Practices in cooperatives can be classified as the good, the bad and the ugly. Good practices are consistent with business strategy and cooperative principles. Bad practices miss the mark on one or both of those metrics. Ugly practices are not really harmful they just fail to achieve the desired goal and create unnecessary complications. Segregating regional patronage is an example of an ugly practice. Under Subchapter T, regional cooperatives are subject to taxation on their member profits unless they distribute it in cash or qualified retained patronage to local cooperatives. Regional cooperatives can choose to distribute nonqualified retained patronage which is deductible to the regional cooperative when it is redeemed. Regional patronage creates taxable income and cash flow into the local cooperatives. The local cooperative then makes decisions as to distributing cash and qualified and nonqualified retained patronage.
Regional patronage adds to the complexity of managing the cooperative firm because the allocation of cash and retained, qualified and nonqualified and the timing of equity redemption varies between the local and regional cooperative. One issue is when the local cooperative redeems equity (some of which came from regional patronage) on a different schedule relative to the regional cooperative. A few cooperatives address this issue by issuing their patrons two categories of retained patronage with one category representing the patron’s share of the regional retained patronage. The segregated regional patronage is then only redeemed to the local member when the regional cooperative redeems their stock held by the local cooperative.
Segregating regional patrons adds another layer of complexity and confusion in the patron’s mind and does not eliminate the inherent challenges in profit distribution and equity management. Most cooperatives are members of multiple regional cooperatives. They would have to issue multiple categories of segregated regional patronage to eliminate the redemption timing issues. The local and regional cooperatives may also have different equity management systems. If the local cooperative is using an age of patron system and the regional is using an age of stock or base capital system, the local cooperatives would have to employ multiple systems to synchronize the redemption timing.
A better practice is for the CEO and board to consider both the member’s realized rate of return and the impacts on the cooperative balance sheet as they make profit distribution and equity management decisions. The management team must protect the cooperative’s working capital, cash flow and solvency and they must consider infrastructure reinvestment. Contingent on those constraints, they then try and get as much cash as possible to the member balanced between cash patronage and redeemed equity. A board and CEO using balance sheet management establish the redemption budget and then apply the budget to the equity management system. The equity redemption decisions of the regional cooperatives impact the redemption budget but do not create a change in the process. Instead of telling the member “we are redeeming (or not redeeming) this segment of your equity because a regional cooperative redeemed (or did not redeem) their equity” you are simply telling them “we are redeeming the amount of equity that the cooperative can afford”.
Several regional cooperatives have recently begun to issue nonqualified equity. That creates another interesting wrinkle on managing regional patronage which I will discuss in a future post