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Transcript
Equity Management Phil Kenkel Bill Fitzwater Cooperative Chair The objective of equity management is to attract members while keeping current members needs satisfied. Also, equity management should try to maintain cooperative profitability while allowing for growth. Equity Process 1. 2. 3. 4. 5. Determine income generation and distribution Determine assets Determine desired financial structure a. Debt/equity b. Working Capital Determine equity redemption budget Determine equity redemption program Equity Redemption Equity redemption is the process of returning equity in cast to member-patrons who have previously invested. The over invested or inactive members should not be responsible for financing a cooperative they do not use. Failure to redeem equity reduces member realized return on equity (ROE). Entire member equity is due at one time. An event must trigger the redemption such as: Member death Age of Patron Retirement from farming Move out of trade area Hardship Advantages Special Programs are used to understand the low financial burden on the cooperative. In this program high priority cases get attention when other plans are not working. Also works well for co-ops offering favorable prices. Disadvantages Cooperative financial planning could be difficult because special programs does not tie equity base with current patronage. The members get poor realized return. Age of Patron (oldest first) Calculations Beginning equity Special Programs $1,000,000 + Additional Investment $200,000 The patronage redeems when the patron reaches a specific age and is the natural person and not a LLC or Trust. Finally upon redemption the patron birth date information is required. = Maximum equity $1,200,000 Advantages - Ending equity (target) $1,100,000 The Age of Patron is simple and easy to understand. Also works well for cooperatives with favorable price. = Redemption budget $100,000 Equity Redemption Programs Defines the way that one or more classes of equity are treated for redemption. The redemption policy is used of everyone in a particular equity class. The overall program should be consistent with the cooperatives equity management objectives. Alternative Redemption Methods Special Programs (uses trigger event) Age of Patron (oldest first) Age of Patron (pro-rated) Revolving Fund plan Base Capital plan Percentages of all Equities plan Disadvantages The young farmers have little incentive to participate. Equity investment is not proportional to patronage. Members expect redemption regardless of the financial condition. Age of Patron (pro-rated) Redeems a portion of each patron accounts for patrons past a set age, and the coop establishes a redemption budget. Pro-rated also determines the total equity of members older than 55. Some coops establish a redemption percentage while others use a fix percentage. Advantage Pro-rated is easier to integrate with the redemption budget. More members receive redemptions and are popular with members who are eligible for AOP. Disadvantage Still not proportional and is redeemed at a decreasing rate but never completely redeemed. With some coops, fixed percentages limits flexibility. Revolving Fund Plan Redeems are based on the age of the stock, based on FIFO, “first in- first out.” Ranging form 18 months to 30 years, and some coops have multiple revolving funds. Advantages Easy to understand and administer. Equities somewhat proportional to use for short revolving periods and coops can adjust equity by adjusting length. Disadvantages With the revolving fund plan there will be good year problems and bad year problems. Disparities can occur between equity and use. And members may expect fixed revolving regardless of financial conditions. Base Capital Plan A base equity is established under invested members continue to increase investments, while over invested members get partial or total redemption. Also, can be combined with a variable cash patronage refund plan, and over invested members receive large cash refunds. Percentage of All Equities (After trigger age: after 65) Reduces member equity by percentages and retiring a percent of outstanding equity, regardless of issuance. Used by a limited number of cooperatives. Advantages Rewards new patrons and works well for cooperatives with a stable membership and patronage. Also, easy to understand and administer. Disadvantages With the percentages of all equities there can be a poor transfers of ownership. Transfer of ownership cannot be completed with out additional provisions from the cooperatives. Conclusion Age of patron is the least desirable because it is the least proportional. The best plan for most cooperatives is age of stock combined with estates. But no simple strategy is best for everyone. Alternatives to Redemption Partial Redemption or Discounting Conversion to Debt or Preferred Stock Exchange of Equity Between Members True Secondary Markets Partial Redemption or discounting Members get paid discounted value of future equity redemption, but have difficulty on choosing discount rate. Income tax consequences are not well established. Conversion to Debt or Preferred Stock Improves co-op cash flow, but it changes co-op’s balance sheet, which gives members more return. Allows exchange of equity between members even though the markets of members are limited. Purchase price may not be realized as a value and member income tax issues are unclear. Exchange of Equity Between Members Most cooperatives restrict these transactions and the price is privately negotiated. Each transaction must be approved by the board and recorded by the cooperative. Advantage Reflects true market value therefore having immediate cash for equity sold. Also, cooperatives do not provide cash for the transaction. Disadvantage Limited markets among qualified members and the purchasers’ faces risk of depreciation of stock. Secondary Markets Allowing cooperative equity to trade in a secondary market… Members control is comprised and relieves cooperatives of liquidity equity for members. Comprise of power must be made for voting stock for producer-members and public nonvoting stock for non-producers. Putting it All Together Equity Programs should raise adequate equity and minimize redemption burden. Also, it should assure fair treatment and generate adequate returns over time. Finally, a cooperative should choose an equity redemption plan that meets their circumstances.