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Limited Cooperative Associations and Early Stage Financing

Cooperatives are the original social enterprise business model and Colorado is emerging as the “Delaware of cooperative law,” thanks in no small part to limited cooperative associations (LCAs), authorized by C.R.S. Title 7, Article 58. The limited cooperative association is a relatively new entity type, adopted in Colorado in 2010.  It offers a balance of flexibility, self-determination, cooperative identity and fundamental protection for the cooperative principles and economic structure. As of 2017, LCAs can also elect the protections and privileges of the Colorado Public Benefit Corporation Act.

LCA’s, like traditional cooperative corporations, are for-profit member-owned business structures that also subscribe and adhere to seven widely recognized cooperative principles.

Benefits

The cooperative and LCA model leverage certain unique theoretical and empirically proven advantages (see references one, two, and three), including:

  • Stickier relationship between user-customer-members and platforms
  • Greater user trust, based on data protection, user-member centricity
  • Higher success rate (lower failure rate) over long-term
  • Higher customer retention rate when ownership is shared
  • More resilient business models through economic cycles
  • Lower workforce attrition rates and higher employee morale
  • More stable governance
  • Alignment of interest between members and investors
  • Tax efficient as primarily pass-through entity for tax purposes
  • Leadership focused more on producing long-term value to co-op’s various stakeholders
  • Distributed capital and equity base creates motivated network of user-members
  • Stabilize and increase positive economic impact in communities
  • More transparent and democratic decision-making processes de-risks strategic maneuvers
  • Longer-term horizon and non-liquidity based options available for equity redemption and planning purposes

Investments and ROI

Like traditional corporations, public benefit corporations, or LLC’s, LCA’s can generate returns for investors.  LCA’s operate with pluralistic purpose, for the benefit of members, to generate a profit, and to tend to the interests of other stakeholders, including investors.  LCA’s distribute profit to their members on the basis of “patronage”; the value of goods or services contributed to or purchased from the LCA, and to investors based on the relative amount invested.  Subject to certain limitations, LCA’s can generate returns for investors based on profitability, distributions on profitable asset sales, refinancing, or through a liquidity event.  LCA’s, as member-owned and democratically-governed entities, seek to grow and operate sustainably for the benefit of their members, and thus do not set out with the objective of demutualizing or undergoing a liquidity event. Consequently, the primary mechanism for generating a return on investment is through sustainable operations and profitability.

 

Financing Examples

Traditional and mature cooperatives have tended to finance operations and growth using a preferred share that earns a target, non-cumulative, non-guaranteed dividend over a minimum holding period of between five to ten years.

More recently, multi-stakeholder start-up LCA’s have been using revenue-based financing mechanisms to raise capital, offering investors a return of up to a multiple of 1-5x the original investment, or a fixed percentage of profit for a fixed duration of time.  Once the cap is reached, the shares are treated as automatically repurchased. These instruments are sometimes called demand dividends.  Even Silicon Valley and New York VC’s are catching on to revenue-based financing and alternative business models as a way of helping to build a more sustainable and healthy business.

Non-exhaustive list of examples of seed-stage investment terms based on recent offerings.

Equity equivalent investment type:“Capped Return, Self-Redeeming”“Profit Share, Self-Redeeming”“Hybrid Profit Share – Capped Return”“Target Dividend”
Original investment (e.g.)$500,000$500,000$500,000$500,000
Return3x cap, no pre-set profit allocationX% of profit for 5-years.Greater of Cap or X% of profits for 5-years, with true-up within 90-days of 5-year anniversaryTarget 5-8% annual dividend (non-cumulative)
LiquidityPriority distribution of Cap, less prior distributions before any distributions to membersX% of positive proceeds after debt.Greater or Lesser of Cap or X% of positive proceeds after debt.Priority distribution of original purchase price plus declared but undistributed dividends.
RedemptionAutomatically redeemed at CapAutomatically redeemed as of 5-year anniversary, subject to true-upPut option at 5-year anniversary. Call option by Cooperative at any time.
Transferability/

Resale

NoNoNoNo
“Bandwidth” for realized ROIDiscretionary cash flowX% of profitGreater of discretionary cash flow or X% of profitAfter-tax net income

 

Creating the Workplace We Want

Management and operation of a law firm has taken many forms over the years and we are exploring new, innovative ways to run our firm. We are experimenting with the use of democratic principles, Teal, and self-management to develop a style that works for us and our clients. Earlier this week, Jason sent an article around to the team that highlighted The Wellington Community Law Centre (WCLC), a New Zealand law firm that went from a traditional hierarchical management system to fully self-managed in six months. Our firm has been discussing and implementing self-management techniques and it was inspiring and encouraging to read about WCLC’s journey. While reading the article I was tripped up by the reference to “advice process.” I had never heard the term before and we haven’t formally chosen a decision-making process to adhere to, so I did a little research. In a nutshell, advice process is an alternative to top-down and consensus decision making. Instead of executives or leaders making decisions, the employee who notices the problem or opportunity is empowered to act on that knowledge and becomes the decision-maker. The decision maker must seek input and advice from the relevant team members, leaders, and stake holders, but is ultimately responsible for creating a proposal and deciding what action to take. The process resonates with me because even as the least experienced member of our firm, I feel empowered to make decisions and suggestion for improving processes or creating new ones. I’m comfortable approaching the more senior attorneys to discuss my ideas and get their feedback and I’m able to pursue projects that interest me and be an active participant in my career development.

My favorite quote from Geoffrey Roberts, the general manager of WCLC, was, “When you treat people with high levels of trust, then they will live up to that. They will give you much more than you can imagine. Anecdotally, I argue that high levels of trust result in high levels of engagement and flexibility.” Perhaps more than anything else discussed, I feel that building trust is critical. For me, feeling trusted makes me feel like I can make mistakes and that I will get productive feedback that will help me grow as a lawyer. Having trust also means that I’m not afraid to come forward when I have made a mistake or to be held accountable for a decision I made. One way our firm fosters a trusting environment is through quarterly retrospectives. Retrospectives give us the chance to reflect on what is and isn’t working – they also help remove the negative connotations from accountability. Instead of accountability being scary, it simply becomes an opportunity to celebrate a win or learn from a decision that didn’t work out.

As a member of a law firm that is treading an unconventional path, I love seeing what WCLC has been able to accomplish. It gives me hope for the future of the profession and it’s nice to know our firm is in good company.

Choosing the Right Entity for Your Business

Last week our team held its first legal café at Green Spaces in Denver. We welcomed a group of approximately thirty entrepreneurs and discussed the nuances of entity choice. Our team was excited for the launch of what we hope will become a mainstay for the firm and a valuable resource for our community. We selected entity choice as our first topic because this early decision can often have far-reaching consequences for businesses. The right entity is critical for many aspects of the business, from protecting the social mission to attracting outside capital. Our hope is that we can help early stage entrepreneurs avoid the pitfalls of choosing an entity not well suited to their long term vision. To that end we created this presentation with an overview of entity types and strategies for choosing the right entity. Those who attended the legal cafe also had the opportunity to participate in an hour of small group Q&A with our team.

The event exceeded our expectations and our team is looking forward to hosting future legal cafes that provide useful information to entrepreneurs at all stages of developing their business.

Building Our Community Through Legal Cafés

A strong and supportive community can enable and catapult any entrepreneur to success. This is even more true for social entrepreneurs, those who find solutions to the most pressing social and environmental problems of our time. As an aspiring social entrepreneur, I can attest to the fact that my community became my champions, confidants, partners, teachers, and emotional support, without whom starting a business would have been a whole lot harder.  

Jason Wiener | p.c., a mission-driven company, believes in supporting our community by designing legal and business solutions that empower social entrepreneurs to find solutions for the most pressing social and environmental issues of our time. However, to get these innovative businesses off the ground, social entrepreneurs need to navigate a maze of options and regulations – a daunting and sometimes expensive task.  

Colorado is one of the most beautiful and exciting states to live in, which is simultaneously experiencing unprecedented, often inequitable and unsustainable growth. We need social entrepreneurs that come up with equitable and empowering solutions for our communities. As a social enterprise, we understand this need and supports social entrepreneurs. We have the expertise, willingness, passion, knowledge, and ability to support social entrepreneurs to form their business, navigate the regulatory environment, and provide business solutions tailored to each venture’s needs. To expand access to this information and high quality legal services, we have launched a pro bono initiative tentatively called the “Community Wealth Building Legal Café” in Denver, which will provide basic legal guidance on the elements of starting up an impactful social enterprise.  

During our first legal café, we will discuss one of the first challenges that entrepreneurs face when starting a business: choosing a business entity that truly fits the entrepreneur, as well as the business’s, needs. Figuring this out can be time-consuming, confusing, and often costly. At this legal café, we will give a thirty-minute presentation on the diverse types of legal entities that entrepreneurs can consider, the pros and cons of each, and how to set these up. We will specifically focus on inclusive and engaging business models that have shared ownership at its core. Employee ownership more equitably distributes power and capital by allowing employees to have a purposeful stake in the businesses. 

This legal café will be held at Green Spaces, a co-working space in Denver. After the thirty-minute presentation we will open the floor to questions. A team of attorneys from Jason Wiener | p.c. will be there to answer all questions about legal entities, social enterprise, and shared ownership. A free light lunch will also be served. Registration is also free. Register on Eventbrite on or before Tuesday, March 27. 

Divest…and now what? Tips for Local Investing

If you’re one of the many who have been moved to take matters into your own hands and ensure that your retirement accounts are divested from sin-sectors, such as fire-arms, alcohol, tobacco, petroleum, mining, or other companies and industries that extract from the earth, people or communities, you may be asking “now what?”  The divestment movement reached a fever pitch when organizations like 350.org and communities around the country compelled foundations, universities, pension funds, and municipal treasuries to take a critical eye to endowment investments to ensure they weren’t invested in companies and funds that were causing or exacerbating climate change.

If the latest bout of news has you thinking about doing your part, we’ll happily take a break from our usual work to help share tips for how to proactively invest in greater alignment with your values.

Take note: we are not financial planners or advisers.  You should consult a licensed financial planner and tax adviser when considering acting on any of this information. This blog comes from my personal journey to invest retirement savings in my local community and in companies and funds that I believe are part of the solution.  We are not experts at this and others have written more prolifically about the subject.

First, here are some great resources for further reading:

  1. Equal Exchange: Investing in the Solidarity Economy.  Check out and consider joining the Equal Exchange Action Forum.
  2. Michael Shuman’s 24-top tools for local investingMichael Shuman has a forthcoming book that is an excellent guide to investing IRAs and Solo 401(k) savings locally.
  3. Green Money Journal.
  4. An Introduction to Financing for Cooperatives, Social Enterprises and Small Businesses.
  5. The Self Directed IRA Handbook, by Mat Sorenson. 
  6. Self-Directed IRAs and the Slow Money Investor.

Second, here are some of the things that I have done:

  1. Move your money out of an investor-owned bank and into a community credit union.  After the Occupy efforts dwindled, one of the things that my family felt it could do was move our banking to our local credit union.  Credit Unions are cooperatively owned banks – they exist to serve their members, not Wall Street shareholders.  There is a huge multiplier effect when you bank with a local credit union. Fees and interest get reinvested into the community.  We bank with Elevations Credit Union, the largest credit union in Boulder County. It turns out Elevations C.U. is also the largest originator of mortgages in Boulder County, making it one of the most important pathways to home ownership.
  2. Check out the newest credit union in more than 30-years to open in Colorado, the Clean Energy Credit Union.
  3. Give preference to mutual insurance companies.  Again, mutual insurance companies are cooperatively owned insurance companies.  Mass Mutual, Northwestern Mutual, Liberty Mutual…get the picture?  Many insurance products are simple commodities and can be purchased through any broker.  It may not seem like a radical act, but choosing a mutual insurance company over an investor-owned insurance company is a big deal. It sends an important signal and it helps demonstrate the power and reach of economic democracy.  I just clicked “submit” on our director election e-ballot; how often do you feel you have a say in the governance of the company that holds your life insurance policy?
  4. Join a local investment club.  My local favorites are the Colorado Co-op Investment Club, and the Slow Money investment club network.  If there are none in your area, start one!  Just make sure you’re aware of and tending to securities laws.  My friend Joe Reimann is a super nice guy and quite willing to help.
  5. STOP TAKING UBERs and LYFTS. Better yet, #deleteuber and #deletelyft.  In many big cities you can easily find a taxi company or a ride hailing service that is cooperatively owned.  For example, in Denver/Boulder, we helped Green Taxi Cooperative form and obtain regulatory approval.  The upshot is that you’ll be riding with a licensed, insured, professional taxi driver, not a college kid who has been up for 36 hours straight and is trying to earn some extra money between classes.  If you really want to put your money where your heart is, then ask yourself whether you should hail a ride from companies that average $3.37/hour wages for drivers.  I say #gocoop and #gocooptaxi.
  6. Check out the Calvert Impact Investment Note. Note, the investment is not for everyone and this is not advice or a recommendation.
  7. Check out “Change Finance Diversified Impact U.S. Large Cap Fossil Fuel Free ETF (NYSE: CHGX)”.  Among the many cool things about this fund is that it is organized as a public benefit corporation.
  8. If you’re like 98% of us, you’re not an “accredited investor.”  This means that until recently you were all but forbidden from investing in privately held companies.  This all changed with the JOBS Act. Title III, in particular, paved the way for non-accredited investor crowd-funding. Subject to certain investment limits, ordinary people can invest directly into privately held companies. This means it is now easier than at any time in the last 80-years to actually invest in your favorite local business.  You’ll have to invest through an online portal, and there are many out there.  Check back soon; we’ll be publishing future blog posts about crowd-funding, direct public offerings and other ways to invest in local businesses.
  9. Set up a self-directed IRA and/or Solo 401(k) plan.
  10. Last, but not least…shop local and shop coop.  Local buying and community purchasing is by far the most effective and direct way to support local business, keep money local and vote with your feet (or is it dollars?).  Why shop at Home Depot when you can shop at a local Ace or True Value Hardware store? Did you know that both of the latter are cooperatives? Each store is independently owned and the store is a member of a wholesale purchasing cooperative. This allows each store to achieve economies of scale with other coop member stores. This aggregated purchasing power translates into better prices for customers.  Locate your closest food coop! If one doesn’t exist, help to start one.

The bottom line is that once you divest, you’ve got to INvest.  It can be overwhelming with so much to learn and so many options to explore.  Remember, you’re not alone.  It doesn’t just take a village…it takes a community.  Good luck and please share your tips and experiences!

VLOG: Frequently Asked Questions

We are announcing a new video blog FAQ series. We will release short videos to answer the questions we are frequently asked.  If you have questions, you can contact us using the link at the bottom of the website and you should register for our distribution list.  I hope you enjoy and leave comments with your feedback.

  • What Is Distributed Ownership?
  • Why Sell My Company To Employees?
  • I Want Shared Ownership, What’s Next? (I also wrote a blog post about this topic) 

 

“I want to run my business as a cooperative, but…”

I received a familiar email from a long-time friend and start-up founder.  She has founded a unique brand and business model that has created a market where one had not previously existed; the dream of most entrepreneurs.  The start-up has grown rapidly and has received international acclaim in mainstream press.  A great position for any growing start-up to be in, right?  Like many start-ups, however, cash is scarce and “sweat equity” is abundant.  She said: “I’m not ready to invest in turning my business into a full-fledged cooperative, but I’d like to start down the path. What can I start doing now?”

I hear this question a lot. I hear variations of it is as well. They go something like “I want to run my business as a cooperative, but:”

  • “I have heard that cooperatives are run as not-for profits.” Or
  • “I am afraid of sharing ownership and diluting what I’ve built.” Or
  • “I don’t know if I’m ready.” Or
  • “I don’t fully understand what it means to operate as a cooperative or with shared ownership.” Or
  • “I don’t know if my team of employees wants to co-own this business.” Or…

You get the picture.  Decisions about ownership are the most intimate and consequential decisions a founder makes.  Hesitation is natural, if not expected.
Here is more or less what I told my friend:

Under the cooperative laws in many states, you cannot technically call a business a “cooperative” unless you form under that state’s cooperative laws, or you operate on a cooperative basis.  Additionally, there are significant tax, securities, contractual and other legal considerations involved in operating on a cooperative basis and sharing ownership, and so you should consult an attorney.

You can, however, start by adopting cooperative practices and principles:

  1. You could start practicing open book management and collaboration. You could schedule regular conference calls to discuss the business’ finances with team members and employees.
  2. Ask team members and employees to vote on things. Start small; have folks vote on the type of coffee to buy.  Progress at a natural pace to more consequential decisions.
  3. You could do one or all of the four things Jennifer Briggs, former co-owner and VP of HR and Organizational Development at New Belgium Brewing recommends.
  4. You could start offering financial incentives to employees and team members, tying revenues and/or profit to compensation.
  5. You could operate as a benevolent dictator and open up decision-making to a consensus or democratic process. You would of course retain the final and definitive vote as the business owner.
  6. You could create committees to focus team members and employees on various aspects of the business, giving official responsibility and even equity compensation for participation.
  7. You could create and offer phantom equity or equity appreciation rights by way of contract so as not to complicate your capital structure.  I disfavor phantom stock and stock appreciation rights as a definitive ownership sharing technique, but they can be an effective and efficient bridge to meaningful shared ownership.
  8. Consider whether to you want to grant ownership rights or sell them in exchange for capital contributions.
  9. Consider whether to allocate ownership based on a retrospective or prospective measurements of “sweat equity.” Equity ownership can be allocated both statically and dynamically. For example, check out the encode.org “for purpose entity” structure, and “Slicing the Pie“.

You may be familiar with stock options plans.  While widely used, I tend to disfavor them as a device to confer meaningful and direct shared ownership. Stock option really only make sense when a business is cash strapped, but growing quickly and anticipates significant future profitability or a liquidity event (company sale, IPO). Stock options offer a tax-advantaged mechanism to pay service provides/contractors/advisers/employees with equity rights that are not taxed until the option is exercised. Stock options plans are somewhat expensive to set up and administer and annual valuations are required. Stock options rarely come with voting rights and the the options holder often cannot exercise ownership over the underlying equity until the options have vested, and the options are exercised.

***

Divying up ownership is one of the most consequential decisions an owner will make. Start with democratic management practices first, and then consider economic democratization with hybrid structures like phantom equity or equity appreciation.  Once you have a clearer picture of the scale potential of the business and your desired ownership design, it makes more sense to formalize a shared ownership structure.

A cooperative structure need not be the only way to share ownership. There are numerous structures to consider and each offers a unique blend of pros and cons.

Lastly, talk about your journey and tell your story! It is important for other business owners to hear that they are not alone.  Check out the 4-part series of our client dojo4’s journey to become a worker-cooperative.

Leaving a Legacy: Creating a Social Enterprise that Outlives Its Founder

More and more, entrepreneurs and investors want more than just a buck:  they want to create a business with a social mission, then preserve that entity’s mission through time. This blog post briefly discusses three ways to keep a business entity on purpose long after the founders have left.

The first way is to borrow a page from much of the rest of the world and use “golden shares.” A golden share is a share with special voting powers greater than the other shares. To illustrate that power:  threatened with a takeover or acquisition that jeopardize the entity’s mission, one golden share could veto the transaction.

While we recognize that golden shares are hardly used in the U.S., we see potential. Our research indicates that the broad, powerful Delaware corporate law (the “gold standard” for U.S. corporations) has the flexibility and breadth to allow golden shares. Case law suggests that golden shares are permissible if they were created for an equity holder at the outset of the transaction.

 

second way to leave a legacy is through a Public Benefit Corporation. The very act of creating a public benefit corporation creates a high level of protection for the entity’s social mission; to delete or amend an entity’s public benefit statement or purpose would require approval of two-thirds of the outstanding stock of the corporation entitled to vote.

 

 

 

A third vehicle for preserving a company’s social mission is through a “perpetual purpose trust.” The Hershey Company, for example, has historically supported kids in financial need. Hershey does this through a purpose trust worth about $12 billion. The mechanism of the Trust’s control is fairly straightforward:  “The Trust owns about 8 percent of the chocolate company’s shares, but because of a dual class stock arrangement it controls about 81 percent of the votes.” This voting power allowed Hershey to reject a $23 billion takeover bid from rival candy maker, Mondelez.

Preservation of an entity’s long-term social agenda is a good thing. Jason Wiener|p.c. has partnered with other thought leaders on this topic (see, for example, Armin Steuernagel and his white paper on steward ownership). Our work-group plans to publish resources for the purpose-driven enterprise; sign up for our email alerts and we’ll let you know when it is available.

The Best Way to Fight Uber? Own It.

Originally published at the Roosevelt Institute

Progressives should embrace employee ownership as one of the best ways to challenge corporate power from the bottom up and put supporting the growth of worker-owned firms in the center of our strategy. As the economy becomes Uber-ized and dominant firms in all sectors take up more and more market share, structural reforms like better antitrust regulation and portable benefits are absolutely necessary, but not sufficient, to reversing inequality.

What’s needed is a massive wave of support for shared ownership and community capital. The difference in an employee-owned business from another type of business is simply where the profit goes: Does it flow up to an executive suite and a small set of investors? Or, is it shared by the members of the enterprise, who put in the time and effort to make it successful? The product may be nearly the same from the perspective of the consumer, but the change inside the firm itself is durable, because it’s not subject to the shifting winds of legislators. Community capital allows those of us with the ability to invest to put our wealth into local businesses, rather than exclusively into Wall Street funds.

These models that were once seen as “niche” and hippie-like may be our best shot at centering working families as both value creators and value receivers in the American economy to come. For example, shared ownership of platforms—the rising business model that Uber embodies, where workers aren’t employees but instead “gig” workers, or independent contractors—can turn a platform into a way for its owners to best employ their skills in a just-in-time economy, as nurses in California have identified. And if the “gig” or “platform” business model is here to stay—and its embrace by millennials demonstrates that it is—there’s a real opportunity to move from the sharing” economy to the shared ownership economy.

In a way, shared ownership is simple: Through a variety of legal structures like a Limited Cooperative Association or partnerships with multiple partners, worker-owners have rights to the value created by the firm just as investors do, and they often have decision-making power over major corporate decisions, as well. Worker ownership of a firm does not mean that everyone sits around in a drum circle to decide what type of pens to purchase—firms owned by employees may look and feel just like a regular firm, where members-owners have the right to vote on the major issues that face the firm. In fact, employee ownership is much more common than people think, in the form of Employee Stock Ownership Plans (ESOPs)—over 10.5 million workers partially or wholly own their employers this way. A recent studyby the National Center on Employee Ownership found some striking statistics about the benefits of ownership: For employee owners aged 28-34, such workers had 92% higher median household wealth, 33% higher income from wages, and 53% longer median job tenure, when controlling for demographic factors.

What employee-owned firms have lacked for a long time is capital: New firms require investors willing to take risks on entrepreneurs with a vision, and investors have long been skeptical of founders who planned to share the value of the firm with employees. But the rise of social capital and impact investing, alongside new opportunities for community capital-raising after the implementation of the JOBS Act and investment crowdfunding regulations, means that capital is starting to unlock for such firms.

Policies to encourage worker ownership have slowly been getting more attention from lawmakers—several Democratic senators have introduced legislation this year to fund employee ownership centers in the states and to create a fund of public capital to support conversion to worker ownership. And prominent progressive voices like Roosevelt Chief Economist Joseph Stiglitz are speaking out in favor of the model. It’s crucial that spreading worker ownership becomes as central to the progressive economic narrative as raising the minimum wage and supporting financial reform.

The best way to fight Uber? Own it.