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“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.

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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.