How to Form a Cooperative
Table of Contents
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.
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 Versus 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.
A co-operative has three key groups of people:
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, that represents the members by overseeing the co-op's business affairs. Usually seven to nine members (minimum three) 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 fundraising 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 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
Listed below is a comparison of the features of the for-profit and not for profit co-operative and corporation business structures.
Co-Operatives - For-Profit
Purpose: Service and saving for members.
Ownership: By members.
Control (Voting): One member, one vote, no proxy voting.
Liability: Members limited to share subscription.
Distribution of Surplus or Earnings: To members in proportion to use of service.
Initiation of Policies: Board of Directors, members and management.
Co-Operatives - Non-Profit
Purpose: For social, cultural and economic needs of members.
Ownership: By members.
Control (Voting): One member, one vote, no proxy voting.
Liability: Members limited to membership amount.
Distribution of Surplus or Earnings: Surplus remains in co-op.
Initiation of Policies: Board of Directors, members and management.
Corporations and Investor Owned Business - For-Profit Corporation
Purpose: Profit for shareholders on investment of time or money.
Ownership: By shareholders.
Control (Voting): The number of voting shares held per shareholder.
Liability: Shareholders limited to share subscription.
Distribution of Surplus or Earnings: Dividends paid on shares.
Initiation of Policies: Board of Directors, shareholders and management.
Corporations and Investor Owned Business - Non-Profit Corporation
Purpose: Social and cultural activities other than personal financial gain.
Ownership: By members.
Control (Voting): One member, one vote unless otherwise specified in the articles or by-laws.
Liability: Limited to the investment.
Distribution of Surplus or Earnings: Surplus remains in 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.
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.
Select 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. 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 economic viability of the venture but also outlines the market advantages of a member owned co-operative, if any. If the feasibility study is positive, this builds enthusiasm among the steering committee for the project and the organizers can proceed to the next step.
Select an interim board - If the feasibility study is positive and the decision is 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.
Incorporate 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 or funding agreements with governments. Incorporate as soon as there is potential exposure to liability.
Develop 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.
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.
Prepare 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).
Conduct a fundraising campaign - Once the legal and filing requirements are in place and the business plan is finished, the board can launch a funding campaign.
Incorporating the Co-Operative
The following information regarding the Co-operative Corporations Act, 1990 and the legal structure of a co-operative is general information and should not replace competent legal advice.
The Co-operative Corporations Act, 1990 is administered by the Financial Services Commission of Ontario.
A co-operative requires at least five persons to incorporate. The exception to this is worker co-operatives that require only three 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, 1990. 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
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, 1990.
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 Newly Updated Automated Name Search (NUANS) that you submit to the Ministry of Finance. A list of the private search houses in Ontario is available from the Ministry of Finance.
Filing for Incorporation
To incorporate a co-operative you need to send the following documents to the FSCO:
You may wish to send a draft version of your Articles of Incorporation to FSCO for an opinion. Obtain the forms required from FSCO. When this process is complete, FSCO will issue a Certificate of Incorporation, 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 Government and Consumer Services by filing an Initial Notice form. This form includes basic information about your co-operative, including its name, date of incorporation, the address of its head office and the names and addresses of its directors and officers. The form is available online (ontario.ca/forms) from the Ministry of Government and Consumer Services; form number 007-07200.
Obtain co-operative incorporation information from:
Financial Services Commission of Ontario
To change your Articles of Incorporation you must file Articles of Amendment with FSCO. 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 FSCO or pay a fee. In order to avoid filing Articles of Amendment with FSCO, 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-operative Association (CCA) or The Ontario Co-operative Association for advice on what to include in your by-laws.
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 two or more provinces and have a fixed place of business in more than one province. Under the federal Co-operatives Act, at least three 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 Innovation, Science and Economic Development Canada at www.ic.gc.ca/eic/site/cd-dgc.nsf/eng/h_cs03926.html
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. By-laws do not need to be filed with FSCO. By-laws 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:
Have the articles and by-laws prepared by professionals familiar with co-operative law and practice. Ensure directors are involved in 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 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-operative's 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 assess the risk associated with investing in the co-op.
A co-operative does not have to file an offering statement if there are:
Standard forms and sample templates for the offering statement are available from the Financial Services Commission's website 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 two 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.
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 a co-op does 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.
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:
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 thirty-five 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 six months' 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 four methods of raising debt capital.
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
The Co-operative Corporations Act, 1990 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:
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, 1990. A member may withdraw from the co-op by giving six 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 six 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 one 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.
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.
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.
Further details of the information in this Factsheet can be found in the Co-operative Corporations Act, 1990. 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, 1990 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:
Co-operatives in Ontario, FSCO, a series of publications that includes: Guide to Setting Up A Co-operative, Incorporating a Co-operative With Share Capital, Incorporating a Co-operative Without Share Capital, Legal Requirements.
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 laws affecting incorporation of co-operatives. The Government of Ontario assumes no responsibility towards persons using it as such.
Phase I - Develop the Initial Business Idea
Step 1: Assemble a Group of Key Organizers
Step 2: Conduct a Feasibility Study
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 three and four 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
Step 4: Complete a Business Plan
If the business plan reveals serious flaws or the group's level of enthusiasm 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:
Step 5: Organize the Internal Structure of the Co-Op
Step 6: Plan and Organize the Co-Op's Start-Up Financing and Funding Drive
Step 7: Organize the Business Enterprise
Step 7A: Plan the Operation of the Co-Op
Step 7B: Recruit and Train the Co-Op's Staff
Step 7C: Ensure the Legality of the Co-Op's Operations
Step 8: Hold the Initial General Meeting
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, 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 two purposes:
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:
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