Equity financing is typically received in exchange for an ownership share in the business. Because cooperatives are unique and are not the default way to run a business, there can be many obstacles in obtaining equity capital.
What is equity financing?
Before understanding equity financing it is important to know what equity capital is. Equity capital is one of the measures by which financial institutions will gauge a business’ potential for receiving loans. The initial funding provided by founding members is also known as equity capital. Equity capital reflects the member’s ownership stake in the cooperative. Equity capital is one of the measures by which financial institutions will gauge a business’ potential for receiving loans.
Two types of equity financing
There are 2 types of equity financing:
- Inside Equity is money received through the cooperative member who pays equity in their membership shares.
- Outside Equity is money coming in from outside the cooperative. This type of equity is more complicated for cooperatives because:
- In California, cooperatives are not permitted to have “outside” or non-member investors. So these investors need to become members of the cooperative most likely as a separate type of “investor” members.
- Cooperative businesses follow the principle that voting rights are based on one’s membership in the cooperative, not on one’s investment of capital. This is different from a traditional capitalist business in which you have more say if you have invested more money. This is a problem when a cooperative tries to attract capital investors because such investors typically would like to have increased ownership and voting rights based on their capital investment. Making it more difficult to find outside equity.
Ways around obstacles to outside equity financing
- Issuing memberships to a separate type of “investor members” who do not work in the business. Investor members typically have less voting power and only have a say in larger transformative events like dissolving the cooperative.
- Another way to incentivize investment is to offer dividends. However, dividend distributions (profit that is not based on patronage) from a cooperative corporation are often limited by statute (e.g., in California, they are limited to 15% of the capital contribution per year). As a result of obstacles to obtaining equity capital, most cooperatives are debt-financed, as opposed to outside-equity financed.
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