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Fostering Employee and Community Based Ownership

Fostering Employee and Community Based Ownership

By-Laws: The Framework for Democratic Control

Money, Power, Information

A worker cooperative is a democratic corporation, owned and controlled by the people who work in the company. A co-op’s Articles of Incorporation and the by-laws are the framework under which that control is laid out. In simple terms, a co-op’s by-laws (or their operating agreement if they’re organized as an LLC) determine how money, power, and information flow through the company. These are the things that matter most when it comes to the pressing issues of ownership and the details of all three have to be clear to all the people involved. To download a copy of ICA’s model by-laws, visit our publications page.

Money Power Information
Money: The by-laws outline how an owner enters and leaves the company and how profits are distributed. This is done through outlining what types of stockholders a firm has and what rights they hold. In a worker co-op, the value of the share and the value and individual are separated using the internal capital account system. Power: What rights do the members have? What rights does the Board of Directors have? Will there be outside investors allowed and what rights do they have? The by-laws determine who has the right to control the corporation. How the board will be elected, how decisions are made and who can makes changes to the by-laws. Information: How often will the members and board of directors meet? How much notice must people be given when certain types of meetings will occur? Without the proper communication systems, the power that members are authorized in the by-laws do them very little good. Systems for communication help ensure that the democratic principles are fully realized.

Can I form a Worker Co-op in My State?

Using ICA’s Model By-Laws, you can form a worker co-op in ANY state. A co-op statute is not necessary.The purpose of the ICA Model Bylaws and sample Articles is to create a democratic cooperative structure within the legal shell of a general corporate, cooperative, or worker cooperative statute. Fortunately, most general business corporation statutes are flexible enough to use in creating a democratic worker cooperative. What this means is that using the ICA model by-laws, you can form a worker co-op in any state, regardless of whether they have a co-op statute or not. Time and again, people say that they can’t form a worker co-op because there is no law on the books – this is wrong! You can form a co-op in ANY state under the general corporation law. The only limitation is that, generally you can’t have the word “cooperative” in your legal name.
-The Framework for Democratic Control There are two key legal elements to forming a corporation, the articles of incorporation and the by-laws. The articles include basic information, such as the name and address of the corporation, the corporate purpose, how much and what kind of stock the company will authorized, the list of initial directors, etc. Most people choose to define the corporate purposes broadly and keep the articles brief. Ordinarily, the details about the cooperative structure is reflected in the bylaws, which are not usually filed with state officials and are thus easier to amend. Amendments to the Articles require shareholder voting and the filing of Articles of Amendment and a fee to the state.
Read on to learn more or visit our resources page to download ICA’s model by-laws and articles of incorporation. 

Choice of Legal Entity: Co-op, C-Corp, S-Corp, LLC, Non-Profit?

When starting or converting a democratic firm, you have to choose what type of business you should be. There are a lot of choices and each carry with them certain benefits and drawbacks. Many worker cooperatives diverge from a “pure” cooperative form, while still maintaining a commitment to democratic work. The result is a wide variety of arrangements that couple core democratic attributes with more conventional artifacts of business and finance. For example, loan contracts can alter legal and financial relationships significantly. Notably, as well, worker cooperatives often issue a second class of stock in addition to membership shares.

ICA’s model by-laws are designed so a worker co-op is able to qualify for the preferential tax treatment co-ops enjoy under Subchapter T of the IRS code. However, using this incentive is a business decision, not a requirement. The cooperative mechanism for accepting outside investment is non-voting, fixed dividend stock. However, some investors or selling owners might want voting rights, profit participation, or guaranteed board seats. And strong business rationale might warrant such arrangements. Worker cooperatives are permitted to forego the cooperative tax deductions under Subchapter T in exchange for greater access to investment capital. Of course, if the workers no longer democratically elect a majority of the board directors, the enterprise can no longer be legitimately described as a worker cooperative.

C-Corp: A traditional corporation where the entity is taxed separately from its owners. In this way, the C-Corp is subject to ‘double taxation’ where profits are taxed at the corporate level and then again when they are distributed to owners. Under Subchapter T, cooperatives incorporated as a C-Corp can avoid this double taxation for dividends paid out to members. While corporations can have an unlimited number of classes of stock, they require the authorization of share classes in the articles—which requires a state filing—and equal treatment of each share within a class.

Cooperative Corporation: A form of stock corporation that specifies that shareholders are members and the corporation operates for the benefit of its members. In states with a worker co-op statute modeled after the Massachusetts Law, the fact that the company is calculated at book value and members share of that value is recorded in an internal capital account is specified. In states with a cooperative statute, you likely cannot have the word cooperative in your name unless your business incorporates under the statute. In states where the state income tax mirrors Subchapter T, it may be necessary to incorporate under the state’s cooperative statute to realize that benefit.

Limited Liability Companies (LLC): LLCs are not taxable entities, but rather pass through entities, where the income from the business passes through to the owners (who are called members, even in non-cooperatives). The member then pays personal employment and income tax on their portion of the profits. In most cases LLCs can have unlimited classes of shares and an unlimited number of members. LLCs are also highly flexible vehicles for accepting investment, the terms of each new investment can be easily tailored without reference to a class of securities—and without amending the articles.  Most LLCs are taxed in the same way as partnerships, therefore to retain earnings and not have members have to pay personal taxes, an LLC has to elect to be taxed as a C-Corporation (a more complex workaround is to establish a separate LLC whose sole purpose is to retain earnings). LLCs electing to be taxed as C-Corps can retain up to $250,000 in retained earnings. In most cases, worker-owners at an LLC electing to be taxed as a C-Corp would be considered employees for purposes of employment law.

In LLCs taxed as partnerships it is not assumed that members are employees. As such, “non-resident aliens” can be worker-owners of an LLC without violating any employment law. This non-employment status can have both advantages and disadvantages – careful attention must be paid to ensure you are in compliance with applicable employment law. Furthermore, non-employees are not eligible for social safety net protections such as unemployment.

LLCs also have far less rigorous requirements for shareholder meetings and record keeping. While this simplifies certain things, a democratic corporation should hold regular (at least quarterly) board meetings and at least annual LLCs are not taxable entities, but rather pass through entities, where the income from the business passes through to the owners or members. Unlike an S Corp, and depending on state law, LLCs can have unlimited classes of shares and an unlimited number of members. LLCs are also highly flexible vehicles for accepting investment, the terms of each new investment can be easily tailored without reference to a class of securities—and without amending the articles. In addition, twenty years of precedent appears to indicate that LLCs have the benefit of allowing noncitizens and other “non-resident aliens” as members. LLC owners face the impact of pass-through tax liability without regard to distributions.  Most LLCs are taxed in the same way as partnerships, therefore to retain earnings, an LLC has to elect to be taxed as an C-Corporation and then establish a separate LLC designated specifically to retain earnings. The owners of an LLC are not presumed to be employees, which can have both advantages and disadvantages – careful attention must be paid to ensure you are in compliance with applicable employment law. Owners of an LLC retain the corporate shield against personal liability for corporate debts and liabilities.

Not-for-Profit: Many worker cooperatives organize as nonprofits. In fact, the ICA Group is organized as a cooperatively structured nonprofit. The employees are the members of the firm and elect the Board of Directors on a one person/one vote basis. Nonprofits must have a charitable mission and cannot pay out profits to their members, although staff can receive bonuses as compensation for labor. Nonprofits have a number of advantages: (1) corporate income is tax exempt, excepting unrelated business income; (2) all retained earnings are permanently reinvested in the firm (allowing business growth and income stabilization); and, upon dissolution, (3) all assets are protected by the state for distribution to another not-for-profit, such as for the purpose of worker cooperative development.

S-Corp: S-Corps are not taxed separately from their owners, and thus avoid ‘double taxation.’ The S Corp has a number of limitations: the corporation cannot have more than 35 shareholders (except in the case of an ESOP), there can be only one class of stock, and all shareholders must be individuals or simple trusts. Moreover, all corporate net income or loss is taken into account each year by the shareholders, without regard to actual distributions. Thus, if the corporation needs to retain substantial earnings, the worker-owners might face tax liability with no cash proceeds to pay the tax. A corporation operating on a cooperative basis in compliance with Subchapter T has much more flexibility to shift the tax burden among the corporation and the members, even while retaining corporate earnings and avoiding double taxation. Owners of an S Corp retain the corporate shield against personal liability for corporate debts and liabilities.

Other Resources:

DAWI_Choice_of_Entity

Choosing a Business Entity: 
A Guide for Worker Cooperatives

This publication by the Democracy at Work Institute outlines the issues related to choosing a legal entity. It walks through the key differences between different corporate forms and provides a chart comparing various forms.

ICA_Employment_Choice Matrix

Employee Ownership Comparison:

Designed primarily for firms exploring selling their firm to their employees, this document lays out the various differences between different forms of employee ownership.