Funding a Cooperative:

While there are some unique characteristics to funding (or “capitalizing”) a cooperative, there are a lot of commonalities with any other business ownership structure.

How is a Business Valued:

Valuation: A snapshot of how much all the profits of a business forever into the future are worth.

Different methods may be used to understand a company, including cash flow, assets, income or a comparable sale price of a similar business.

Risk: how do you know a company will keep performing, now and in the future?

Inflation: prices in the economy increase, will the value of the company keep up?

Capital Strategies:

Debt

Money that is borrowed and must be paid back to the lender with additional interest payments. Lenders do not have ownership rights, unless the borrower cannot pay back the loan, in which case lenders take control of collateral.

Debt Providers:

Community Development Financial Institution (CDFI)

• Currently the primary financier of Coops
• Financial institution certified by the US Dept. of Treasury
• Important facts to consider: Interest rate on the loan; how much financing is needed; how much collateral the CDFI requires;
• Will often have higher interest rates on loans than traditional banks, but provide funding for projects that traditional banks will not

Commercial banks

• Financial institution that generally provide lower-risk capital to individuals (like home mortgages) or to existing businesses (like working capital loans)

Credit Unions

• Owned by members
• Mission to serve members; community-focused programs and loans

Private equity

• While technically “equity” as the name suggests, private equity uses large amounts of debt, in addition to equity, to fund the purchase (“buyout”) of a business

Microfinance institutions

• Organizations that lend small quantities to create opportunities
• Range from internet-enabled crowdfunding platforms (which raise funds from individuals) to international institutions (which raise funds from philanthropic sources, governments, or investors)

Venture debt

• Alternative to equity capital for early stage businesses (often technology startups) that have demonstrated some record of success, but are still outside the risk profile of traditional lenders
• Does not require collateral, in recognition of startups’ lack of assets that could be used as collateral; instead, risk is compensated by warrants (options to buy stock in the company at a fixed, often discounted price in the future)

Bonds

• Financial instruments that corporations (and even municipalities) issue when they need to raise large amounts of money from debt
• Because they are often too large for any one single lender, bonds allow lots of investors to become “mini-lenders”

Characteristics:

Debt financing is generally more risk-averse. Financing is affordable because interest payments are deducted from taxes.

Access to collateral, or assets of the cooperative (be it property, equipment, or inventory) gives financier's insurance that they will be “paid back” if everything goes south, is a critical blocker for coops.

Debt Security Instruments Available:

Debt securities are financial assets that entitle their owners to a stream of interest payments. Unlike equity securities, debt securities require the borrower to repay the principal borrowed. The interest rate for a debt security will depend on the perceived creditworthiness of the borrower.

US Treasuries - Short term, and mature within a year. They can be cashed in (i.e. redeemed) only at the end of a period of time (maturity), and are sold at a discount if sold before maturity.

Mortgage - A loan against a property. In case of a failure of payment, the property can be seized and sold to recover the loaned amount.

Bonds - Generally issued by governments, central banks or large companies (ie. corporate bond) and are backed by a security. Bonds ensure payment of a fixed interest rate to the lender of the money. On maturity of the bond, the initial amount loaned (ie. principal) is paid back.

Debentures - Debt instrument not backed by any collateral, but backed by reputation (and credit worthiness)

Alternative Structured Debt Security Products - When a standard loan isn't enough to cover a unique transition, mixed elements of debt and equities called alternative structures can be implemented. CDOs CDOs, Credit Default swaps, hybrid securities.

Note: The Small business administration (SBA) administers many venture capital programs to startups and small businesses. These include long-term loans and loan guarantee programs that help small businesses obtain funding from other sources

Credit Enhancement

Loan Loss Reserve: LLRs are a credit enhancement approach commonly used by state and local governments to provide partial risk coverage to lenders—meaning that the reserve will cover a prespecified amount of loan losses. Institutions can draw on the LLR to cover losses on defaulted loans according to the terms of the loan loss agreement between the lender and the state and local government.

Secondary Market Support: Availability of funds from the secondary market can allow lenders to recycle and relend their loan funds more quickly than they would be able to do if they had to wait for their loans to mature. Although LLRs support the primary lender, the benefits and risk coverage of the LLR must be assignable to the secondary market capital source (provider) if the loans are sold to an investor in the secondary market.

Equity

Capital received for an interest in the ownership of the business

In light of the fact that all cooperatives face constraints in obtaining equity capital, cooperatives have unique methods of acquiring equity capital. Many investors want some oversight or control over the operations, that may challenge the democratic model of cooperatives, and narrowing the pool of mission-aligned equity available to cooperatives

Common Equity

Money invested in the business without guarantee of payback or financial return; “at risk” capital that entitles the investor to share in ownership, control, and any business profits and losses.

Common equity can be contributed by worker-owners themselves, but because of membership requirements, conventional common equity from outside, non-member investors is not an available source of capital for cooperative businesses.

Preferred Equity

Preferred stock is a source of initial equity capital. There is typically no market for preferred stock in a cooperative and cooperative profits are distributed based on use, not stock ownership. Because of those facts, cooperative preferred stock typically carries a dividend rate, often limited by law to 8%.

Outside non-member investment

Cooperatives may choose to issue non-voting preferred stock to outside investors. This has become a standard tool to raise additional capital from mission aligned investors, such impact investors and charitable foundations who invest with a relatively long-term perspective and who support the mission and values of the cooperative. In general, the capital invested through such non-voting preferred stock is something thought of as “rented” capital, and is paid out after (i.e. subordinated) to the patronage capital of member owners.

Outside investor-member equity

Limited cooperative associations are a hybrid cooperative model that permits the issuance of voting stock to investor-members. Investor-member voting rights are statutorily limited, and ordinary patron-members always have the majority voting control. This new form of limited cooperative association has created potential for the cooperative model to scale more quickly.

Capital Providers:

Community Development Financial Institution (CDFI)

• While also offering debt products, CDFI’s also offer money for a stake in ownership of a company as equity.

Investment banks

• Intermediaries between a corporation and the financial markets. That is, they help corporations issue shares of stock in an IPO or an additional stock offering. They also arrange debt financing for corporations by finding large-scale investors for corporate bonds.

Pension funds

• Pension funds are pooled monetary contributions from pension plans set up by employers, unions, or other organizations to provide for their employees' or members' retirement benefits.

Venture capital

• a form of private equity and a type of financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential.

Private equity

• Investment who work in partnership with other financing to either buy or restructure companies that are not publicly traded

Family offices

• private wealth management advisory firms that serve ultra-high​-net-worth (UHNW) investors.

Accelerators

• A fixed term, mentorship & business development program that can contribute assets from services like legal/financial advice to mentorship, often for a % of ownership in a company

Friends + family

• Raising money from family members or friends, typically as a loan.

Hedge funds

• A limited partnership of investors that uses targeted methods of investment to realize large capital gains.

Crowdfunding

• Raising small amounts of money from a large number of people.

Non-dilutive Capital

A capital source that does require ownership in a company in exchange for its investment.

Capital Providers

• Governments
• Foundations
• Philanthropy
• Non-profits
• Academic institutions
• Corporate social responsibility groups

Characteristics: Generally does not have a financial return, but may have a non-financial, social, or environmental return.

Available Capital Products:

Program Related Investments - a tax exempt charitable foundation can make a debt, equity, or other investment. These can take the form of equity, debt, or forgivable loans, convertible loans, and other types of investment.

Mission Related Investments - Impact investments describe investments made by a foundation that are more in-line with the foundation’s mission as opposed to status quo investment pattern for many foundations where the sole purpose is to maximize return on investment

Grants - Less common to for-profit entities, but is possible with compliance with IRS requirements for expenditure responsibility.

Convertible Grants - Form of hybrid grant/loan.

Example: US Federation of Worker Cooperatives is creating a revolving grant fund to help existing co-ops grow their business. The fund initially provides a grant to the co-op, and when the co-op reaches the level of growth that allows it to attract other sources of financing, the co-op will pay back the grant to the Federation.