Legal Entity Choice for Cooperatives

Not legal advice.

I want to dispel a common misconception: that cooperatives must be cooperative corporations.  That’s not true.  Cooperative lawyers are not afraid to organize cooperatives as LLCs; we do it all the time.

A cooperative can be organized as a cooperative corporation, an LLC, a general business corporation, a benefit corporation, or in some situations, a not for profit corporation.

What makes it a cooperative is not the legal entity. A cooperative has these essential elements: it is equitably owned by the members, it is democratically run by the members, and it is organized primarily to benefit the members as patrons.

The choice is usually between cooperative corporation and LLC, so I’m going to sum up the main benefits and drawbacks as they apply to many co-ops:

Cooperative corporations can sell many shares of stock to the public.  This is great  when you have many members, and members come and go, as in a consumer co-op. Also, most states have a securities law exemption for cooperative corporations, which means you can raise some capital by selling membership shares to the public, without a burdensome registration process. For example, in Illinois, cooperative corporations can raise up to $10,000 from each member, and in California, cooperative corporations can raise up to $1,000 from each Community Investor Member.

Drawback: in a cooperative corporation, workers are presumed to be employees for some employment law purposes, such as minimum wage laws. With a start-up consumer co-op, such as a food co-op, the founding members can raise money and get a lot of organizing and start-up work done before hiring the first employee.  For a start-up worker co-op, however, the owners are the workers, and you most likely need to put time in to get the business going even if you can’t afford to pay yourselves minimum wage for all hours worked.

​LLC: the most common situation in which I steer a client towards an LLC is when it is a start-up worker co-op that is short on cash and cannot afford minimum wage and workers’ compensation. The benefit of the LLC is that owners are presumed *not* to be employees, so the burdensome requirements of employment law generally would not apply. (This is especially clear when the business is small.)

An LLC can be the right choice when you want to customize the rights and duties of classes of members more than the co-op corporation statute will allow.

Cautions: Tax. LLC’s pass all of their income and losses to members.  This means that if you retain earnings, you’ll need to plan ahead and distribute enough cash to members for them to pay their taxes, or members could be upset about having to pay taxes on income they did not receive.

LLC’s generally cannot use the word “cooperative” in their business name.

And there are no special exemptions for raising capital in an LLC.

Quick Decision Tree:

• Is this a food co-op or other consumer co-op?  If yes–> consumer co-op.
• Is this a start-up worker co-op that’s boot-strapping and short on cash?  If yes–> LLC.
• Is this an established worker co-op that already treats workers as employees, and you’re seeking to raise capital by selling preferred shares to investor members? If yes–> consider converting to a cooperative corporation.
• Are the members growing crops? If yes–> agricultural co-op will give you even better tax status and capital-raising options.

​If you have specific questions about your own co-op, feel free to contact me to schedule a free legal strategy session.