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Frequently Asked Questions

Table of Content

What is a Cooperative?
How Do Cooperative Members Get Paid?
Legal Structure of a Worker Cooperative
Are worker cooperatives the same as ESOPs?

What is a cooperative?

A cooperative is a group of people working together for a common goal. Cooperatives can take many forms, but there are three major groups:
  1. Consumer cooperatives
  2. Producer cooperatives
  3. Worker cooperatives

Consumer cooperatives

The most common consumer cooperative in our region is the credit union. For most people, they function just like regular banks, but they are not. They don't have shareholders who keep some of the profits. Instead, they have lower fees, pay more interest or charges less when you want to borrow. Most people are unaware that credit unions are democratically controlled by their members, but they are.

Another common type of consumer cooperative, the food co-op, fills the need for organic fruits and vegetables and other specialty items. Once the regular grocery stores started to listen to their customers and began to carry these item, the need for food co-ops was reduced. The largest food co-op in our region is the Park Slope Food Co-op in Broklyn.

Producer cooperatives

Danish farm products, ham, butter, cheese, are known and respected throughout the world. That probably wouldn't have happened without cooperatives. Closer to home, Land-o-Lakes and Florida's Natural are producer cooperatives. Most people are unaware of this. They just want their butter and their orange juice.

Worker cooperatives

There are only about 400 worker cooperatives in the United States. In northern Italy, there are more worker cooperatives than what we call regular companies. The world's largest worker cooperative is the Mondragon cooperative in Spain. What started as a small woodburning stove manufacturer has grown to a multi-national conglomerate. It is really a network of cooperatives sharing resources, financing and expertise with each other. Closer to home, the largest in the United States is Cooperative Home Care Associates in the Bronx with approximately 2,000 member owners.
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How Do Cooperative Members Get Paid?

As with everything else in a cooperative, the members get to decide how what is left over after all expenses have been paid is distributed to the members. There are lots of choices and the decision will usually depend on the kind of legal entity you have chosen. The most significant consideration for most are the tax implications. What will put the most money into the hands of the members and ensure the survival and/or growth of the cooperative?

As a point of principle, everything the cooperative makes belongs to the members. Typically, members will be paid a salary like other employees and get a w-2 at the end of the year. Others are paid a distribution equivalent to their share of the anticipated earnings and get a form k-1 at the end of the year. In either case, if there is still something left over, it will be paid out as surplus. You can think of it as the rest of what you earned. Surplus is roughly equivalent to profit, but since it is not tied to the amount of investment, but to the amount of labor the member provided, we use the term surplus.

It is best to work with an accountant who understands how cooperatives work.
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Legal structure of a worker cooperative

There are basically two sets of laws dealing with cooperatives: State and Federal laws. State laws deal mainly with the legal formation of the entity, but can also include tax and securities laws. Federal laws primarily deal with taxes and securities. No Federal laws govern corporate entities.These two sets of laws are quite separate. Sometimes they even conflict with each other.

It is possible to conduct business either as an individual or a collective. A collective is just an unincorporated partnership. Doing that, exposes you to all kinds of liabilities and it is not advisable. Incorporating your business as a corporation or Limited Liability Corporation (LLC) essentially separates it from you. The business becomes a separate legal entity. You can not, except in certain rare circumstances, be sued for things the company does.

New York is one of several states with a Cooperative Corporations Law which sets rules for companies incorporated as cooperatives. One great benefit is that it allows you to use the word “cooperative” as part of the company’s name. None of the other options allow that. There are also a few disadvantages. First, when you incorporate this way, you are also bound by the rules of the law. You cannot easily make up your own rules like you can in a partnership or LLC. Second, organizing this way also immediately subjects you to all employment laws of your State including workers’ comp, minimum wage, overtime, etc. When you organize as a small LLC where all members are directors, you could treat each other as partners instead of employees. Partners and management employees are subject to different more flexible employment rules, but be sure to seek legal counsel before doing this.

The other set of laws governing cooperatives are both Federal and State tax laws. Federal tax law contains a special tax rule for cooperatives commonly known as Subchapter T. Like Subchapter S for regular corporations, Subchapter T also allows cooperatives to avoid double taxation. Under Subchapter T, profits, called surplus, distributed this way is independent of capital. Instead of being tied to number of shares owned, it is tied to patronage, the amount of business a member does with the entity. In a worker cooperative, it is usually a combination of hours worked and/or pay.

The IRS does not define what qualifies as a cooperative. That definition is made in case law such as Puget Sound Plywood. Among other things, to be recognized as a Subchapter T corporation, the company must be organized as a cooperative where each member has only one voting share and therefore only one vote.
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Are worker cooperatives the same as ESOPs?

Both are forms of employee ownership, but that is just about the extent of their similarity. ESOPs, or Employee Stock Ownership Plans, are fundamentally retirement plans much like 401k plans except they invest only in company stocks. You may have heard of Stock Option Plans, but that is something completely different.

An ESOP is an example of indirect ownership. A worker cooperative is an example of direct ownership. In an ESOP the employees do not directly own their shares. They are held in trust for their benefit by a Trustee appointed by the employer. Therefore, ESOP participants do not usually have any influence on how the company is run. The Trustee votes their shares for them. Only a very small number of 100% employee owned companies have taken the final step towards democratic governance. Most companies with ESOPs have implemented a culture of employee participatory management style, but not actual control.

In a worker cooperative, each employee purchases and directly owns one voting share of the company. Each owner has one vote, so the main difference between worker cooperatives and ESOPs is in the area of control.

Most worker cooperatives pay out profits called surplus annually, but often retain a portion to be owned collectively. The company will pay the taxes on that portion. Another portion may be deposited in the worker’s individual capital account along with their initial buy-in share. When that happens, enough will be paid out in cash to cover the taxes on the worker’s portion of the surplus. In ESOPs, the shares that are held in the employee’s individual account is not taxed until he or she leaves the company and withdraws the funds in the account.

So both have individual capital accounts and both get liquidated and paid out when the participant leaves or retires. It is for this reason ESOPs need to have an annual evaluation to determine the value of their shares. Liquidating the voting share in a worker cooperative prevents control attached to the voting share from leaking out of the company.
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