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LEGAL GUIDE to COOPERATIVE CONVERSIONS a Business Owner's Legal Guide to Cooperative Conversion Including Conversion Models, Case Studies and Sample Documents

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LEGAL GUIDE to COOPERATIVE CONVERSIONS a Business Owner's Legal Guide to Cooperative Conversion Including Conversion Models, Case Studies and Sample Documents LEGAL GUIDE TO COOPERATIVE CONVERSIONS A Business Owner's Legal Guide to Cooperative Conversion Including Conversion Models, Case Studies and Sample Documents Created by: Janelle Orsi | William Lisa Sushil Jacob DISCLAIMER: The research that provided the basis for this publication was supported by funding under an award to the Metropolitan Transportation Commission (MTC) from the U.S. Department of Housing and Urban Development. The substance and findings of the work are dedicated to the public. The author and publisher are solely responsible for the accuracy of the statements and interpretations contained in this publication. Such interpretations do not necessarily reflect the views of the federal government or MTC. For a copy of the specific research findings and the methodology underlying that research, please go to http://www.theselc.org/cooperatives. i TABLE OF CONTENTS The Purpose of this Guide ................................................................................................................... 1 Important Disclaimers: ........................................................................................................................ 1 Introduction to Employee-Owned Cooperatives................................................................................. 2 The Benefits of the Cooperative Form .................................................................................................................... 2 The Legal Definition and Structure of Cooperatives ............................................................................................. 3 Voting and Governance ......................................................................................................................................... 3 Patronage Distributions and Capital Distributions ............................................................................................ 3 Capital Structure, Capital Accounts ...................................................................................................................... 4 Types of Legal Entities ........................................................................................................................................... 4 Deciding to Convert into a Cooperative .................................................................................................................. 5 The Mechanics of Cooperative Conversion ......................................................................................... 6 Four Cooperative Conversion Types ........................................................................................................................ 6 Type A: Convert the Original Entity .................................................................................................................... 6 Type B: Form a New Entity and Acquire the Business’ Assets ....................................................................... 6 Type C: Form a New Entity that Buys the Original Entity, Merge the Two Entities ................................. 6 Type D: Form a New Entity that Buys the Original Entity, Operate Both Entities .................................... 6 Deciding Between an Asset Sale or Entity Sale ................................................................................... 7 Outstanding Liabilities and Method of Sale Choice ............................................................................................... 7 Tax Considerations in Method of Sale Choice ........................................................................................................ 8 Noncapital Assets, Capital Assets and Capital Losses ........................................................................................... 8 Noncapital Assets .................................................................................................................................................... 8 Capital Assets ........................................................................................................................................................... 8 Capital Losses ........................................................................................................................................................... 9 Depreciation Recapture............................................................................................................................................... 9 Effects of Entity Form ................................................................................................................................................ 9 Pass- Through and Taxable Entities..................................................................................................................... 9 Sole Proprietorships and Single Member LLC's ............................................................................................... 10 Partnership and Multi Member LLCs ................................................................................................................ 10 Corporations........................................................................................................................................................... 10 S Corporations ....................................................................................................................................................... 11 C Corporations ...................................................................................................................................................... 12 Section 1042 ................................................................................................................................................................ 12 Eligible Worker Cooperative ............................................................................................................................... 13 ii Qualified Replacement Property ......................................................................................................................... 13 1042 for Entities Other than C Corporations................................................................................................... 13 Allocating the Purchase Price in an Asset Sale ...................................................................................................... 14 The IRS Categories of Allocation ....................................................................................................................... 14 Conflicting Interests .............................................................................................................................................. 15 Valuing the Business and Determining a Sales Price ....................................................................... 17 Overview of Factors Affecting Business Valuation ............................................................................................. 17 Appraisal and Valuation Approaches ..................................................................................................................... 17 Income Valuation Methods ................................................................................................................................. 17 Discounted Cash Flow Method .......................................................................................................................... 18 Capitalization Method ........................................................................................................................................... 18 Market Methods ..................................................................................................................................................... 18 Asset Based Methods ............................................................................................................................................ 19 Working with Professionals ...................................................................................................................................... 19 Documents Required in a Cooperative Conversion .......................................................................... 21 A Rough Timeline and Summary of Documents ................................................................................................. 21 Step 1 - Letter of Intent + Employee MOU – the “Ok, Let’s Do This” Documents ................................... 21 The Letter of Intent .............................................................................................................................................. 21 Memorandum of Understanding (MOU) among Workers ............................................................................ 21 Step 2 – The Conversion Agreement + Cooperative Governance Documents – the “Here is Exactly What Everyone is Going to Do” Documents ....................................................................................................... 22 The Conversion Agreement ................................................................................................................................. 22 Cooperative Formation and Governance Documents .................................................................................... 23 Step 3 – Executory Documents – the “Now Everything is Final and Official” Documents ........................ 23 Step 4 – A Few Final Formalities ............................................................................................................................ 25 Financing
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