Bylaws are one of the founding documents for a new food co-op (or any corporation). What do bylaws do?
Some of the Main Jobs of the Bylaws are to:
- Start by saying what the organization does, and what its purpose is.
- Some co-ops adopt the Cooperative Principles.
- Establish how people can become members, so we know who is a member and who is not.
- Say how meetings work. How are meetings called, how are they run, how does voting work? How do you know when a decision has been made?
- The Board. Who’s eligible? How are Board members voted in? What are the officer positions, and what is each officer in charge of doing?
- Board meetings. How are decisions normally made? What if there’s a need for a special meeting, or a decision needs to be made immediately, and there’s no time for a meeting? When does the membership get to review a decision made by the Board?
- How and when can someone be pulled off the board?
- How and when can someone be kicked out of the co-op?
- How do member refunds work? Does the co-op put some money aside to build a reserve? How much of that reserve is considered the Co-op’s money, and how much is considered member equity?
- What happens when (if) the co-op winds down, either because it goes out of business or because the members decide to sell to another co-op? If there are assets, who gets them?
The Bylaws should help the Co-op Qualify for Favorable tax treatment.
It’s best for most food co-ops to be taxed under Subchapter T, which is an important part of the U.S. tax code for cooperatives. Under Subchapter T, a food co-op will not be taxed on net income from member purchases that the co-op refunds to members (“patronage dividends” or “patronage refunds”), IF the co-op meets certain requirements.
To help make sure the co-op meets those requirements, the bylaws should give the co-op a duty to give patronage refunds (if there’s sufficient income). All members need to receive patronage refunds equitably, based on the amount or value of business done with the co-op.
The bylaws should obligate the co-op to distribute the patronage refunds at least once a year, to make the payments by nine months and fifteen days after the close of the fiscal year, and to distribute at least 20% of those refunds in cash, and to give a “qualified” written notice of allocation to each member documenting any patronage refund that’s not distributed in cash.
The bylaws should state that by joining or remaining a member of the co-op, the members consent to take patronage refunds into account for the purpose of their own income taxes, to the extent required by law. (The co-op should also give each member a separate written notice that this bylaw exists, and a copy of the bylaws.) Now, in a food co-op, the members probably will not have to pay tax on their patronage refunds. There is an exemption for patronage dividends that come from the member’s own money spent on “personal, living, or family items” (26 U.S.C. s. 1385(b)(2)). But it’s better practice to include language in your bylaws saying that the member consents to include the patronage dividend in her gross income to the extent required by law, to make sure the co-op itself qualifies for Subchapter T. This allows for the possibility that some of the patronage refund could come from the co-op’s income that was not from the sale of “personal, living, or family items.”
Comply with State Co-op Statutes
In Illinois, the current Co-operative Act, 805 ILCS 310/1 et seq., requires that no owner may own more than 5 shares of stock or more than $500 worth of stock, so keep that in mind when creating your membership requirements.
Your state may have other requirements for co-ops.
Sampling of other Co-op’s bylaws:
Please keep in mind that state law requirements vary by state, and these samples might not meet the requirements of your state.
This past Wednesday (11/13/2013), the teach-in at SELC’s Resilient Communities Legal Cafe was about the Rights of Nature, by Linda Sheehan. I went in thinking it was going to be some fluffy, ultimately meaningless stuff about how animals have rights. But actually Linda’s message is a big deal. Here’s what I got from the presentation.
1. Don’t you feel outraged when someone blows up a mountaintop or clearcuts a forest? When that happens, what’s being violated?
2. Don’t you believe that you and all people have a right to clean water, clean air, clean food, and a world where our grandchildren will be able to live? At this point, I’m questioning the livability of the planet for my potential grandkids. Not to mention that for some reason GMO corn makes its way into my kid’s mouth. Doesn’t that violate some rights we have? Don’t we all have a right to preserve the commons?
If we have these rights, then why is it OK to trash our natural resources? Linda Sheehan’s message is that destruction is allowed because our legal system treats the natural world as property, and environmental laws basically give companies the right to pollute a little bit (and Agriculture can pollute a lot), and it’s all about minimizing the pollution, but the right to “develop” is presumed. In order to change our system to one where human beings can survive and thrive on a long-term basis, we need to flip the thinking behind our legal system by recognizing that the natural world has a right to exist (and I think this is intertwined with our rights as humans to have that beautiful natural world continue to exist). This means that a river has the right to flow. Species have a right to exist, to thrive, and to evolve. And we can think about human needs in terms of whole-person health and happiness, which very much depends on the natural world continuing to exist, and to thrive.
Some countries and U.S. cities have enacted laws recognizing the rights of nature.
[R]esidents have a fundamental and inalienable right to clean water from sustainable sources, clean indoor and outdoor air, a sustainable food system that provides healthy, locally grown food, a sustainable climate that supports thriving human life and a flourishing biodiverse environment, waste disposal that does not degrade the environment, and a sustainable energy future based on renewable energy resources.
This is law in Santa Monica, and this ordinance gives the City and individual residents the ability to sue to enforce the ordinance.
Let’s first ask: Why do so many businesses incorporate in Delaware?
For hundreds of years, Delaware’s court system, legislature, and administration have focused on making things work for corporations. Delaware’s General Corporation Law is updated regularly based on recommendations from the lawyers who serve the many Delaware corporations. The Delaware Secretary of State’s Office runs efficiently and is user-friendly. But maybe most important is that Delaware’s special court for corporate matters (the Court of Chancery) decides many cases and issues written decisions, and the result is a well-developed “body of law.” That is, if you can think of a conflict that might come up, legal counsel can find out who got sued for what, who won, and why, in Delaware case law. This allows a corporation to plan ahead to avoid litigation. (In other states, there may be no clear answer, so avoiding a problem could be impossible.)
These effects snowball. Delaware has become known as the place to incorporate, so more companies do incorporate there, and the result is a huge number of corporations under Delaware law, with more and more all the time. This leads to more cases, which makes Delaware’s case law even more detailed. Delaware law is known by corporate lawyers across the country, and the more companies go to Delaware, the more important it is for lawyers to know Delaware law. Delaware has become a common denominator, and part of the value is just its reputation. An investor might be more comfortable investing in a business that’s incorporated in Delaware, even if the business’s home state’s law would work just fine.
Another reason is tax. In some situations, setting up a Delaware company or subsidiary can reduce a company’s state tax bill. This depends on the type of income and in what state the income is earned. If your company makes income from intangible assets like intellectual property, your company may be able to benefit, but you’ll need to see whether your home state’s law will allow you to take advantage.
Would your business benefit by incorporating in Delaware?
There are some reasons to incorporate in the state where you’re doing business.
1. Filing fees. There’s a fee to form a new corporation or an LLC. You can form your new legal entity in any state, but you can’t just start doing business in a state where you haven’t filed. If you incorporate in another state (like Delaware), you’ll also need to register with your home state’s secretary of state as a “foreign” entity. For example, to do business in Illinois, you file an “Application for Authority to Transact Business in Illinois.” The fee for that filing is generally the same as the fee to form a corporation. So if you incorporate in Delaware but do all of your business in Illinois, you’ll have to pay two filing fees instead of just one (Illinois only).
2. Franchise tax and administrative work. You’ll have to file an annual report and pay a franchise tax in the state where you’re incorporated and the state(s) where you do business. If you’re incorporated in one state and mainly do business in another state, you’ll have to do the annual report and pay the franchise tax in both states.
3. Securities law. Any time you sell someone the opportunity to invest in your business, where they put in money and expect a return (without doing any work themselves), that’s a security. Securities are highly regulated–you still can’t sell securities to the general public, and you’ll generally have to file some forms with both federal and state governments.
If you’re doing most of your business in one state, and you’re incorporated in that state, and you want to raise capital from people who live in your home state, then you can take advantage of the intra-state exemption to federal securities law (15 U.S.C. s. 77c(a)(11)). That exemption says that if your offering is just to the residents of the state where you do business, then state law can handle it, and the federal government doesn’t need to be involved. If you don’t advertise publicly, you may just need to file a simple form with your secretary of state. But, if you’re incorporated in another state, this exemption won’t work.
4. Tax–probably neutral. In general, business income is taxed by the state where the income is earned, so in general, incorporating in Delaware would not help you avoid state income tax in the state where you actually operate. If you do business mainly in one state, and incorporate there, you just file the one state tax return and be done with it. (If your income is from intangible property, you may want to consult a tax professional about this. This paper discusses the Delaware tax haven for royalties and its effect on state revenues.)
As you can see, the reasons to incorporate in your home state are more relevant to smaller businesses. A small company, e.g. a new brewery, might have investors who know the business is locally based. The quality (prestige?) of the court system is probably not an important consideration because the company is not expecting to get sued any time soon. The brewery’s home state’s law might do a fine job answering a few questions to get set up. Avoiding extra administrative requirements makes it easier to get the real work done.
As a business gets bigger, the reasons to incorporate in Delaware grow. A venture capitalist investing millions might want a Delaware corporation. A big business can expect lawsuits, so a great court system and highly detailed case law for corporate matters makes a difference. (By the way, Delaware companies can only keep some, not all, of their litigation in Delaware courts. They can still be sued in another state, for example, if a faulty product hurts someone in that other state). A big corporation does not care if it has to file several annual reports–it’s worth it.
If you have a new small business that mostly operates in one state, e.g. where your headquarters are, then there’s probably no need to run off to Delaware, just because some parts of the herd do that. Incorporating in your home state probably makes more sense for a new small business.
A question came up recently about guns–not something I normally deal with. A client wanted to know what the new Illinois concealed carry law (see statute here) means for their properties. This client is a landlord who wants to create co-op-like rental housing, and they wanted to know whether the concealed carry law means that tenants would have a right to have guns in the properties.
Something didn’t seem right about this. Landlords can prohibit pets. Co-ops make all kinds of rules, like prohibiting personal items from the common space, or not allowing any alcohol on the premises.
Here’s how to think about this, legally: the U.S. Constitution says what our government is and what it does. Some parts of the Constitution say what the government cannot do. The Second Amendment says, “A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed.” The Second Amendment itself does not say who shall not infringe, but the U.S. Supreme Court has held that it means the government (not individuals). After the Supreme Court’s holding in McDonald v. City of Chicago, it means the federal and state governments (including local government bodies). In sum, the second amendment does not allow any federal, state, or local government to prohibit keeping handguns in the home for self-defense.
BUT the second amendment does not apply to individuals. (And that wouldn’t really make sense–individuals don’t generally get to make rules about what items others may or may not own). If a landlord prohibited all guns on the property, even legal ones, and an unhappy tenant complained about it, that tenant would not have a case. So the good news: the new Illinois concealed carry law does not require you to allow guns on your property. Picture an old-timey saloon, where patrons had to turn over firearms before entering.
If you’ve been reading articles for entrepreneurs on the internet, you’ve probably read much advice on fund-raising. So you may already know that a “private placement” is a campaign where a business sells an investment to one or a few investors, to raise money to start a new business or expand a profitable one.
You probably hear of people raising millions of dollars from people they know. If you don’t know a multi-millionaire who’s ready to invest in your business, read on…
You can probably still raise enough money by combining investments from several people. How?
1. First, decide what you are offering. How much do you need to raise? Do you want to offer debt, where you will have fixed payments no matter how much you will make, or equity, where you will have to give away some of your business? Or a revenue share? What terms can you offer, where you know you’ll be able to pay the investors back and make a profit?
2. Write up a disclosure document (often called “private placement memorandum”). This document tells your potential investors what you’re offering, and it should include everything they might want to know to help them make the decision to invest or not. So all information about your business, your assets, and how their money will help you make money, will go in here. It also explains the investment you’re offering.
3. Identify the people to whom you will offer this investment. As of September 23, 2013, you will have a choice. You can advertise your offering publicly if you only sell the investment to accredited investors (briefly: wealthy people). OR you can sell to up to 35 non-wealthy people if you don’t advertise. OR you can sell to an unlimited number of non-wealthy people if you raise under $1 Million and don’t advertise. There’s more to these rules, and I recommend consulting a lawyer to make sure you’re following securities law.
4. File certain forms with the appropriate regulatory agencies. Typically, it’s something called Form D. If you’re offering in multiple states, you need to file with the federal SEC and in all states in which you’re offering the investment (or if you’re using the new rule, just the states where someone purchases). If you only offer to Illinois residents, depending on the size of your campaign, you may be able to use just the simplest of these forms, Illinois 4G.
5. Run your campaign. Reach out to your contacts, letting them know about your offer. Do whatever it is that business people do to make deals.
6. When someone indicates interest, you give them the disclosure document. If they agree to purchase, you “close” the transaction. You both sign a contract for the investment, you give them documentation of the investment–usually a note or stock certificate, and you take their money.
7. Not done yet… you need a system for keeping track of your obligations. You pay the loans back as they become due, or pay dividends according to your bylaws and agreements. It’s also important to make sure you keep records to show you’re complying with securities rules.
This is a quick overview, not legal advice. Securities law is a serious thing. If you offer unregistered investments to the public, you could be breaking the law, and if you defraud people, you could get in serious trouble. To find out what counsel does for you when you raise money, this post explains. If you have a campaign in mind and would like to talk to me about it, check out my legal services for capital-raising, or send me a message.
You’ve heard Delaware is the place to incorporate–but should you?
In general, incorporating in Delaware is better for a large business, and incorporating in your home state is better for a small local business.
Advantages for bigger businesses that don’t help small/local start-ups:
- Large, detailed, and up-to-date collection of court decisions means most legal questions about corporate law have already been answered. This means that when a conflict comes up, you can probably avoid litigation because it’s clear how a court would rule. This doesn’t help a new, small company that isn’t facing corporate law disputes. And this only applies to corporate organizational matters and contracts formed in Delaware, not other types of disputes, for example, if an Illinois customer gets hurt using a product bought in Illinois.
- If your income is royalties, incorporating in Delaware could reduce your taxes. This does nothing for a new brewery, for example, because for income other than royalties, you file and pay tax in the state where you actually make the income.
- A lot of it is reputation. Delaware corporate law is a known quantity, and high-dollar investors may feel more comfortable investing in a Delaware corporation. That is not a good reason for a new, small company without demanding VCs to incorporate in Delaware.
Disadvantages to incorporating in Delaware if that’s not your home state, that big businesses don’t care about:
- You’ll still have to register with the Secretary of State’s Office where your primary office is and where you have a significant presence, like a retail space. That registration is just as expensive as incorporating, so you’re paying double filing fees. The fee is only about $150, plus the cost of having someone do it, so this matters more to small businesses.
- You’ll have to file 2 annual reports, pay 2 states’ franchise tax, and file 2 sets of state tax forms (at least).
- Securities law. Any time you sell someone the opportunity to invest in your business, where they put in money and expect a return (without doing any work themselves), that’s a security. Securities are highly regulated, and you almost always have to file some forms with at least state, and usually federal and state governments. But if you’re doing most of your business in one state, and you’re incorporated in that state, and you’re raising capital only from people who live in your home state, then federal law says “We’ll let state law handle it.” This cuts your filing fees and costs, but it only works if you’re incorporated in your home state.
I wrote a more detailed explanation for this article on www.triplepundit.com.
Have you heard there’s a new benefit corporation statute in Delaware? As you may know, Delaware is the go-to state for organizing business entities… so does that mean your new benefit corporation should incorporate in Delaware? First you should understand why businesses incorporate in Delaware in the first place. For larger businesses or those seeking major venture capital, there’s a benefit. For new, small businesses or locally-based businesses, there are probably more drawbacks than benefits. My recent post on triplepundit.com gives you a clear, simple explanation of why to incorporate in Delaware, or not.
You can incorporate there no matter where you do business, and take advantage of Delaware’s friendly legal set-up for businesses. The Secretary of State’s filing system is easy to use. Delaware’s long history of deciding business law cases now gives business owners clear answers on any legal question that might come up. That means you can find the rules ahead of time and avoid litigation (in other states, there might not be a clear answer). Business owners also incorporate in Delaware so that investors will know what they’re getting–a business under Delaware law, and they’re comfortable with that.
(a) Notwithstanding any other provisions of this chapter, a corporation that is not a public benefit corporation, may not, without the approval of 90% of the outstanding shares of each class of the stock of the corporation of which there are outstanding shares, whether voting or nonvoting:
(1) Amend its certificate of incorporation to include a provision authorized by § 362(a)(1) of this title; or
(2) Merge or consolidate with or into another entity if, as a result of such merger or consolidation, the shares in such corporation would become, or be converted into or exchanged for the right to receive, shares or other equity interests in a domestic or foreign public benefit corporation or similar entity.
Translation: If a business is not already a benefit corporation, it cannot become one without approval of 90% of all shares. Even shares that don’t normally have the right to vote. Ninety percent. (In contrast, Illinois requires the “minimum status vote,” which is 2/3 or as low as 1/2 if the Articles of Incorporation say so). This applies to all existing corporations in Delaware, because the benefit corp. statute is brand new.
Delaware has made it very difficult to convert an existing corporation to a benefit corporation. This makes sense from a business perspective, if you assume that such a conversion would hurt the value of the stock (I disagree with this, maybe naively). It’s a compromise that may have helped pass the statute by addressing the concerns of stockholders who don’t want their investment “threatened” without their permission.
But this compromise leaves us stuck where we are. It just makes me picture a gigantic mass of corporations–our economy–that cannot shift towards benefit corporation status. Like a large ship that already takes a long time to turn around, this provision makes it take even longer.
You’ve clicked over here because you want to see if a business you’re involved in should be a worker co-op. What exactly is a worker co-op?
A business just needs a couple of basic features to be considered a worker cooperative.
Democratic Control. A worker co-op makes its decisions democratically. One person = one vote. This is quite different from voting in a corporation, where owners vote based on the number of shares they own. Owners of an LLC determine among themselves how decisions will be made, so if those owners agree that all owners will have an equal vote, they are already part way to operating as a worker co-op.
Each Worker’s Earnings are Based on What She/He Puts In. In order for a business to be considered a cooperative for tax purposes, earnings must be distributed to owners based on “patronage.” ”Patronage” means “business done with or for” the cooperative. In other words, the co-op as a whole decides how to measure each worker’s contribution. It’s usually based on hours worked, and you can add a premium for whatever might be extra valuable, like bringing in new business. Some co-ops pay higher for the jobs no one wants to do, to make sure those tasks will be covered. This way of figuring each worker’s compensation means that one worker won’t be paid more and another paid less just because of chance, when they were hired, how much they previously made, and other vagaries of salary negotiations.
Commitment to the Cooperative Principles. People who organize their business in this democratic way generally adopt the internationally recognized cooperative principles.
Addressing some misconceptions:
A worker co-op is a for-profit business. A worker co-op’s goal is generally to make money and provide some product or service, and a non-profit cannot distribute income to its owners.
A worker co-op can have employees. In a worker co-op, the business is owned by its workers. That does not mean that the co-op has to immediately allow anyone to become a member. Most co-ops have a trial period, where a prospective member works as an employee first. The co-op sets up its own qualification for new members and can take the time to make sure someone is a good fit.
Further Reading: To learn more about how to start your new worker co-op or transition an existing business into a worker co-op, I recommend this guide from the Sustainable Economies Law Center, and this guide from the Northcountry Cooperative Foundation.