Unallocated Equity versus Cooperative Principles
Phil Kenkel
Bill Fitzwater Cooperative Chair
A cooperative is a user-owned and user-controlled business from which benefits are distributed in
proportion to use. This definition contains the inter-related principles of user-owned, usercontrolled and user-benefits. These basic cooperative principles describe the ideal and provide a
goal for specific management practices. An interesting practice to consider is the creation of
unallocated equity.
Unallocated equity represents earnings of the cooperative that is not issued to specific members but
is instead held as permanent capital base. Maintaining an adequate amount of unallocated equity is
an important part of balance sheet management. Lenders like unallocated equity because it provides
a permanent equity that is not revolved. Unallocated equity also provides a cushion to absorb loses
without being forced to write down the value of the member’s allocated equity. Price volatility and
business risk have increased the need for unallocated equity. However, unallocated equity has been
criticized as violating cooperative principles.
A common argument is that unallocated reserves represent the cooperative corporation’s capital and
used at the discretion of management. This argument is largely incorrect. The creation of capital in
the cooperative has no impact on its use. Managers and boards work hard to make decisions in the
best long-term interest of the cooperative. The ratio of allocated to unallocated equity has no impact
on decisions, and doesn’t conflict with the “user-controlled” principle. Concerns over unallocated
equity violating the ‘user-owned” principles are only slightly more justified. Cooperative members
are the residual owner’s of the cooperative’s assets. One could think of unallocated equity as
belonging to each member in the same ratio as the allocated equity.
The problem with unallocated equity in respect to cooperative principles is that it is available to
members only when the cooperative is dissolved. This relates to the “user-benefits” principle. The
earnings are assigned to unallocated equity are never returned to the member through equity
retirements. The relationship between use and benefits is now imperfect. A counter argument is
that unallocated equity benefited the members by allowing the firm to operate on a stable basis and
by reducing the cooperative’s interest costs which are indirectly paid by members. Earnings
generated from non-member or subsidiary business are also often assigned to unallocated equity. In
this case the relationship to the user-benefit principle is less clear since it could be impossible to
fairly assign the earnings on the basis of cooperative use.
The practical question of unallocated equity is how much is enough and how much is too much.
Unallocated reserves are a vital tool to provide financial stability and maintain access to capital.
Excessive levels of unallocated equity make the cooperative more valuable dead than alive and
provide an incentive for members to liquidate the cooperative. A good target is to have sufficient
unallocated reserves to equal twice the largest historical or foreseeable net operating loss.
9-15-2010