How do we finance co-operatives?

It is one of the biggest issues facing co-operative businesses today: how does a co-operative bring in the finance it needs to develop while ensuring the members stay...

It is one of the biggest issues facing co-operative businesses today: how does a co-operative bring in the finance it needs to develop while ensuring the members stay in control? It is also one of the two debates at Co-operative Congress on 27 June, where co-ops across the country will come together to discuss critical issues facing the sector and decide on an action plan for the next 12 months.

There have been a number of developments around the concept of co-operative finance in the last year. At an international level, the International Co-operative Alliance published a report detailing options for financing co-operatives. At a national level, the last year witnessed reforms of co-operative law that increased the amount members could invest from £20,000 to £100,000. At a local level, community shares is a growing grassroots movement of people pooling resources to start new enterprises and save vital assets.

Congress 2015 takes place on 27 June
Congress 2015 takes place on 27 June

But arguably we need more than this – innovations that can work for co-operatives of different sizes, with different structures, in different industries. Co-operatives UK has been looking at emerging models among co-operatives in the UK and internationally, and exploring what developments may benefit the sector.

We have picked out four ideas. They are not proposals but suggestions for discussion online and at Co-operative Congress this year, and which we will be asking members about over the coming months.

1. Reinvigorate member investment models

It is a co-operative principle that members contribute capital which can be used to finance growth. This is practiced to varying levels across the co-operative sector. Many farmer-controlled businesses, for example, benefit from significant contributions from members, while community shares is flourishing because people are willing to invest in community enterprises.

Arguably, there is a need to reinvigorate member investment across the co-operative sector more widely, whether in worker-owned or customer-owned co-operatives. There are challenges, such as investment limits for worker owned businesses with a relatively small number of members, or in customer-owned co-operatives where the link between the member and the co-operative is not always so strong. And for many co-operative member capital will only go so far, with members’ share capital contributions potentially not sufficient during start up, or to provide the level of capital investment needed for take-off.

Perhaps what is needed, then, is the reinvigoration of member investment through the development of new models that can work for different co-operatives, at different stages, across the sector.

2. Models for non-member investment

Where finance from inside a business does not stretch far enough, most businesses turn to external investors. The concern for co-ops is that external investors will gain control of the business.

There are, however, a number of options for external investment that co-operatives can pursue. In the UK, the Financial Conduct Authority, which regulates co-operatives and mutuals, confirms that co-ops can accept non-member equity so long as their shares are clearly identifiable as ‘investor shares’, and member control is protected through limitations on voting rights. Internationally it is well established that co-operatives can raise capital from non-member institutional investors, such as pension funds, insurance companies and venture capital funds, so long as overall control of the co-operative remains in the hands of members.

Further, a co-operative could sell debt instruments to non-members, while the advent of online crowdfunding platforms and social investment markets opens up new possibilities.

Though it remains controversial, around the world both individuals and institutions are non-member investors in co-operatives. The issue is to ensure appropriate measures are taken for members to retain control. Perhaps what is needed, therefore, is to develop models for non-member investment.

3. A co-operative investment fund

Some of the most successful co-operative economies around the world are supported by strong financial infrastructure within the co-operative sector.

In Italy, for example, all co-ops are required by law to pay 3% of pre-tax profits into a co-operative investment fund. Between 2005 and 2009 these funds provided €34.7m in equity capital and €64.6m in loans to co-operatives – directly supporting approximately 4,000 jobs.

The UK’s co-operatives could consider establishing an investment fund along these lines. It could be owned by the contributing co-operatives in a democratic fashion, with members having overall determination of strategic direction.

This investment institution could be managed patiently and prudently, with an emphasis on high impact long term commercial decisions that deliver real growth in the co-operative economy. They could invest in both the debt and equity of co-operatives, help fund employee buyouts, and perhaps even access capital markets on behalf of co-operatives.

4. An asset lock to provide assurance to investors

Because of the limits of raising external finance, co-operatives often focus on a steady reinvestment of operating profits to finance patient growth, with a slow build-up of reserves over time. Reserves enhance capital position so that the co-operative can invest in productive activity and lever in additional debt finance and equity. These practices do not have to be formalised, but often are through the reinvesting of significant portions of profits into a common pot, sometimes called an ‘indivisible reserve’. These reserves are a common holding of assets that are not distributable to members at any point and over time are the main means for financing patient growth in many co-operatives around the world.

Further improvement to co-op legislation could better lock in this internal reinvestment. Such reinvestment locks, or asset locks, are prominent in the legal frameworks of countries with strong high-impact co-ops.

These mechanisms greatly enhance long term collective investment and growth, while providing everyone involved – not least member investors – with crucial reassurance that the capital in their co-operative will not be re-appropriated for private gain. There may also be a case for government to introduce a tax relief on profits reinvested in small asset locked co-operatives.

We see a significant imbalance in our tax system that rewards external investors over long term insider stakeholders. Government should provide equal treatment in the tax system for the patient long term approach to investment found in co-operatives.

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