The Role of Federal and State
Policy in Formation and
Success of Cooperative
Businesses
Dave Swanson
612-343-8275
swanson.dave@dorsey.com
Agricultural and Food Cooperatives in Rural Development:
Implications of Business Dynamics for Public Policy
June 16-17, 2004
USDA Cooperative Workshop June 16-17, 2004
Definitions of Cooperative
• Tax Law Definition
• Capper-Volstead Definition for Farm Coops
• Borrowing Eligibility – CoBank, CFA, NCB
• Coop Trade Association Eligibility Standards
• Rochdale Principles
• State & Federal Securities Laws
Common Theme:
Allocate Margins by Patronage
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USDA Cooperative Workshop June 16-17, 2004
Evolution in Organizational
Models Generally
• Historical model: tax neutrality
(partnerships and tax-exempts) v. limited
liability (corporations)
• Current model: increasing options to
combine tax neutrality with limited liability
and more emphasis on public (highly
liquid) v. private (less liquid) ownership
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USDA Cooperative Workshop June 16-17, 2004
Comparison of “Traditional”
and “New Generation” Coops
Traditional Cooperative
• Open Membership
• Voluntary Membership
• Low Up-Front Membership Cost
• Retain Margins/Revolve Patronage
Equities
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USDA Cooperative Workshop June 16-17, 2004
Comparison of “Traditional”
and “New Generation” Coops
New Generation Cooperatives
• Limited Membership
• High Up-Front Membership Cost
• Longer-Term Contractual Commitment
• Shares Are Traded
• Margins Are Distributed
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USDA Cooperative Workshop June 16-17, 2004
Tax Attributes of Coops
• Subchapter T
– Patronage Sourced Income Deduction
– Operation on a “Cooperative Basis”
– Patronage Allocation (pre-existing duty)
– Democratic Control
– Subordination of Capital
– Mutuality of Interest
– 20% Cash Distribution in 8½ Months
– Sourcing of Income/Expense
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USDA Cooperative Workshop June 16-17, 2004
Tax Attributes of LLCs
• Pure Pass-Through of Tax Attributes to
Members
• No Patronage Requirement (but it’s
allowed) –– facilitates non-member
equity
• Publicly Traded Partnership Rules
• Self-employment Tax
• Passive Activity Loss Limitations
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USDA Cooperative Workshop June 16-17, 2004
Is Capper Volstead Critical?
• Capper-Volstead Does Not Mandate
Cooperative Label
• Price Fixing Exemption & Allows Market
Power Unless Undue Price Enhancement
• Joint Venture Analysis for New Ventures
• Importance for Common Marketing Pools
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USDA Cooperative Workshop June 16-17, 2004
Securities Law Attributes of
Coops
• Section 521 Exemption
• Forman case
• Blue Sky Exemptions
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USDA Cooperative Workshop June 16-17, 2004
The Equity Limitation
• Patronage based earnings distribution limits the
pool of potential “investors”
• Limits on preferred stock as an equity source
– Dividend allocation rule
– State law limits on dividend rate
• Joint ventures as an equity source
-Tax and securities issues for new coops
-Cost and complexity
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USDA Cooperative Workshop June 16-17, 2004
Cooperative Conversions

EExisting Coops → conversion to LLC
potentially a taxable transaction for
coop & members
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USDA Cooperative Workshop June 16-17, 2004
Cooperative Conversions

Conversion Examples:
Dakota Growers Pasta
Minnesota Corn Processors
South Dakota Soybean Processors
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USDA Cooperative Workshop June 16-17, 2004
Choice of Entity For New
Ventures–
Coop v. LLC
It’s an “Art” Not a “Science”
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USDA Cooperative Workshop June 16-17, 2004
Choice of Entity For New
Ventures–
Coop v. LLC

The Tax / Equity Flexibility Factor
Coop
 May be tax neutral
(but with limits)
 Outside equity
limits
LLC
 Tax neutral
 Outside
equity
flexibility
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USDA Cooperative Workshop June 16-17, 2004
Choice of Entity For New Ventures–
Coop v. LLC
Some Driving Factors
• Securities Registration
– Cost
– 521 Exemption
– Intra-State
– Private Placement
• Tax Credits — Ethanol
• Blue Sky Exemptions
• Borrowing Eligibility
• Importance of NonProducer Investment
• Special Program
Eligibility
• Nature of the Farm
Product Involved
• Nature of the Market
and End Products
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USDA Cooperative Workshop June 16-17, 2004
Some Other Coop Strengths &
Weaknesses
STRENGTHS
• Common interests (other than profit) can
promote long-term view in decisionmaking
• Potential to achieve greater market power
• Greater potential to share know-how?
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USDA Cooperative Workshop June 16-17, 2004
Some Other Coop Strengths &
Weaknesses
WEAKNESSES
• Limits on farmer-owners’ ability to access
equity and appreciation (especially
traditional coops)
• Problems with retiring farmers (especially
NEWGEN coops)
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USDA Cooperative Workshop June 16-17, 2004
An Idea for Redefining Federal
Cooperative Policy
Primary Farmer Benefit Test
v.
Cooperative (or 100% Farmer Ownership)
Test
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