REVOLVING COOPERATIVE EQUITY - member-users of that cooperative business and A GENERATION OF normally comprises a very small proportion of that total equity base upon which the firm operates. MISUNDERSTANDING Conversely, the bulk of equity capital used by cooperatives evolved from their use of, and About mid-semester each fall, I introduce to my dependence upon, the revolving capital program undergraduate students the general topic of (RCP). As a means for generating equity capital, “cooperative finance.” By this time, the students RCP has probably been used by virtually all have already been exposed to cooperative agricultural cooperatives at one time or another. principles and have a basic-level grasp of operational practices. As I begin my lecture on Under the RCP, current cooperative patrons revolving cooperative equity, one can tell by the contribute each year to the capital base through perplexed expressions on the students’ faces that the cooperative’s retention of a portion of current my message is not being clearly received. savings or a per-unit retain. The capital thereby Forgetting for the moment my instructional generated each year is retained and used deficiencies, one presumes that the subject is “temporarily” by the cooperative and returned unusually complex or confusing. As college (revolved) to the contributing patron at some future sophomores and juniors, these students associate time when it can be supplanted by new capital with the terms “equity capital” those monies similarly generated in a subsequent year. generated by corporations through their direct sale of common/preferred stock to prospective private investors. As these students soon discover, the Revolving Capital Attributes acquisition and maintenance of adequate equity capital by cooperative businesses is quite a As originally conceived and implemented, the RCP different matter. The cooperative peculiarities are contained a number of attractive features for both numerous and varied. They comprise the financing cooperatives’ operations on an ever- basis for a generation of misunderstandings with revolving pool of equity capital funds. Among the regard to cooperative operations and they account, more attractive attributes of the program were the in large part, for the confused looks on the faces of following: my agricultural economics students. The objective of this discussion is to point out those major 1. The fulfilling of working capital needs and the cooperative peculiarities as they relate to the financing of modest facilities or equipment generation and maintenance of equity capital. We expansion could be accomplished largely from shall discuss reasons why a cooperative’s equity current savings and/or per-unit retains. This capital base must continue to grow and alternative did not present cooperative patrons with a means for securing this growth. Finally, we shall direct out-of-pocket cash expense and all address a basic cooperative conflict that ultimately equity generated in this manner was assigned evolves between a cooperative’s operational to the patron through the issuance of revolving needs and its philosophical underpinnings. capital certificates (the face value of which the patron could assign to the asset side of his personal accounts). Cooperative Peculiarity 2. Insofar as RCP-generated equity certificates Very little cooperative stock is sold to private were non-interest bearing and not due-dated, investors and little, if any, finds its way into the the cooperative gained access to a low cost commercial markets for the transfer of such and relatively unconstrained pool of funds to securities. That equity generated directly through underwrite their operations. the sale of cooperative stock is usually confined to 1 WASHINGTON STATE UNIVERSITY & U.S. DEPARTMENT OF AGRICULTURE COOPERATING 3. Perhaps the most attractive alternative of RCP this dilemma. In many cases competitive factors was that it functioned in a manner that was and changes in economic conditions have become philosophically compatible with the so-called external factors contributing towards a cooperative principles. The revolving feature, cooperative’s need to expand rapidly or otherwise itself, meant that as long as the revolve period change its method of operation. Technological remained relatively short, the current patrons changes, for example, have forced many of the cooperative would bear the primary cooperatives to expand large sums of money for burden of financing its current operations. modernization or revised marketing and distribution Moreover, the distribution of this burden would methods. Similarly, many marketing cooperatives, approximate closely the degree to which each which for years merchandised their product at the patron used or was reliant upon the wholesale level, are now finding it necessary to cooperative enterprise. move into the retail market in order to secure a more dependable market for their patron’s product. A Weakness Overlooked This need for rapid cooperative growth or change, when coupled with a modest ability to generate Implicit in the successful use of RCP were the internally the necessary equity capital, has set the basic assumptions that agricultural cooperatives stage for a basic conflict or weakness in the future would experience modest but gradual growth, financing of many cooperatives. The dilemma savings generated and retained would be sufficient worsened when in 1962; the “consent” provisions to support a disciplined growth in the equity capital of the Revenue Act were implemented. Under base, and inflation or other economic distortions these provisions, cooperative patrons were would not create imbalances in the capital revolve required to report non-cash patronage distributions cycle. Through the mid-1960s, these assumptions (retained savings) as taxable income. Patrons remained relatively valid. But, the converse has could no longer amass, tax free, assets in the form occurred in the past decade. of cooperative equity capital. These changes generated the existing situation of patrons now In keeping with the basic philosophy underlying seeking higher proportional cash patronage cooperative activity, agribusiness cooperatives payments and/or a more reasonably current have always placed a high priority on service to its (shorter) capital revolve program. member-patrons. Non-cooperative enterprises, during this same period, have operated more directly in search of the financial betterment of their New Financial Policies Required? stockholder-owners. While both forms of organizations went in search of equally meritorious Because of the conflict just noted, by the mid- goals, the basic difference in their search has led 1960s most cooperatives were diligently searching cooperatives to provide extra benefits and services for a new or improved means for accumulating and to their patrons ... oftentimes to the extent that the maintaining equity capital. A quick review of the entities’ financial performance has been adversely literature suggests that a large variety of plans, impacted. In other more serious cases, in their programs, and schemes were devised and search of the ideological aspects of cooperative implemented. activity, management and directors have occasionally subverted the firms’ operational Some early program changes included the creation efficiency. As the ability to generate savings of tax-paid retained earnings much like those deteriorated, so did the cooperative’s ability to generated by conventional corporations. Insofar accumulate capital through retains. At the same as this program change was still linked to the time, this continued search for diversity and an cooperative’s ability to generate savings, it expansion of services provided comprised the comprised only a partial solution. Other program basis for the need of an accelerated rate of growth changes included the full or partial replacement of in capital accumulation. The divergence of these revolving capital with securities (preferred stock) trends soon became apparent as cooperatives bearing no implied or actual revolve obligation. were forced to rely more heavily on debt capital to While this program had some intuitive appeal, it underwrite their expansion. proved to be operationally difficult for many cooperatives. First, these securities had to be A cooperative’s desire to provide full and quality freely transferable. Private investors were not service to its membership is not the sole cause of accustomed to such issuances and specialized 2 markets for their sale never developed. Second, to acceptable procedure. For larger, multi-product be marketable, the securities had to bear dividends cooperatives, the patronage basis may represent set at a competitive level. Insofar as such an erroneous measure of members’ use. securities could be held by nonmembers, and insofar as these represented a prior claimant on For example, products that generate little or no the cooperatives’ operations, they no longer had savings as a result of their sale distort the true access to low-cost equity with which to operate. In usage of the cooperative’s assets. More simply, if addition, some concerns were expressed that a member purchased only relatively low margin these practices violated longstanding cooperative products or services, that member’s usage on a philosophy relating to “services at cost” and patronage basis could be well below that “exclusive member-patron ownership.” proportion of company assets actually employed to provide that product or service.