Agricultural, Cooperatives, Finance, Agribusiness, L10, L23, L16, Q13,

Barton, David G.

Boland, Michael A.

Chaddad, Fabio Ribas

Eldon, Eversull

English

Research Papers in Economics

 
3rd Quarter 2011 | 26(3) 
CURRENT CHALLENGES IN FINANCING AGRICULTURAL COOPERATIVES 
David Barton, Michael Boland, Fabio Chaddad, and Eldon Eversull 
JEL Classifications: L10, L23, L16, Q13 
Keywords: Agricultural, Cooperatives, Finance 
A review of JSTOR, an online system for archiving academic journals, reveals 1,921 unique citations—articles, 
proceedings papers, book reviews—for the word “cooperatives” in the American Journal of Agricultural Economics 
and Review of Agricultural Economics.  Of these 1,921 citations, 620 are in the area of finance, more than any other 
category.  This body of research suggests that cooperative finance is a critical challenge for agricultural cooperatives’ 
survival and growth. Our engagement with industry cooperative leaders also suggests that the income distribution 
decision and the equity management decision, including equity investment and redemption, and the balance sheet 
management decision continue to be on their priority list. This article summarizes the results from a survey of 
cooperative leaders to better understand current challenges in financing agricultural cooperatives. 
Elements of Cooperative Finance 
A cooperative is a business operated primarily to provide benefits to members through marketing transactions, 
including input buying and output selling, and through a distribution of patronage earnings from these transactions; in 
return, members have a responsibility to provide equity capital—ownership—and exercise member control—
governance. Members are quick to seek out the benefits of the cooperative business model but often reluctant to 
accept the corresponding responsibilities of ownership and control. Three functions underlie broad cooperative 
principles today. These are benefits, control, and ownership. Benefits include both market access at fair prices and 
other terms of trade and a claim on the income from these marketing transactions, usually distributed to patrons as 
patronage refunds proportional to use or patronage.Control is exercised through voting by members on governance 
issues including bylaw approvals, business mergers and dissolutions and election of directors. Voting power may be 
one-member, one-vote, sometimes championed as democratic control, or proportional to patronage and/or equity. 
Ownership is obtained by the investment of equity capital by patrons either through cash purchase or through the 
retention of income from operations. Income may be retained in allocated form as per unit retains or retained 
patronage refunds, or in unallocated form as retained earnings. The cooperative business model is unique because it 
is user- or patron-oriented instead of investor-oriented. 
In general, there are four unique and separate roles of users: customers, patrons, owners and members. Those who 
engage in buy or sell marketing transactions with the co-op are customers. Patrons are customers who are granted a 
claim on the patronage income proportional to use, as a patron and customer. The claim is not based on ownership 
unless ownership is managed to be proportional to patronage. This is the core difference between patron-oriented 
and investor-oriented business models. Patrons also own the cooperative. They have ownership rights derived from 
providing equity capital. Patrons who qualify as voting members are granted control through their voting power. In a 
pure cooperative with no nonmember or non-patronage business a customer or user is also a patron, owner and 
member. Many cooperatives prefer to use the term member instead of patron to convey the primary role. The selection and implementation of an effective financial 
strategy is critical to the long-term success of any 
business, especially a cooperative business. Some of 
this is attributable to the uniqueness of the cooperative 
business model and its relationship to standard business 
finance. The uniqueness of the cooperative business 
model results from its focus on the role of the patron and 
the relationship of this role to the other roles of owner, 
member and customer. Cooperatives; fraternals—
Knights of Columbus, Thrivent, Modern Woodmen of 
America, Ancient Order of Hibernians, and so on; mutual 
societies—State Farm, New York Life, American Family, 
and so on; and financial services firms—Nationwide, 
Vanguard, for example—share this uniqueness 
compared to investor-oriented types of businesses such 
as proprietorships, partnerships and corporations. 
Financial Keys to Success of Cooperatives 
Cooperatives must be competitive like any business. The 
cooperative business model is unique but it is still a 
business that is subject to the principles of business 
finance, business management and economics. It must 
be managed as a business that can compete in a 
capitalistic and highly competitive market economy. The 
primary economic justification for organizing and 
operating a cooperative is to correct and prevent market 
failures that are present or could be present. Other 
related justifications include providing missing services, 
reducing costs of service, and being price and service 
competitive in the marketplace—known as the 
“competitive yardstick” role.  Some cooperatives also 
attempt to increase the value of patrons’ incomes by 
bargaining for higher prices or better terms of trade rather 
than accept “market prices.” 
Irrespective of its purpose and role, a cooperative should 
strive to be as profitable as possible and then distribute 
those profits to its patrons. A cooperative should 
implement the core principle of the cooperative business 
model, service or operation at cost, by being competitive 
in the marketplace, making as much profit as possible, 
and then distributing profits and residual cash to patron-
owners. Distribution should be done in a way that 
maximizes the long-run benefits to the group, keeping in mind that the group has heterogeneous interests at any one 
time due to their unique place in their business and personal life cycle. This distribution of patronage refunds or 
patronage income implements the service at cost principle of cooperatives. The payment of patronage refunds for a 
“non-pooling cooperative”, or net margins for a “pooling cooperative”, is the primary way cooperatives implement the 
service at cost principle. Patron-owners get what is left over through a combination of cash patronage payments, 
cash equity redemption payments and cash payments of net marketing proceeds. 
Cooperatives should use balance sheet management when making income distribution and equity redemption 
payments. A cooperative must position and protect the business for short-run and long-run sustainability by adhering 
to a balance sheet management philosophy that manages both liquidity and solvency. Adequate risk capital must be 
provided by establishing and following liquidity and solvency guidelines as an element in the overall business 
strategy. Then the cooperative should pay out in cash to patron-owners any residual cash as cash patronage refunds 
or equivalent, and allocated equity as equity redemptions for cash not needed to meet the guidelines. Owners always 
get what is left over in any business, as residual claimants, and patron-owners of cooperatives are no different. The evaluation and choice of alternative strategies 
must be done within an integrated and comprehensive 
finance, strategy and risk management framework. For 
an agricultural cooperative, that framework should 
include both the patron-producer perspective and the 
cooperative business perspective. In other words, a 
cooperative can be viewed as an extension of the 
patron’s business, such as a farm, or as an 
independent firm that attempts to prosper in a market 
economy. Both perspectives are important. 
Critical Challenges 
Based on the survey results cited above, there are 
three particularly critical financing challenges facing 
cooperatives. They command much attention from 
cooperative boards of directors and the members. 
Financing Asset Growth for Members 
The most mentioned critical challenge identified by the 
survey respondents was the need to acquire and 
maintain adequate equity capital to help finance growth and provide increased working capital. Production agriculture 
is experiencing a boom, especially in the crop production sector. This has resulted in the need for agricultural 
cooperatives and similar agribusiness to add assets to service the needs of production agriculture. In addition, prices 
of farm inputs and outputs have become more volatile, increasing the price risk to producers and agricultural 
cooperatives. Increases in crop yields, coupled with the ability of seed genetics to grow crops in geographic regions 
where they had not been grown before, and advances in irrigation technology have created a need for new grain and 
agronomic assets. 
Maintaining Sufficient and Consistent Profitability 
The second most mentioned challenge was the need to be profitable in order to finance much-needed assets and 
maintain a strong balance sheet. This finding is consistent with research showing that cooperative investment is 
tightly linked to its ability to generate cash flow through operations. Since most equity capital is obtained from 
earnings, this implies maintaining and improving profitability is also critical. Another challenge related to profitability 
cited by many respondents was the increased need for equity capital to improve liquidity and solvency so that the 
cooperative could offer risk management tools to producers, such as locking in a net margin per acre, by executing a 
grain selling decision in conjunction with agronomy and energy purchase decisions. 
Managing Business Risk While Maintaining Ownership 
The third most mentioned challenge was balancing or managing the trade-off between adhering to the ideal principle 
of proportionality of equity investment with the urgent need to provide more equity risk capital. Members want the 
cooperative to invest in assets that increase profitability and reduce business risk, requiring more equity investment to 
finance the assets and strengthen the balance sheet, but at the same time do not want the cooperative to slow down 
the rate at which equity is redeemed to the members as a way to increase equity investment. In other words, 
members want the benefits of the cooperative but don’t want to accept the corresponding ownership responsibility. 
This puts even more pressure on boards of directors and managers to assure that the cooperative is profitable, to 
create more equity investment, and to use higher leverage to finance assets. 
A recent USDA study on equity management by Eversull (2010) reported that 21 cooperatives were using a base 
capital plan linking equity capital to current users of the cooperative. That is the best plan in traditional “open” 
cooperatives for maintaining proportionality of equity capital investment with use by current patrons of the 
cooperative. It is also the most complex equity management system and is more difficult to communicate to 
members. It is clearly evident that many crop farmers are very profitable as found in state farm management 
association records and in the dramatic increases in land prices. Thus, it may be easier for cooperatives to improve 
profitability by increasing net margins to pay for the much-needed improvements in assets, if cost efficiencies and 
competition permit. Balance sheet management that selects liquidity and solvency targets and only redeems excess equity as the 
residual distribution of cash is considered the best way to manage aggregate patron equity investment and manage 
balance sheet risk. Equity management that selects equity redemption methods which maintain equity investment of 
individual patrons as close to proportional to use is considered the best way to manage individual patron ownership. 
The revolving fund and base capital redemption methods are the preferred methods. 
Need for Education about Cooperative Finance 
It is evident that education of leaders and members 
about cooperative finance is critical if leaders and 
members are to understand why a cooperative must be 
profitable and why cooperative finance practices must 
be aligned with the cooperative’s business model. 
These are tenets of effective income distribution and 
balance sheet management. If members view the 
cooperative as the vertical extension of their farming 
enterprises, then the ultimate objective is to maximize 
after-tax discounted cash flow back to the producer-
member. A list of key topics for further research and 
education was identified by the industry leaders. 
Concluding Comments 
Alignment of a financial business strategy on 
cooperative principles and the cooperative’s business 
model, including equity management, are critical issues 
for the success of an agricultural cooperative. 
Financing and managing the asset growth needed to 
meet member needs, and keeping equity proportional 
to usage are two critical issues for financing agricultural 
cooperatives.Cooperative finance has been an 
important topic for agricultural economists and 
continues to be an important topic today as evidenced 
by the comments from these cooperative leaders. Land 
grant university economists have long conducted 
extension education programs for managers and 
directors of cooperatives. Such programs remain 
relevant today, especially those addressing cooperative finance. 
For More Information 
Eversull, E. (2010, June). Cooperative Equity Redemption (Research Report 220). Washington, DC: United States 
Department of Agriculture, Rural Business-Cooperative Programs. Available online: 
http://www.rurdev.usda.gov/rbs/pub/RR220.pdf 
eXtension resource page. (2011). Available online: http://www.extension.org/cooperatives 
The Journal of Cooperatives (2011). NCERA 210 Research on Cooperatives. Available online: 
http://www.agecon.ksu.edu/accc/ncera210/JournalofCooperatives.htm. 
David Barton (dbarton@k-state.edu) is Professor of Agricultural Economics and Director Emeritus of the Arthur 
Capper Cooperative Center, Department of Agricultural Economics, Kansas State University, Manhattan, Kansas. 
Michael Boland (boland@umn.edu) is Koller Professor and Director of The Food Industry Center, Department of 
Applied Economics, University of Minnesota, Saint Paul, Minnesota. Fabio Chaddad (chaddadf@missouri.edu) is 
Assistant Professor of Agricultural And Applied Economics, University of Missouri, Columbia, Missouri and Insper 
Business School, Sao Paulo, Brazil. Eldon Eversull (eldon.eversull@wdc.usda.gov) is Acting Director of the Statistics 
Staff at the U.S. Department of Agriculture Rural Development, Business and Cooperative Programs, Washington 
D.C. The views expressed are those of the authors and do not necessarily reflect the positions of the Federal Reserve 
Bank of Kansas City, the Federal Reserve System, or Purdue University. 
© 1999-2011 Choices. All rights reserved. Articles may be reproduced or electronically distributed as long as 
attribution to Choices and the Agricultural & Applied Economics Association is maintained. 
 

Current Challenges in Financing Agricultural Cooperatives

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