When converting to a cooperative, it may be difficult to obtain all financing necessary to purchase the business in a single loan or transaction. In such cases, the cooperative or individual workers could receive loans to complete a partial buy-out, and, after paying down those loans, obtain more financing in one or more additional stages to complete the buy-out. Using a multi-stage buy-out can be helpful in obtaining financing sources by spreading out the purchase into multiple payments.
How multi-stage buyouts work
In a multi-stage buyout sale structure, the worker-owners secure a loan (which could come from the initial, “selling” owner) to finance the first transaction in converting your business to a cooperative. Once the worker-owners pay down that loan, they secure another loan to buy another portion of the business. This continues until the worker-owners own 100% of the business (stocks/assets). In order for the owner to take advantage of the 1042 Rollover, at least 30% of the business must be transferred in the initial transaction. In the years following the transaction, the cooperative will need to dedicate its profits towards repaying the loan, whether that loan came from a financial institution or an individual. This will reduce the cooperative’s net income available for distribution as patronage dividends. In a multi-stage buyout, the cooperative should perform the steps in the plan outlined in the buy-out agreement in order to eventually purchase 100% of the business.
Using a multi-stage buyout also means that the business would become a cooperative that, during the staged buyout process, is only partially owned by the workers. This brings up interesting questions related to both governance and allocation of earnings, since the concept of a worker cooperative, by definition, requires control by and distribution of earnings to the workers. In our case study of Select Machine’s conversion, it meant that the sellers had to give up substantial control despite retaining a majority shareholder interest after the initial transaction. In other cooperative conversions, it’s possible to create a second entity that is fully owned and controlled by the workers, and which slowly buys shares from primary business owners over time. This scenario is not ideal, but it is an option where the sellers are unwilling to finance the complete buy-out with a promissory note.
Protecting the seller in a multi-stage buyout
In multi-stage cooperative buy-outs, the selling owner can play a critical financing role. There are a few ways the seller can support the conversion:
- Keeping her equity stake in the business.
- Providing collateral (backing) for the loans the cooperative receives for the conversion.
- Providing a loan to the cooperative.
This is a vulnerable position for an owner to be in. There are mechanisms that can help to protect the selling owner. These mechanisms can be included in the sale agreements (for example in the Offering Statement, Stock Purchase Agreement, etc.) with the seller so the cooperative will act in a way to protect the owner’s remaining ownership interests. For example, you can build safeguards into the governance documents, such as a supermajority voting requirement for decisions affecting the owner. There can also be other reserved rights for the owner when deciding major decisions, such as major corporate changes. These mechanisms can be written out of the governance documents when the owner’s stock has been repaid or redeemed.
Related articles
Select Machine Selects the Right Conversion Approach to Avoid Layoffs
Legal Case Study: Select Machine Select Machine is an Ohio-based firm that manufactures, sells, and distributes custom parts for demolition and construction equipment. It was founded in 1994 by Doug Beavers and Bill Sagaser. They chose to convert their business when they were ready to retire to avoid laying off their employees. Exploring Cooperative Conversion
Determining the Sale Price of the Business in a Cooperative Conversion
There are many factors that affect business valuation including the seller’s personal needs and the terms of the sale. Cooperative conversions add more complexity to determining the sale price and it is important to understand all your options. Additionally, in the cooperative conversion context, both the terms of sale and sales price will be affected
Signing a Sales Agreement During a Cooperative Conversion
Generally, a sales agreement will need to be negotiated and signed by the initial owners and the new cooperative entity. The agreement should include the sale price, the list of assets being transferred, and the terms of the transfer. Here we will learn more about what typically goes into this type of agreement when the
