What is an Employee Co-op?

In employee cooperatives, the business is owned equally and entirely by the participating employees. Members of the cooperative typically vote on all major decisions, elect the board of directors, and often serve on the board. Each member of the cooperative has one vote.

Cooperatives can function under a variety of rules that vary from one business to the next. There are, however, some commonalities among most coops.

Company Size and Revenue

Although larger co-ops do exist, this form of employee ownership is most commonly found among very small companies. Typically, businesses that are well suited to coops have 20 or fewer employees and revenue of $1 million or less.

One reason coops are suited to smaller firms is that this form of ownership can be set up and administered at a reasonable cost.

Who Is a Member?

Not all employees are necessarily members of the cooperative. At many coops, employees must work a certain amount of time before they are allowed to join. Some coops then vote on whether specific employees can become members.

Some coops may determine that particular types of employees (such as high level managers or seasonal workers) are not eligible to become members.

Employees who do not wish to join the cooperative are not required to do so.

Investments and Returns

Employees join the cooperative typically by buying a share in the company, often through a lump sum payment or periodic payroll deductions. Once they join, members have an “account” in which their share of the business resides. (This is not a formal account but a virtual bucket that holds funds for each member.)

Members hold their share until they leave the company.

At the end of the fiscal year, the cooperative decides how to distribute any net revenue. Decisions on these allocations may be made by the board or may be outlined in the organization’s bylaws.

Net revenue goes into one of two accounts: a general account for the business (to pay bills or buy equipment, for example), and an account held on behalf of each member of the coop.

Net revenue earned by employees who are not members of the coop typically goes into the general business account. Net revenue earned by coop members often is allocated to both the general account and members’ personal accounts. If the business needs more money in its account in a given year, less money will be allocated to members’ personal accounts.

Net revenue is allocated proportionally to coop members based on established criteria that reflect how much work they have contributed to the company. (Hours worked is a common criterion.)

These allocations are taxable to the member, even though the member may not be able to access all of these funds for some time. For this reason coops typically pay members 20 percent or more of the allocation in cash, to help them pay their taxes. Doing so may ensure tax benefits for the coop as well.

When employees leave the coop, their accounts are paid out them according to the terms of the plan. It may take several years before members get their full payout. Spreading out payments in this way reduces the strain on the coop, which must raise funds to buy out the capital owed to exiting members.

Challenges for the Business

Obtaining financing is one of the biggest challenges facing coops. Many banks and lending institutions are unfamiliar with coops and uncomfortable with the idea of lending to them.

Some relief may be available via a recent law—the Main Street Employee Ownership Act of 2018—which seeks to make it easier for businesses considering employee ownership to obtain loans from the Small Business Administration.

A complicating factor for potential coops is that—unlike employee stock ownership plans (ESOPs), which can transition gradually to being employee owned—coops must transition to employee owned status in one fell swoop. This adds more pressure to the business because it increases the amount of financing a coop must obtain.

Laws in some states—most notably Ohio—may provide mechanisms to ease this transition.

Another challenge is that potential members may not have the cash on hand to buy into the coop. This tends to be a greater concern when starting a coop business from scratch, as opposed to transitioning an existing business, since start-ups typically require more capital up front and may not yet have a reliable form of revenue with which to operate.