Choosing the Right Legal Structure for Your Coop
If you wish to start a cooperative business, it is important to choose the right legal structure for a number of reasons, including the application of employment law, liability, and taxation. This section will help you get started choosing the best legal structure for your coop. The legal structure you choose could be an “entity” that is registered with your Secretary of State (like an LLC), or a partnership, which is not registered with the Secretary of State.
What are entities, and why register one?
By “entity,” we mean an organization that is registered with your state’s Secretary of State office and is legally separate from any of the individual co-op members. Registering an entity with the Secretary of State will generally limit the potential liability of the members in case the co-op gets sued (with a few exceptions). Registering an entity will also result in more paperwork, like, paperwork that has to be submitted to the Secretary of State, and tax returns that have to be prepared and submitted for the entity. And depending on the state you live in, it could result in additional taxes. (For example, in California, there is a minimum franchise tax of $800 per year.)
You could choose not to register a separate entity and just start doing business with your fellow co-op members, in which case you would legally be considered a “partnership”. However, you should be aware that the owners of partnerships have unlimited liability, meaning that if the business gets sued, the winner of the lawsuit can force the owners to pay the court award out of their personal assets, like their bank account, house or car. The same applies to creditors trying to collect on a debt – they can force each of the owners to pay the debt using their personal assets. If you are not concerned about getting sued or paying back debt, you might be comfortable with this risk. Also, you can take out liability insurance to help pay for a court award in case of a lawsuit. This may be a good idea whether or not you decide to register an entity, since the payment for the court award may come from the insurance company (if the company accepts the claim) and not from your business or personal money.
🎶We don’t need noooo legal entity🎶: What are partnerships?
As mentioned above, if you just start doing business with your fellow coop members without registering a separate legal entity with your Secretary of State, you’ll be legally considered a partnership, and each of you will be considered a “partner” or co-owner of the business. The upsides include not having to file paperwork with the Secretary of State and not having to pay an extra tax if your state requires it. The downsides include unlimited legal liability as mentioned above, and each partner having unlimited power to make legally binding agreements for the business. To make things a little more predictable, you can have all the partners sign a partnership agreement that sets rules about these matters, including how much of the business’ debts each partner is responsible for, and when each partner can sign or make an agreement for the business. You can also get liability insurance. This may be a good idea whatever legal structure you choose, since insurance may pay for damage caused instead of the payment coming from the business or the owners.
Considerations for picking the best legal structure for your cooperative
In general, the choice of legal structure will primarily inform:
- Whether coop members (owners) are considered employees or not
- The tax category or status
- Roles, relationships and decision-making
- Insurance you might be required to purchase
- Industry licensing requirements
- Whether or not you can use “cooperative” in the business name
Here are some questions to help you gather more information that you can use to determine the best legal structure for your cooperative:
- What will be the main activities of the co-op?
- Certain structures lend themselves better to certain activities. An example is XYZ. Explore which type of coop is best suited to what you want to do [link whole sentence to “Types of Coops”].
- How will it earn revenue?
- Does it need to raise capital? If so, how will it raise capital? Through member contributions and/or through outside investors? Grants?
- Will all the workers be members? (I.e., will there be employees of the coop who never become members?)
- Will all the worker-owners have the legal right to work in the United States?
- Will the workers be more like employees (supervised closely, only working for the coop) or more like independent contractors (given a project to complete on their own, and working for multiple clients including the coop)?
- Will there be a probationary period before a worker can become a member?
- Can the co-op pay all the workers at least minimum wage from the very beginning and pay all the other costs associated with having employees, like employment tax, workers’ comp, etc.?
- How do you want the coop to be governed? By a board elected by the members, by the members themselves, by one or more managers?
- Would it bother you to have to observe certain “formalities” (such as holding regular governance meetings, complying with rules about meeting notice, keeping meeting minutes, having elections, having officers)?
- How do you want to distribute excess revenues? Do you want some of it to be held within the coop and not become the property of the members?
- Given your business plan, what are your biggest concerns about taxes? Profits being taxed twice (i.e., once at the entity level and again at the member/investor level)? Having to pay a tax on gross receipts? Having to pay employment tax on distributions of profits to members? Having to deal with “pass through” tax treatment (i.e., members having to pay taxes on all profits each year, whether the entity keeps them or pays them out to members)?
- Would it bother you to have an entity that is not well understood by most lawyers and accountants?
- Is it important to you to use the word “cooperative” in your name?
The Democracy at Work Institute offers a list of 28 questions to consider before meeting with a lawyer, which will also help you decide on the best legal structure for your coop.
Still want more information on how to choose a legal structure? Read “Forming a Worker Coop: LLC or Cooperative Corporation?“
Related Articles
Democracy at Work Institute – Choosing a Business Entity
This resource breaks down the different business entity options when starting a worker cooperative. It offers pros and cons to each option so that you can know what is best for your worker cooperative. Download by Democracy at Work Institute Related Resources
California Worker Cooperative Entity and Tax Choice
When considering entity types for a worker cooperative, there are multiple options available. One possibility is to incorporate as a cooperative corporation if one exists under state law. However, it’s important to keep in mind that there are other options to choose from. To help make an informed decision, it’s helpful to consider factors about
Legal Entities
When formed as a specific legal entity, cooperatives are able to legally enter into contracts and operate as a business. California recognizes several types of cooperative legal entities, each with their own structure and requirements. Other states may have have their own specific legal entities, so it’s important to understand the options available to you
