Part 1 – Sources of funding

Co-operatives can borrow from financial institutions, such as banks. The availability and cost of this funding will be impacted by bank lending policies, credit regulation and market rates.

Financial institutions require evidence of the capacity of borrowers to repay a loan and service the interest payments. They will impose conditions on the loan to protect themselves against the risk of loss. Loan conditions may include providing assets as security for the loan or personal guarantees from directors. If the co-operative defaults on interest or other repayment requirements, the financial institution will recover the debt by taking control over the assets or seeking repayment from directors who have provided a guarantee. Not all lending requires security. Some financial institutions will lend small amounts without security.

Co-operatives should prepare a business case to support a decision to apply for this type of funding. A business case will identify any assets that may be available as security for borrowing and present the information that lenders need in order to decide whether to lend.

Constraints: There are no legal constraints on co-operatives’ ability to borrow.

Advantages: This form of fundraising is easy to initiate, as financial institutions have established processes for borrowing.

The Capital Builder provides guidance on preparing a business case that may be used in an application to a financial institution.

Disadvantages: Co-operatives must meet the lending terms and conditions of the financial institution, which may not meet the co-operative’s funding need.

Transaction costs include loan application fees and the cost of providing security over assets if required. Commercial interest rates apply, and these may make this type of borrowing expensive for smaller co-operatives, particularly if the co-operative does not have any history of borrowing. Larger co-operatives will have better bargaining power with respect to interest rates and fees.

Borrowing adds to the liabilities on the balance sheet.

Risks and risk management: The co-operative may not be able to find a financial institution prepared to lend the required funds without security. If the co-operative succeeds in obtaining loan funding, it may not be able to repay the principal borrowed or pay the interest costs. The lender will take action against the co-operative and take control over any assets that were provided as security for the loan. Managing these risks is best done through good business case preparation to assess options for funding and analysis of the co-operative’s current and prospective financial position under different funding scenarios.

Grants

Grant funding opportunities exist for a range of industries and purposes. They may be offered by government agencies or philanthropic entities.

Success in obtaining a grant depends on the co-operative preparing an application that demonstrates how it meets eligibility criteria and presents a case to show that it is capable of administering the grant funds appropriately and delivering the desired outcomes from the funding.

Grant funding terms and conditions will impose a time frame for delivery of outcomes and may require the presentation of audited or reviewed financial statements. Funding is part of the co-operative’s income and it is expected that it will be fully expended over the period of the grant.

Some grant funding may be dependent on the co-operative providing matching funds or resources, which would necessitate allocating other resources or accessing funds from other sources.

Advantages: Grant funding can be a good way to fund a particular project provided that it meets the grant purpose and eligibility.

Disadvantages: Applications for funding are competitive and the co-operative may not receive funding despite having met eligibility and purpose criteria. There are some transaction costs in preparing the application and the grant conditions may impose constraints on the co-operative’s freedom in using the funds.

Government loan programs

Government agencies will from time to time make concessional loans to enterprises to further community or industry development policies. Loan programs may be administered directly by a government agency or through an intermediary, such as a bank.

Co-operatives can apply for these concessional loans in the same way that other enterprises may apply. Just as with a grant application, the co-operative must demonstrate that it meets the eligibility criteria for the loan and that it can service the loan. There may be additional reporting requirements in respect of the use of the loan funds.

As for grant funds, applications for concessional loans may require the co-operative to show it is contributing its own funding towards the project.

Advantages: Concessional loans will be cheaper than borrowing funds from a financial institution. Supplier-owned co-operatives that meet the definition of a co-operative company under the Income Tax Assessment Act 1936 are able to deduct both principal and interest payments on government loans – see s120(1) of that Act. Some States operate specialist co-op loan programs for this purpose. Read the BCCM’s Government Co-operative Loan Scheme in Australia factsheet.

Disadvantages: A government loan will be a liability on the co-operative’s balance sheet and will generally require repayment of principal and interest over a specified period of time.

Applications for concessional government loans are competitive and the co-operative may not receive funding, despite having met eligibility and purpose criteria.

The Capital Builder provides guidance for the preparation of a business case to seek funding and assists the co-operative in assembling the necessary information for applications.

Co-operatives require members to contribute capital in the form of member shares or subscriptions when they join. The terms of issue for member shares are set out in the co-operative’s rules. Member shares are different from company shares. Member shares have a fixed value. They are not shares in the net assets of the co-operative. Nonetheless, they are a type of risk capital because members risk losing the value of their shares if the co-operative is not successful. They are repayable if the member leaves the co-operative.

Co-operatives can offer additional member shares to raise funds. Alternatively, new classes of shares can be created to fund new activities. For example, a co-operative wishing to construct new storage facilities for members’ produce can issue a class of shares with storage rights attached. A new class of shares would require an amendment to the co-operative’s rules.

Co-operatives can pay dividends on shares. The dividend is limited by regulation to 10 per cent more than the interest rate for a five-year term bank deposit – Co-operative National Regulation Cl3.19 and Co-operatives Regulations WA Cl24.

Fundraising by offering more shares to members requires the co-operative to engage with members to encourage the take-up of shares or a new class of shares.

Constraints: Only co-operatives with share capital can offer shares.

Advantages: The process for offering shares is simple and inexpensive. No regulatory approval is required.

Transaction costs include:

• member engagement and marketing costs;
• administrative systems to record new share subscriptions or payment plans for share subscriptions; and
• if there is a new class of shares, the cost of developing terms for new shares and amending the rules.

Share capital is inexpensive to service because dividends are limited and payable only if declared by the board from a surplus. Shares for non-distributing co-operatives have no dividend rights. The value in offering additional shares in a non-distributing co-operative is the improvement or increase in services funded by the shares.

Disadvantages: The amount of potential funding is limited by the co-operative’s member profile. Where members rely on their co-operative to provide key business support services, it is easier to market the benefits of additional share capital. However, small consumer co-operatives may find it difficult to raise substantial funds from members.

Increasing member share capital increases the liabilities on the co-operative’s balance sheet.

Risks and risk management: Greater amounts of member share capital expose the co-operative to the risk of having to repay larger amounts of capital if members leave. Repayment of share capital can be extended through substituting debentures or CCUs, although these carry an interest obligation.

Distributing co-operatives can establish compulsory share and loan schemes.

Compulsory schemes require members to either buy more shares or provide loan funds to the co-operative.

Compulsory schemes are regulated under the Co-operatives National Law. They require a special resolution from members and a disclosure statement to be approved by the Registrar. Members who do not agree to the proposal have the option of resigning if the resolution is passed. New members who join the co-operative after the resolution is passed are required to acquire the additional shares or provide the loan funds. For example, if the minimum share capital for membership is $100, but the co-operative resolves that members must purchase an additional $50 in shares, new members joining after the resolution is passed will be required to purchase $150 in shares.

Constraints: Compulsory schemes are only available to distributing co-operatives. A compulsory loan has a maximum term of seven years and the rate of interest payable is limited to the most recent dividend rate paid on share capital.

Advantages: The process is clearly defined in legislation – for shares s82 CNL and in Western Australia, s146 Co-operatives Act WA; and for loans s343 CNL and in Western Australia s255 Co-operatives Act WA.

A compulsory scheme provides certainty, raises the funds, and fairness by way of members making equal contributions.

Transaction costs are modest. The regulatory fee for approval of the disclosure statement is between $300 and $400. Other costs include preparing the disclosure statement and setting up a payment system for members to pay for the shares or provide the loan funds.

Disadvantages: Shares and loans are both liabilities on the balance sheet.

The approval of documents by the Registrar may take up to 28 days. Member engagement, information and events may need significant time. The special resolution process requires a further 28 days.

Risks: Compulsory schemes can be divisive. Members may not pass the special resolution.

If the special resolution is passed, a proportion of members is likely to resign, triggering a repayment of share capital and loss of member numbers. To minimise this risk, the co-operative may need to engage professional assistance to prepare the terms of the scheme, necessary disclosure and to assist with managing member engagement.

All types of co-operatives can offer debentures to their members or to members and employees.

The process for offering debentures is set out in the CNL – s338 CNL and in Western Australia, s252 Co-operatives Act 2009 WA.

These offers require a disclosure statement that must be approved by the Registrar. The disclosure statement must contain sufficient information for a member or employee to make a decision about whether to invest. The disclosure statement is not required to cover the co-op’s history and current operations. Members and employees are assumed to have this knowledge.

As debt instruments, debentures are repayable after a specified period of time. They carry interest that may be fixed or variable.

Constraints: There are no legal constraints on either distributing or non-distributing co-operatives offering debentures to members and employees.

Advantages: Debentures can be structured to present attractive investment opportunities for members without the limitations of shares. They can pay either a competitive interest rate to create a link to the financial success of the co-operative, or a more modest interest rate, coupled with the increased member value derived from the project funded by the debentures.

Neither the interest rates nor the maximum term for debentures is limited by regulation, meaning their design can be tailored to the needs of the project and satisfy member investment appetite. They are an inexpensive funding option for non-distributing co-operatives that do not have share capital.

Extending the offer to employees enlarges the pool of potential investors and can provide incentives by aligning employee interests with the co-operative’s success.

Transaction costs are modest. They include the cost of preparing the disclosure statement and additional administration to receive payments and record debenture issues. Regulatory fees are between $300 and $400. It is possible that most of these tasks could be performed without external professional assistance. The Capital Builder provides guidance for drafting the disclosure statement.

Debentures offered to members do not need to be secured against the assets of the co-operative.

Interest payments on debentures are tax deductible for the co-operative.

Disadvantages: Debentures increase liabilities on the balance sheet. Co-operatives must have a plan to accumulate the funds required to redeem the debentures at the end of their term or prepare a fresh issue of debentures.

Risks and risk management: Members may not be prepared to invest in the co-operative and the amount required may not be met. The risk of not raising the required amount through offering debentures is less than the risk of a share offer to members because debentures have more certainty of a financial return.

To minimise this risk, the co-operative should test the market by engaging closely with members and employees, so that the terms of issue of the debentures are sufficiently attractive to raise the required funds.

CCUs are interests in the amount of the co-operative’s capital over and above issued share capital. The flexibility in settling terms of issue for CCUs allows them to be designed as permanent capital or debt. CCU holders do not have any voting rights in the co-operative: voting remains a right of membership.

CCUs can be redeemable or irredeemable. They can pay interest or dividends.

Redeemable CCUs can be redeemed either at a specified time or event, or at the option of the co-operative. They may only be redeemed out of profits or a new issue of CCUs. They may be convertible to shares. Dividends and interest rates on CCUs are not subject to regulatory limits, although, as with all other dividend payments, dividends are subject to declaration by the board from any profits. Their face value may be fixed or variable.

Offering CCUs to members requires a two-stage process:

• approval of the terms of issue by both the Registrar and the member; and
• approval by the Registrar that the disclosure statement contains the required information.

Registrar approval of the terms of issue is required to ensure that they comply with the co-operative principles and the co-operative’s rules.

Constraints: All co-operatives can offer CCUs to members or members and employees, providing the co-operative’s constitution permits the issue of these instruments.

Advantages: CCUs can be structured to present attractive investment opportunities for members and employees, while also accommodating the co-operative’s funding need and spreading the cost of servicing the CCUs.

CCUs that are irredeemable and carry a dividend will be classed as permanent capital or equity on the co-operative’s balance sheet. As interests in the capital of the co-operative, CCUs do not require asset backing.

Offers to members provide a way for members to participate more in their co-operative’s financial success. Extending the offer to employees enlarges the pool of potential investors and can align employee interests with the success of the co-operative.

Transaction costs are modest. Regulatory costs are between $300 and $500 for the required approvals. Co-operatives may be able to prepare the necessary disclosure documentation themselves, but may need expert assistance to design the terms of issue.

The Capital Builder assists co-operatives to prepare the disclosure statement and terms of issue.

Disadvantages: Under the co-operative principles, the part of a co-operative’s capital in excess of the members’ share capital is called common property. Common property is not owned by members as such; it is property that is jointly controlled by members. A co-operative’s common property is the capital it builds over time to ensure longevity and resilience for current and future members.

Issuing CCUs tends to create a financial interest in the co-operative’s common property that may compromise this co-operative principle. Members with CCUs may seek to increase the financial reward of their CCUs by influencing board decisions on dividends, rather than recognising the co-operative’s purpose as a service provider for the long term.

Risks and risk management: Members may not be prepared to risk investing in the co-operative and the amount to be raised may not be met. To minimise this risk, the co-operative should test the market by engaging closely with members and employees, so that the terms of issue of the CCUs are attractive and meet their acceptable levels of risk.

Members with large holdings of CCUs may seek to ensure that their investments deliver financial rewards and may overlook the purpose of the co-operative as a service provider to members. Co-operatives seeking to issue CCUs to members should consider the maximum parcel size for individual investors, limit the total value of CCU interests to be offered or concentrate on demonstrating how the investment in CCUs delivers value through better services to members.

All co-operatives can make a public offer of debentures. Public offers are open to members, employees and external investors.

A public offer requires a disclosure statement containing sufficient information for any person to make a decision to invest. Unlike member offers, the disclosure statement for a public offer must include information about the co-operative’s business model, as well as the instruments being offered.

The regulations governing the disclosure statement and the process match the requirements for a public offer of similar securities by a company. The CNL imports relevant provisions of the federal Corporations Act 2001 that require the preparation of a disclosure document. The imported provisions require the disclosure document to be lodged with the Registrar who is the relevant supervising authority – s337 CNL and in Western Australia s250 Co-operatives Act WA.

An impact of importing the federal provisions is that a debt instrument that is offered to the public cannot be called a debenture unless it is secured against either real property or tangible assets whose value is sufficient to repay the debentures. A debt instrument that does not have the required asset backing must be called either a secured note, if there is some security, or an unsecured note if there is no security. In addition to the requirements for security, the co-operative must appoint a trustee to look after the interests of debenture or note holders. The trustee would hold the security over any assets used as backing for the debt instruments.

As debt instruments, debentures and notes are redeemable after a specified period of time. They carry interest that may be fixed or variable. Neither the interest rates nor the maximum term for the debenture or note is limited by regulation, making their design subject to market appetite and providing flexibility to suit the co-operative’s funding need and capacity to service the instruments.

Constraints: There are no legal constraints on offering debentures to external investors.

Advantages: A public offer provides access to a larger market of potential investors. The offer is not limited to investors in the State or Territory where the co-operative is registered, due to mutual recognition provisions under the CNL scheme, which includes Western Australia.

A public offer of debentures or notes may be a useful method to encourage local community support for the co-operative. The Capital Builder assists co-operatives in preparing terms of issue and provides guidance in respect of regulatory processes and disclosure.

Disadvantages: Transaction costs are higher than for a member offer. Testing the market for such an offer, developing terms of issue and preparing the disclosure statement are likely to require external advice and assistance.

Lodgement fees are significantly higher, at approximately $2,500 to $3,500. Additional costs are those associated with preparing and registering the security over assets for the debentures and the appointment of a trustee. Trustee fees are chargeable over the life of the debentures.

Debentures and notes increase liabilities on the balance sheet, and co-operatives must have a plan to satisfy redemptions.

Risks: The offer may be undersubscribed. Market testing and promotion need to be well prepared to minimise the risk of not attracting sufficient investment to meet the funding need.

Debenture holders, who are not members, become stakeholders in the co-operative. Despite not having voting rights, as stakeholders they may exert pressure on the co-operative board decisions. This risk may be managed by specifying limits on holdings by external investors and limits on individual investment parcel sizes.

The co-operative may be unable to redeem the instruments at the due date. A redemption plan is important to minimise this risk. For debentures held by members, they may be convertible to shares or the co-operative may plan for a new offer to redeem debentures.

Co-operatives can make a public offer of CCUs. Public offers are open to members, employees and external investors.

A public offer requires a disclosure statement containing sufficient information for any person to make a decision to invest. Unlike member offers, the disclosure statement for a public offer must include information about the co-operative’s business model, as well as the instruments being offered.

The regulations governing the disclosure statement and the process match the requirements for a public offer of securities by a company. The CNL imports relevant provisions of the federal Corporations Act 2001 and modifies the provisions to make the Registrar the relevant supervising authority – s337 CNL and s250 Co-operatives Act WA.

The regulatory process for an offer of CCUs is similar to the process for an offer to members. The terms of issue of the CCUs must first be approved by the Registrar and by special resolution of the members. This is then followed by lodgement of a disclosure document with the Registrar and a public exposure period.

The flexibility of these financial instruments means CCUs can be designed as either debt or permanent capital. CCUs as permanent capital have the potential to attract investment from both members and external investors. CCUs create an interest in the co-operative’s capital over and above share capital. They can have a fixed value or the value may be variable and linked to the underlying capital. This provides scope for these instruments to be quoted for trading on the stock exchange.

The Capital Builder assists co-operatives in preparing terms of issue and provides guidance in respect of regulatory processes and disclosure.

Constraints: All co-operatives can offer CCUs to external investors, provided their constitution contains rules permitting CCUs.

Advantages: CCUs are the only type of instrument that can be classed as permanent capital on the balance sheet. To be recognised as permanent capital, CCUs must be irredeemable.

Distributions on CCUs can be dividends, which are subject to a board declaration from available profits. As an interest in the co-operative’s capital, CCUs do not require specific security backing, making the transaction costs cheaper than for an offer of debentures.

As noted above, CCUs may be quoted on the stock exchange provided they meet the stock exchange rules.

A public offer provides access to a larger market of potential investors. The offer is not limited to investors in the State or Territory where the co-operative is registered, due to mutual recognition provisions under the CNL scheme.

Disadvantages: Under the co-operative principles, the part of a co-operative’s capital in excess of the members’ share capital is called common property. Common property is not owned by members as such: it is property that is jointly controlled by members. A co-operative’s common property is the capital it builds over time to ensure longevity and resilience for current and future members.

CCUs may compromise the principle and purpose of common property by appearing to create individual ‘shareholders’ in the common property.

CCUs are new financial instruments and not well understood by markets. Offers of these instruments will require the inclusion of information to explain their nature and the general nature of co-operatives.

Transaction costs can be high. Co-operatives will need expert legal and financial assistance to advise on how the instruments affect the capital structure, as well as to develop appropriate terms of issue, the disclosure statement and to manage market testing and options. Lodgement fees are higher than for member offers at $2,500 to $3,500.

Risks and risk management: The offer may be undersubscribed. Market testing and promotion need to be well prepared to minimise the risk of not attracting sufficient investment to meet the funding need.

CCU holders who are not members become stakeholders in the co-operative’s common property. Despite not having any voting rights, as stakeholders they may exert pressure on the co-operative board’s decisions. This risk may be managed by specifying limits on holdings by external investors and limits on individual investment parcel sizes. Given the potential challenge to co-operative principles posed by external holdings of CCUs, it may be appropriate to link returns on CCUs to social impacts as well as financial return. Social impacts will require a commitment to additional reporting.