Your approach to converting an existing business depends largely on the type of business you’re converting. Forming a Steering Committee can be helpful for navigating this process. The Steering Committee must then assess a few key aspects of the business they are attempting to convert. Depending on how the existing entity is organized, the Steering Committee may be able to simply adjust the existing entity’s key documents, or it may have to create a new entity that then purchases the existing business/business assets. Below are a few scenarios that can help you determine how to approach a cooperative conversion.
Is the existing business a sole proprietorship?
If the existing entity is a sole proprietorship, it may make the most sense to create an entirely new cooperative entity, as sole proprietorships do not feature limited liability. If you have limited liability, something happens, and you get sued, they can only go after the assets of the business. If you get sued as a sole proprietorship, they can go after your business and personal assets as well.
Is the existing business an LLC?
If the existing entity is an LLC, it may be possible to remain an LLC and simply add new “members.” The operating agreement would need to be amended to create a cooperative structure through provisions regarding membership, democratic governance, profit-sharing, etc. LLC members (i.e. owners) are not generally considered employees, and thus a cooperative formed as an LLC may have more flexibility with respect to employment requirements like minimum wage, payroll tax deductions, overtime, workers’ compensation insurance, issuance of W-2s, etc. Sometimes this flexibility is valuable for small or start-up cooperatives that want to rely more heavily on “sweat equity” for a time.
LLCs are “pass-through entities,” meaning that taxes are not levied at the entity level – LLC profits are distributed to members, and members then pay taxes on them. In this way, LLCs avoid the “double taxation” that corporations are sometimes subject to. For more on taxation of cooperatives, see Subchapter T: Patronage Taxation. However, it may make sense to organize a new cooperative entity (a legal cooperative or a non-cooperative corporation) that then purchases the LLC. While the flexibility of an LLC can be a boon, it also means that it would be relatively easy for future membership to demutualize the business; meaning moving the business further away from cooperative structure and governance.
Is the existing business a corporation?
If the existing entity is a corporation, it may make the most sense for the converters to simply amend the business’s key founding and governance documents (articles of incorporation and bylaws) to become a “cooperative corporation.” Even if your state does not offer a cooperative corporation statute, a corporation’s articles and bylaws can probably be amended to meet your cooperative goals and more importantly, qualify for pass through taxation under Subchapter T.
Unlike an LLC, worker owners of a cooperative corporation may be considered “employees” for the purpose of employment requirements.
Workers can set up a new cooperative to buy some or all of the company’s stock and hold it in a separate company for the employees. This new entity would basically act like an employee leasing company with just one client. This option might appeal to the current owner because, unlike immediately converting the business to a cooperative where all employees get voting power right away, the owner keeps control until all the stock is bought. However, this setup can be awkward and doesn’t generate income just from owning stock.
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