By way of review, redemptions of allocated equity are always the lowest priority after first providing for the cooperative’s liquidity, its solvency and its need to replace, update or expand its property, plant and equipment (“PPE”). The Board's fiduciary obligations run to the Cooperative first, then to members and patrons (equity holders).
Wouldn’t it be great if your cooperative could strengthen its liquidity and/or its solvency and/or update or expand PPE and simultaneously add to the value of your member’s equity? That is how an appreciating co-op equity interest benefits your cooperative. And its members.
No longer does the board of directors choose between paying down debt, spending money for PPE improvements or redeeming equity. An appreciating equity interest could work for the benefit of the Cooperative and its members (assuming, of course, the Cooperative's capital requirements prevent the Board from doing everything with cash. Straight cash is always better, right?)
The challenge for existing cooperatives without appreciating interests and their members is that the accretion in value will be owned by patrons at dissolution of the Cooperative, but not before. In other words, the Cooperative should be growing in value as it spends money on PPE or building its balance sheet strength. That growth in value, however, is not reflected in the value of allocated equity. Until dissolution, the value of each member's allocated equity depreciates in value each year until the equity is redeemed with cash.
You might say, but the "value", if any, arises from the Cooperative generating more cash flow to redeem more allocated equity in the future. True in the abstract. But that rarely happens in practice. PPE investments are not that chunky and insular. The Co-op spends $4.0 million this year on a new hub fertilizer plant, but it does not end there. The Co-op can thereafter easily spend $500,000 to $1.0 million per year to keep up with rolling stock, floaters, repairs and improvements. This constant pressure prolongs the desired balance sheet strengthening that one might expect to occur more quickly after a large PPE expenditure.
Growth in PPE usually means growth in permanent accounts receivable and inventory. So in addition to PPE, the Co-op must also finance growth in working capital to maintain adequate liquidity. This can prolong the desired balance sheet strengthening that one might expect to occur more quickly after a large PPE expenditure.
Moreover, diversified co-ops are under constant pressure. If its not agronomy this year, then it will be feed or petroleum. Remember, we have been and continue to discuss co-ops that are in capital intensive businesses with nearly insatiable appetites for more capital to build more PPE. About the time that the co-op pays down the debt from one large PPE expenditure or project or expansion, the co-op is heading back into another large PPE expenditure before the allocated equity holders benefit from a speed up of the redemption of their equity.
And all the while that PPE expenditures are evaluated and undertaken, the Board of Directors and Management are constantly managing the Co-op's solvency and liquidity. The bank wants the Co-op to strengthen solvency while not weakening liquidity.
If expenditures on PPE and/or to strengthen solvency and/or liquidity could also benefit holders of allocated equity, if that is the equity interests of members appreciated in value, the Board of Directors could discharge its fiduciary obligations more easily and comfortably by receiving two benefits (stronger co-op and growing value of member's equity) from one expenditure. But allocated equity does not appreciate in value. It is only valued when it is redeemed for cash by the Co-op.
In fact, before dissolution, expenditures on PPE or improving the Cooperative's balance sheet compete with redemptions of allocated equity while the Cooperative is operating in the ordinary course of business.
Until the cooperative dissolves, no one knows precisely who is or will be entitled to the remaining proceeds (after all debts, preferred stock, dividends and allocated equity are paid). We do know, however, that at dissolution the remaining proceeds are distributed on the basis of historical patronage, theoretically going back to the formation of the Cooperative unless the articles of inc or bylaws shorten that window.
The approach of allocating all patronage earnings and then redeeming everything with cash is a great approach so long as your cooperative’s financial and economic metrics allow the cooperative to generate sufficient cash to redeem equity in accordance with member expectations.
The hard, cold, brutal truth is that it is very difficult for cooperatives operating in capital intensive commodity businesses to simultaneously maintain and build balance sheet strength, replace and update PPE and also redeem equity with cash fast enough to satisfy members and patrons reasonable expectations.
Hence, appreciating equity interests may well have a place in the cooperative community.
I don't agree that the board's fiduciary duties run first to the cooperative and only secondarily to its equity holders. Allocated margins are the property of the members individually and never become the property of the cooperative corporation, which holds allocated patronage capital as an agent or trustee. As such, the cooperative owes fiduciary duties that run to the members and former members individually. Placing all capital needs of the cooperative ahead of patronage capital redemptions may satisfy the fiduciary duties owed to current patrons because they benefit from lower borrowing costs as the result of using their capital interest-free, but it cannot satisfy the fiduciary duties owed to former members. Cooperative boards must recognize that they owe duties to former members that rank ahead of the needs of the co-op and its current patrons. The only way to satisfy these duties is to promptly return former member capital or to pay interest thereon until it can be returned. Under the user-owner principle, current patrons of a cooperative are supposed to provide its equity capital, not former members. That many cooperatives exploit former-member capital demonstrates a fundamental weakness of the cooperative model. I agree that it is far preferable for cooperatives to issue appreciating equity interests than to continue abusing the capital of former members who are locked in but frozen out from any return upon their capital. Paul Lawrence
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