once you receive your certificate of incorporation, you have
60 days to register your co-operative with the Ministry of Consumer
and Business Services by filing an "Initial Notice" form. This
form includes basic information about your co-operative, including
its name, date of incorporation, address of its head office,
and the names and addresses of its directors and officers. The
Financial Services Commission of Ontario will send you this
form along with your certificate of incorporation.
Obtain Co-operative incorporation kits from:
Financial Services Commission of Ontario
P.O. Box 85
5160 Yonge Street, 4thfloor
North York (Ontario)
M2N 6L9
Telephone: 1-800-668-0128
(416) 226-7776
Web site: www.fsco.gov.on.ca
To change your articles of Incorporation you must file Articles
of Amendment with the Financial Services Commission of Ontario.
A fee is charged each time these documents are filed.
By comparison, changing the by-laws of your co-op is simpler and
does not require you to file documents with the Commission or pay
a fee. In order to avoid filing Articles of Amendment with the Financial
Services Commission, include most of the basic rules of your co-operative
in its by-laws, rather than in its articles. These rules would include,
for example, how elections work and how members must deal with the
co-op.
Contact a co-operatives association such as the Canadian Co-operatives
Association (CCA) for advice on what to include in your by laws.
Federal Incorporation
If the co-operative is going to do business outside Ontario consider
incorporating federally. To incorporate under federal legislation,
the co-op must be conducting business in 2 or more provinces and
have a fixed place of business in more than one province. Under
the federal Co-operatives Act, at least 3 persons, of age 18 or
older are required to incorporate a cooperative. It is important
to note that co-operatives incorporated outside of Ontario jurisdictions
are subject to the Ontario Securities Commission (OSC). This means
they will be required to meet the regulations and securities legislation
administered by the OSC.
Information about federal incorporation can be obtained through
the Co-operatives Secretariat, Agriculture and Agri-food Canada
by phoning (613) 759-7194 or on the Web site at www.agr.ca/policy/coop/.
Preparing By-Laws
The next step is to elect officers and enact by-laws. By-laws explain
how the co-operative will operate and expand on the articles of
incorporation. Bylaws do not need to be filed with the FSCO. They
take effect once approved by the board of directors and ratified
by the members. All by-laws must comply with the provisions of the
Act.
Some of the topics to covered in the by-laws are:
- Membership and divisions of membership
- Requirements for membership and rights and responsibilities
of members
- Requirements for supply agreements
- Member loans or share capital; share or loan certificates
- Meetings of members
- Board of directors and officers — number, duties, terms
of office and compensation
- Election of delegates
- Use and distribution of surplus funds
- Borrowing powers; cheques, drafts and notes
- Bonding of employees and officers
- Custody of securities
- Execution of documents
- Fiscal year, notices, amendments
Have the articles and by-laws prepared by professionals familiar
with co-operative law and practice. Ensure directors are involved
the process and that they understand how the articles and by-laws
affect the co-op.
Financing The Co-Operative
Co-operatives can raise capital through equity or debt financing.
Co-operatives can choose to incorporate either "with share capital"
or "without share capital". Incorporating "with share capital" allows
a co-operative to raise capital by selling shares as well as using
debt instruments such as debentures. A co-operative that incorporates
"without share capital" can only raise capital through debt financing
and may not issue shares. A co-operative must decide how they will
file before the incorporation process begins.
The business plan for the co-operative states how much capital
the co-op will require and for what purpose. Additional capital
may be raised through preferred share offerings, member loans and
other securities. If the co-op is not successful this investment
may be lost.
Offering Statements and Exemptions from Filing
Before a co-operative can issue either shares or debentures it
must determine if it is required to file an offering statement with
the FSCO. The purpose of the offering statement is to provide potential
investors with a full, true and plain disclosure of all material
aspects of the co-operatives operations and proposed business. This
includes both the current state of the business and the intended
use of the money being raised. The offering statement allows a potential
member to access the risk associated with investing in the co-op.
A co-operative does not have to file an offering state if there are:
- 25 or fewer security holders
- more than 25 security holders but the shares or debt obligations
issued to members does not exceed $1,000 per member in a year
and does not exceed an aggregate value of $10,000 per member or
the aggregate value of all securities issued does not exceed $200,000
Standard forms and sample templates for the offering statement
are available from the Financial Services Commission’s Web
site at www.fsco.gov.on.ca. Offering statements are legal documents
and can be complex. Advice from a professional with specific experience
preparing such documents should be sought.
Equity Financing
(Incorporating With Share Capital)
If a co-op will require a large amount of capital, for equipment,
supplies, facilities, etc., it would likely benefit from share capital
incorporation. When incorporating with share capital, patrons must
buy membership (common) shares in the co-op as a requirement of
membership. This is an investment in the co-op. If the co-op is
not successful, the investment may be lost. Share capital incorporation
allows greater financing flexibility because a share capital co-op
can use debt financing as well as equity financing. Non-share capital
co-ops however must incorporate without share capital.
Types of Shares
There are 2 basic types of shares, membership shares and preference
shares.
Both types of shares are par value shares. This
means that when your co-op redeems or buys back its shares from
members or other investors, the amount they receive for each share
is equal to the amount they paid for the share. To help protect
investors against inflation, your co-op may choose to pay an extra
amount or premium for preference shares they redeem.
The maximum premium for a preferred share is 10% per year compounded
or the Consumer Price index, whichever is greater. Paying a premium
will help ensure that the value of your co-op's shares keeps pace
with inflation. Paying premiums also means that your co-op will
have less equity, so striking a balance is important.
Your co-op may pay investors a return on its membership and preference
shares. This return is called a dividend. The maximum dividend
any co-op may pay on membership shares is capped at 2% above the
prime rate of any financial institution (credit union, bank, trust
company) named in the co-op's by-laws.
There is no cap on the dividend that may be paid on preference
shares unless your co-op chooses to have one.
Membership Shares
If all the equity your co-op needs can be raised from members alone,
it might be enough for your co-op to issue only membership shares.
In this case the co-op would require members to buy a minimum number
of membership shares as a condition of membership.
Co-ops that issue shares must issue membership shares. Membership
shares may be held only by members. Because of this, co-ops restrict
how members may transfer ownership of their membership shares. If
co-ops do allow transfer of membership shares, the approval of the
board of directors is required. This feature of membership shares
may affect how attractive they are to member investors.
Preference Shares
Your co-op might also consider issuing preference shares if there
are members or other community investors willing to invest. Preference
shares may be held by members or other investors and may be more attractive
because:
- Co-ops generally require dividends to be paid on preference
shares before they are paid on membership shares. Co-ops that
offer an attractive dividend on their preference shares and establish
a record of paying this dividend will find it easier to attract
investment in the future.
- When a co-op is dissolved, preference shareholders generally
rank ahead of holders of membership shares in their claim on the
co-op’s assets, but behind creditors and debenture holders.
Other Ways to Raise Equity
Your co-op can also require members to use some or all of their
patronage returns to buy more shares. By doing so, your co-op can
ensure that its equity grows each year, provided of course that
your co-op has earned enough to pay patronage returns in the first
place.
Another way for your co-op to use its own earnings to increase
its equity is to pay out dividends in the form of shares rather
than cash. Dividends paid out in the form of shares are called stock
dividends. Stock dividends allow your co-op to pay dividends and
add to its equity capital at the same time. Members may find stock
dividends more appealing than other investors.
Advantages of Equity Financing
Equity financing gives your co-op flexibility. For example if your
co-op raises enough equity to buy significant assets, it may use
these assets to borrow more funds. In this way, your co-op’s
equity can be used to attract more financing.
Although it is wise to establish a record of paying dividends on
preference shares, your co-op (like other corporations) is not legally
required to do so. Whether your co-op pays dividends depends on
its earnings. By contrast, creditors have the right to sue your
co-op for missed interest or principal payments on loans. If your
co-op has some difficult times when it is short of cash, it will
have more flexibility with a strong equity base.
Debt Financing
(Incorporating Without Share Capital)
Incorporating without share capital means that instead of buying
shares in the co-op, members are required to lend the co-op a minimum
amount of money on which interest is paid (currently a maximum of
prime plus 2%). Loans are usually long-term to give the co-op stability.
To incorporate without share capital and with 25 or fewer members,
all that is required is the amount of the membership fee, the restriction
of the transfer of member loans, the classes of membership and the
minimum member loan required, if any.
Should members decide to leave the co-op, they must give 6 month’s
notice in writing for the investment to be returned, or if the co-op
would find this a financial hardship leading to insolvency, it may
pay one-fifth of the investment to the member each year for 5 years.
There are 4 methods of raising debt capital.
- Member Loans
If your co-op will not be issuing shares, at least some of its
financing will likely be in the form of member loans. Member loans
are loans required as a condition of membership in a co-op. Co-ops
issuing shares may also require member loans.
Like dividends on membership shares, the maximum rate of interest
co-ops may pay on member loans is capped at two percent above the
prime lending rate of any financial institution (credit union, bank,
trust company). Co-ops must repay member loans, together with any
accrued interest, when the member leaves the co-op.
- Patronage Loans
Your co-op may also require members to lend it some or all of their
patronage returns. Patronage returns loaned back to your co-op are
called patronage loans. By requiring members to make patronage loans,
your co-op can use its own earnings for debt financing. The maximum
rate of interest your co-op may pay on patronage loans is the same
as on member loans.
- Additional Member, Non-member and Institutional
Loans
If required the co-operative may borrow additional money from members,
non-members, and financial institutions at the going market rate.
The availability and cost of those loans depends on the financial
condition of the co-operative and its credit rating.
- Debentures
If your co-op needs to borrow large amounts of money, consider
issuing debentures. Specific assets may be used as security by co-ops
issuing debentures. If your co-op has fixed assets financed by equity,
such as real estate and buildings, it may be able use these to attract
investment in its debentures. Co-ops may issue many kinds of debentures,
but usually they promise to make regular interest payments and to
pay off the principal on a certain date. If your co-op fails to
make these payments, debenture holders have the right to sue your
co-op. There is no cap on the rate of return your co-op may offer
investors on its debentures, although you will need to decide how
much the co-op can afford. Debentures can also be unsecured.
Section 3. Operating The Co-Operative
Using The Revenue Surplus
Surplus is what is left of earnings after paying operating expenses.
How a co-operative uses its surplus can directly affect the financing
requirements. The co-op will likely need to keep part of its surplus
in the form of retained earnings or reserves. Retained earnings
are used to finance expansion in operations or to replace worn-out
assets. Determine the operating requirements of the co-op before
distributing any earnings to members and shareholders.
Co-ops have traditionally distributed most of their surplus to
members as patronage returns. If your co-op plans to attract large
amounts of equity by convincing investors it intends to pay dividends
on its shares, it will have to balance this commitment with members’
desire for patronage returns.
Taxation of Surplus Earnings
The method used to distribute the surplus earnings affects the
tax treatment of the surplus both for the co-op and its members
and investors. Patronage returns are paid out of your co-op’s
pre-tax income and are recorded as an expense. Paying patronage
returns lowers the amount of tax your co-op may have to pay. Patronage
returns paid by worker co-ops and some kinds of non-consumer co-ops
are taxed as income earned by the member.
Dividends on shares are paid out of the co-op’s after-tax
income and are taxed in the hands of the member. Co-op shareholders
may claim the federal tax credit for dividends paid by the co-op.
For specific tax information consult an accountant.
Other Co-operative Regulations and Issues
Audit Requirement
The Co-operative Corporations Act specifies that an auditor must be
appointed to examine the financial records and make an annual report.
The auditor must be impartial and cannot be a director or employee
of the co-op. If membership is small and financial assets are limited,
an auditor may not be required. No audit is needed if:
- the co-op has 15 members or less who agree in writing, or
- 50 members or less who agree by resolution and meet the prescribed
maximums for an audit exemption, and have no government subsidy
or grant that requires an audit.
Costs of an audit can be significant and will vary depending on
the complexity of the business.
Withdrawal of Members
Member shares of the co-op are personal property and are transferable
subject to the conditions in the Co-operative Corporations Act.
A member may withdraw from the co-op by giving 6 months notice.
After the notice period has expired, the co-op must begin to purchase
the member’s shares or repay the member’s loans. A deceased
member’s shares or loans must be paid out within 6 months of
death. A member can be expelled by a majority vote of the Board
of Directors and the co-op must pay out the former member’s
shares or loans within 1 year. A member who has voted against a
resolution that (in effect) materially changes the nature of the
co-op may withdraw their membership and their shares or loans must
be paid out within 90 days. A material change could include a sale
or disposition of the property of the co-op, amalgamation with another
co-op or conversion of the co-op into a corporation.
In each case, the Act contains riders giving the co-op the
power to delay pay-out of members if the pay-out would render the
co-op insolvent or be detrimental to the financial stability of
the co-op. A co-op is considered insolvent if liabilities exceed
the realizable value of assets or if it is unable to pay debts as
they become due.
Dissolution
If members decide to dissolve the co-op, they must first signify
their intent by filing articles of dissolution with the Ministry
of Finance. Member loans and patronage returns rank second after
the ordinary debts of the co-operative which are paid out first.
Net surplus is then either apportioned equally among the members
or paid out in proportion to the patronage rebate paid over the
past 5 years. Alternately, the money may be given to charity.
If the method of disposing of surplus funds is not in the articles
of incorporation or by-laws, the funds will be apportioned equally
to members regardless of the number of shares held.
Marketing Agreements
Co-ops that market their member’s goods will enter into marketing
contracts or agreements with their members. This agreement outlines
in writing the rights and duties of the member to market their products
through the co-op. It also outlines the terms and conditions under
which the products will be marketed and accounted for. The contract
is used to assure the co-op of a continuous supply from its members
and can contain means of obtaining compensation for damages from
the non-cooperating members. It is a contract of either purchase-and-sale
or agency and is a vital document for most agri-food co-ops. This
can be included in the by-laws.
Summary
Further details of the information in this Factsheet can be found
in the Co-operative Corporations Act. Because co-operative incorporation
is different from regular business incorporations, it is recommended
that advice from professionals familiar with co-operative law and
practice be obtained. This document contains only an overview of
the Co-operative Corporations Act and should not be used
in place of the Act.
Sources of Information on Co-Operatives
In addition to the Ministry of Finance, information is available
to co-ops from:
- Canadian Co-operatives Association — Ontario Region (CCA)
1-888-745-5521 or (519) 763- 8271,
Web site: www.ontariocoop.ca
- Co-operatives Secretariat, Agriculture and Agri-food Canada.
(613) 759-7194,
Web site www.agr.ca/policy/coop/
- Farm Improvement and Marketing Co-operatives Loan Act, Agriculture
and Agri-food Canada (613) 759- 6289, Web site: www.agr.ca/misb/nmp/fimcla/
- Center for the Study of Co-operatives (306)-966-8509 E-mail
coop.studies@usask.ca,
Web site: www.usaskstudies.coop/
- Agricultural Business Information – OMAFRA Business Development
Web site: www.ontario.ca/agbusiness
References
Co-operatives in Ontario, Ontario Ministry of Finance, A series
of publications that include: Guide to Setting Up and Co-operative,
Incorporating a Co-operative With Share Capital, Incorporating a
Co-operative Without Share Capital, Legal Requirements.
How to Form a Co-operative, Co-operatives Secretariat, Agriculture
and Agri-food Canada,
Web site: www.agr.gc.ca/policy/coop/kitcoop/sphashe.html
This publication is intended as general information and not as
specific advice concerning individual situations. Although it outlines
some of the legal and tax considerations of co-operatives it should
not be considered as either an interpretation or complete coverage
of the Income Tax Act or the various law affecting incorporation
of co-operatives. The Government of Ontario assumes no responsibility
towards persons using it as such.
Appendix 1. Steps In Forming A Co-Operative
Phase I — Develop the Initial Business Idea
Step 1: Assemble a group of key organizers
- Identify the needs or issues that the co-op would address such
as:
- opportunities for value added processing
- unavailability of certain products and services
- poor quality of certain products and services
- products and services overpriced
- market development
- Identify professional assistance needed to launch the business:
- legal consultant
- co-operative development consultant
- feasibility study, business plan and financial consultant
- accounting consultant
- Form a steering committee to guide the feasibility study
Step 2: Conduct a feasibility study
- This includes market, production, cost, sensitivity and financial
analysis
- Identify available technical and financial assistance
- Assess receptiveness to the co-operative business in the local
community
- Evaluate if the co-op is the best legal framework to use or
if the kind of co-op selected is the most suitable
- Define the intended benefits of the co-operative for members,
(e.g. quality, price) and characteristics:
- products and services offered (consumers' co-operative)
- or products and services marketed (producers' co-operative)
- or salaries and working conditions (workers' co-operative)
Evaluate the project's potential to attract the minimum number
of members required. If this study is not conclusive, re-evaluate
the business idea. If this study shows that the planned co-operative
is feasible, the group can proceed to the second phase.
Phase II — Co-ordinate the Pre Co-operative Activities
Steps 3 and 4 may occur at the same time or may occur in the reverse
order as shown here. Developing a business plan may be difficult
to direct or complete unless at least a temporary structure is in
place.
Step 3: Hold an organizing meeting
- Choose the corporate name of the co-operative, the location
of its head office
- Define the co-operative's mission (objectives, purpose)
- Elect an interim board of directors and secretary to the board
- Officially submit an application for incorporation as a co-operative
to the Financial Services Commission of Ontario or to Industry
Canada, if you are incorporating federally #9;
Step 4: Complete a Business Plan
- Choose a business planning team
- Obtain financing for the business plan from such sources as
internal financing by the members, special grant and/or negotiate
a technical assistance or business start-up agreement with a specialized
organization.
- See Appendix 2, Developing a Business Plan.
If the business plan reveals serious flaws or the level of enthusiasm
in the group for the plan is low the interim board members may decide
to terminate the project. If the opposite is true then the group
can proceed to Phase III
Phase III — Organize and Start Up the Co-operative
Set up ad hoc committees to distribute the workload among the members
of the interim board of directors. For example:
- planning committee
- financing committee
- property committee
Step 5: Organize the internal structure of the co-op.
- Decide on the co-ops structure and define the various categories
of members, if necessary (consumers, suppliers, workers)
- Determine the roles and responsibilities of the various democratic
bodies (general meeting, board of directors, committees)
- Establish the articles and by-laws
- Recruit members
- Provide appropriate Director training
Step 6: Plan and organize the business's start-up financing and
funding drive
- Determine the value of the membership share to become a member
(for example, $5 or $50?)
- Evaluate the value of the share capital on start-up and during
the first 3 years of operation (in terms of the expected growth
in the number of members)
- Draw up the overall financing plan for the first 3 years of
operation
- Refine or review the business plan
- Negotiate the capital contribution of external financial partners
(if necessary); venture capital corporations, private funds,
caisse populaire or credit union investment programs
- Negotiate medium term credit union or bank loans and a line
of credit
Step 7: Organize the business enterprise
Step 7A: Plan the operation of the business
- Draw up an organization chart of the enterprise
- Do the operational planning for the first year of activities
- Negotiate contracts for the supply of necessary products
and services (inputs) and, as required, sales or marketing
contracts (depending on the kind of co-operative and the nature
of the enterprise)
- Devise and implement an accounting system
- Define the duties and responsibilities of each position
- Develop a salary policy
- Select and recruit the person to occupy the position of
chief executive officer/general manager
Step 7B: Recruit and train the enterprise's staff
- Select and recruit employees
- Organize and offer a staff training program
Step 7C: Ensure the legality of the enterprise's operations
- Obtain the legal authorization necessary to start up the enterprise's
activities: municipal, provincial and federal governments
Step 8: Hold the initial general meeting
- Adopt the by-laws
- Approve the co-operative's membership in a sectoral federation
or other co-operative organizations
- Appoint an external auditor
- Elect the members of the board of directors, and of any
other committees
Appendix 2. Developing the Business Plan
of a New
A business plan is a document providing a complete description
of the co-operative enterprise you wish to form. It describes
in detail the products or services that will be produced or sold,
the organization of work and the management approach, the results
of the market study and the marketing plan, the human resource
plan, equipment and material needed, financing requirements and
the financing plan.
The business plan is a work tool. It serves 2 purposes:
- To facilitate the acquisition of external capital, credit
union/bank loans or grants. It must explain to investors why
they should invest in the enterprise, and your team's ability
to launch and develop it successfully.
- To facilitate control of the process of launching and developing
the new co-operative.
It will be a blueprint for launching and monitoring the co-operative's
activities and results. It must be written in clear and straightforward
language.
A business plan contains the following sections:
- Summary of the business plan (2 pages maximum)
- Brief description of the co-operative (1 page)
- Name, address of the head office, date formed
- Type of co-operative, objectives, number of members
- Analysis of the co-operative's market
- Brief description of the characteristics of the products
or services offered with respect to comparable products and
services available on the market
- Characteristics of the market, size, parts of the market
held by competing enterprises, market segments, market trends
- Characteristics of your sales strategy (direct, through
third party, shipping costs, etc.)
- Characteristics of the clientele (members or non-members),
age groups, gender, occupation, family income, location, buying
habits, etc.
- The price of your products or services
- Description of products and services
- The originality of the products and services compared to what
is available from the competition, their distinguishing characteristics
(include photographs or sketches if necessary)
- Description of any research and development activities required
before they can be marketed (give associated costs and timetable)
- Description of new products and services development plan
- List of legislation that must be complied with and legal authorizations
that must be obtained before they can be introduced on the market
- Marketing plan
- Estimate of sales for the first 3 years and the market share
sought (refer to your detailed market study on which you based
your sales
- List of buyer-members or potential buyers who have already
expressed an interest in buying
- Description of market segments targeted (size, location, other
characteristics)
- Description of your strategic market penetration plan and its
cost (how you will advertise your products and services, promotion
campaign, media publicity, discounted membership prices, etc.)
- Operations
- Advantages of the location of your place of business
- Characteristics and costs of the building and equipment already
owned, or to be bought or leased (attach a plan if necessary
and refer to detailed descriptions in an attachment)
- Description of the process and methods of producing the products
and services
- Description of the characteristics of the manpower required
(professional qualifications, number, salary costs, etc.)
- Management and organization
- Characteristics of the co-op’s structure and method
of operation (division of powers and responsibilities, names
of the directors and a brief description of their expertise
)
- Organization chart of the co-op and the method of operation
(management philosophy, names of managers, their qualifications,
a description of their duties, their responsibilities and
reporting relationships)
- Identification of external professional resources with whom
you plan to deal (organization specializing in start-up assistance,
accounting firm, marketing consultant, trainer, etc.)
- Timetable of activities
- Projected financial statements to include:
- Statement of assets and liabilities for the first 3 years
- Statement of earnings for the first 3 years
- Projected cash budget for the first year, estimate of working
capital for the following 2 years
- Break-even point (level of revenue beyond which the co-operative
will generate a surplus, after fixed and variable costs are
subtracted)
- Financing plan
- Total investment needed for start-up
- Short and medium-term investment plan
- Source of funds (share capital, external investors, medium-term
loans, etc.)
- Amounts by source, conditions of acquisition (interest, share
of surplus, etc.), repayment schedule, security give
