Leaving home?
Reasons vary for co-op conversions; critics
remain wary of producers losing control
By Nancy Jorgensen
Editor’s Note: Jorgensen worked for
CoBank in Denver for 13 years before
establishing her own communications and
marketing consulting business in
Pomerene, Ariz., which specializes in cooperatives.
o-op conversions aren’t
exactly sweeping the
nation — only a handful
have converted to limited
liability companies (LLCs)
or other business forms in recent years.
And of these, most proudly say that
they are still producer controlled.
Regardless, co-op conversions concern
some co-op leaders, who say the
risk is great that converted co-ops will
eventually wind up under the control
of outside investors.
Promoters of the concept counter
that co-op conversions give producers
another avenue for raising capital
needed to become players in valueadded
agriculture markets and can help
them gain other operating efficiencies.
The debate involves many of the
same principles and issues that arise in
the sale of co-ops to non-cooperative
businesses, recent examples being the
sale of Minnesota Corn Processors and
the now-scuttled sale of FCSAmerica
(see Nov-Dec. issue of this magazine).
Are producers sacrificing their longterm
good and that of producers who
follow them for short-term gains? Is
the conversion being undertaken primarily
for the benefit of management
staff or a select few members with
large amounts of stock, rather than the
overall membership? Or will the conversion
open the door to greater marketing
clout for producers? Should the
definition of “cooperative” be expanded
to include producer-owned LLCs as
a new type of co-op, and should they
receive Capper-Volstead protection?
These are just examples of the questions
raised by some co-op conversions.
This article does not examine
all of these questions, but it will focus
on why several co-ops have recently
converted to LLCs or other corporate
structures, and how some co-op leaders
view co-op conversions.
Why some co-ops convert
Attorney Mark Hanson is viewed by
some as an “evangelist” in the cause of
co-op conversions, having been the
architect of several. “We’re supportive
of co-ops,” says Hanson, an attorney
with Lindquist and Vennum, a
Minneapolis-based firm with 13 attorneys
devoted to co-op law. “We still
help form more new co-ops than we
convert. But some successful co-ops
have outgrown the form.”
Hanson says co-ops convert for
three major reasons: “To gain capital,
to gain liquidity or to access enterprise
value — the value of the business as a
going entity. In successful co-ops, the
value of the farmers’ commodities is
small compared to the co-op’s enterprise
value.”
Hanson estimates that only a dozen
co-ops have converted to LLCs or
other business forms in recent years.
This doesn’t include conversions of coops
which have all their members
residing in only one state. These are
harder to track because they aren’t regulated
by the federal Securities and
Exchange Commission. However, the
number of such “one-state” co-op conversions
is thought to be very small.
In a report on demutualization (the
term commonly used for conversion of
consumer co-ops — such as housing,
utility, insurance, food and credit coops
— to investor-owned business)
which he co-authored for the National
Cooperative Business Association,
Nadeau noted that Australia once had
a large co-op business sector, but experienced
“massive privatization” in
recent years.
While such occurrences are still
rare in the United States, “growing
economic pressures to demutualize
requires a coordinated response if
widespread loss of member choice and
control is to be avoided,” he wrote.
Lack of capital is often used to justify
co-op conversions, he adds, saying this
underscores the need to find new ways
to help co-ops gain access to capital.
The four co-ops discussed below
each started out as new-generation,
value-added co-ops. Adding value to
farm commodities usually requires
building capital-intensive processing
plants, and that means sizable investments
by producers. In these four
cases, the minimum investment
required for membership ranged from
$1,500 to $20,000.
Farmer-members of all four co-ops
voted to adopt new structures that
allow for non-farmer investment. In
each case, more than 80 percent voted
for the conversion. It is important to
note that all but one of the companies
remains 100 percent farmer-owned and
controlled. Dakota Growers raised
outside capital, but farmers still own
more than 90 percent of the shares.
Golden Oval Eggs LLC;
Renville, Minn.
One of the top 10 producers of liquid
eggs in the nation, Golden Oval
Eggs owns more than 5 million laying
hens and had sales of $80 million in its
last fiscal year. In 1994, when Golden
Oval formed, the co-op required its
700 farmer-owners to deliver a minimum
of 2,000 bushels each of feed
corn annually, and to invest $3.50 per
bushel, with each bushel representing a
share.
The desire for greater transferability
of co-op stock was the major reason
it converted to an LLC.
“A lot of our shareholders are
retirement age,” says Marie Staley, vice
president and chief administrative officer
for Golden Oval. “They’d like the
company to remain farmer-owned, but
they want to pass shares down to their
children, even if the children aren’t
farmers.”
The new LLC structure brings
shareholders more liquidity, since they
can sell shares to non-farmers. Shares
recently traded for $6.
“Farmers are proud to own the
business, but at the end of the day,
they want to make money,” says Staley.
“Even if that means a different [business]
structure.”
Staley adds that under the LLC
structure, farmer-owners continue to
benefit from the market the company
created for grain, but they are no
longer obligated to deliver grain to the
company. This benefits those who no
longer farm, or who can’t meet their
obligation in times of poor production.
U.S. Premium Beef, Ltd.,
(an LLC); Kansas City, Mo.
Steve Hunt, CEO of U.S. Premium
Beef (USPB), says liquidity of member
investments ranks as the top reason for
USPB’s conversion. “The LLC structure
increases liquidity and flexibility
for our members,” says Hunt. “As their
businesses change, they may want to
slow down, divest or expand.”
USPB’s 1,900 members include
ranchers and feedlot owners in 36
states. At its initial stock offering in
1996, owners purchased a minimum of
100 shares at $55 per share, with each
share representing the right and obligation
to deliver one finished animal to
USPB’s processing company.
Today, the company owns the
nation’s fourth largest beef processor,
National Beef Packing Co. It had been
partners with Farmland Industries in
the company before buying out
Farmland when the latter filed for
bankruptcy.
Since converting in late 2004,
USPB has offered two classes of stock,
of which only Class A stock owners are
obligated to deliver cattle. A member
who owned 100 shares before the conversion
now owns 100 Class A units
and 100 Class B units, which combined
now trade for $170.
Owners of Class A units also benefit
from receiving a dividend based on the
profitability of the company, and additional
premiums based on the quality
of beef they deliver. Class A units
receive 33 percent of dividends, while
Class B units earn 66 percent.
“A rancher nearing retirement
could sell Class A units to a niece who
raises cattle, for example, and hold on
to his Class B units,” Hunt says,
USPB, which had $800 million in
net sales for 2003, continues to see
major benefits in remaining a producer-
owned business. “Surveys of USPB
customers show that consumers trust a
product that’s directly tied to the producer,”
Hunt says. “They trust how
we treat our animals and the
environment, our animal health
practices, and the quality of our
beef.”
South Dakota Soybean
Processors LLC; Volga, S.D.
Rodney Christianson, CEO
of South Dakota Soybean
Processors (SDSP), cites taxes as
the No. 1 reason his co-op’s
2,100 members voted to become
an LLC in 2002
A co-op may pass tax liabilities on
to its members based on business done
with each member — based on patronage.
However, the South Dakota company
expects to handle more nonpatronage
business in the future, and
co-op members would be double-taxed
on that business — both at company
and individual levels.
In an LLC, Christianson says “All
profits and tax liabilities are passed on
to the member or partner.” He says
the LLC structure better meshes with
SDSP’s goal to maximize member
profits. Christianson estimates 2004
sales at $240 million.
Based on members delivering 28
million bushels of soybeans per year,
the company produces 620,000 tons of
soybean meal, 50,000 tons of hulls and
310 million pounds of oil. “What if
SDSP develops a market for 40 million
more pounds of oil?” Christianson
asks. “It would be difficult to develop a
patronage relationship with our members
for the added soybeans we would
need.”
Christianson says members have
seen their original minimum investment
of $5,000 increase two to three
times. “Our goals remain steadfast:
adding value and returning that value
to our members. The direction is in
the hands of our members and the
board of directors. The organization
builds and keeps loyalty only if it adds
value to its membership.” SDSP’s governance
has retained many co-op features,
such as one-member, one-vote.
USPB owners also responded to tax
concerns. “As a co-op, anything
deemed non-patronage income was
double-taxed,” says Hunt. “As an LLC,
we can pass through all taxes to the
producer.” Non-patronage revenues in
USPB’s future might come from applying
food safety additives to the carcass
in the processing plant, he adds.
Dakota Growers Pasta Co. Inc.,
(a C-corporation); Carrington, N.D.
Durum growers in North Dakota
and Minnesota formed Dakota
Growers Pasta in 1991, before the
term “new generation co-op” had even
been coined. About 1,000 producers
agreed to purchase a minimum of
1,500 shares in the new co-op for
$3.85 each, and to deliver 1,500
bushels of durum each annually to the
co-op.
Back then, the Durum Triangle of
north-central North Dakota produced
most of the nation’s durum, a wheat
used to make pasta. But years of heavy
rains in the area following the formation
of the co-op caused the spread of
a plant blight known as scab. As a
result, durum production declined in
the co-op’s primary membership area,
so production moved west to other
parts of North Dakota and Montana.
“Mother Nature wasn’t kind to the
farmers who originally put up the
money,” says Timothy Dodd, CEO of
Dakota Growers. “Our members no
longer had the ability to deliver
high-quality durum.” Members
tried to swap grain with the new
producers. “Still, we ran the
risk of being called on the
carpet [for failing to source
the majority of their crop
from members] with no
source of durum.”
Despite this challenge,
ownership in Dakota
Growers proved profitable.
“We paid back farmers’ original
investment long ago
through dividends and stock splits,”
Dodd says.
Since the conversion in 2002,
investors have owned two types of
stock: common stock, which can be
sold to anyone, and Series D stock, a
preferred stock conveyed exclusively to
co-op members before the conversion.
Series D stockholders own a firstcome,
first-served privilege to deliver
durum. They can transfer D stock to
other producers, subject to board
approval.
Dakota Growers, the third-largest
manufacturer of dry pasta products in
North America, generated net revenues
of $145 million in 2003, despite
more consumers trending toward lowcarbohydrate
diets. Through a partnership
with another firm, Dakota
Growers has responded with a new
product offering that reduces the number
of digestible carbs found in tradi
tional pasta. This pasta will be marketed
under the Dreamfields brand.
While the other three co-ops converted
to LLCs, Dakota Growers
became a C-corporation. “The company
took this route because it could
reorganize on a tax-free basis, compared
to the LLC option,” says Ed
Irion, the pasta company’s vice president
for finance. “It also provides
greater opportunities for liquidity and
access to capital.”
Lindquist and Vennum’s Hanson
— who represented three of the four
co-ops (all but SDSP) — weighs in on
the tax issue: “LLCs are tax-efficient
for distributing income over time,
while C-corporations increase public
investment and liquidity,” he says. Ccorporation
status is preferable if
leaders foresee the business becoming
a publicly traded company. A co-op
should become an LLC if generating
income takes precedence over growth,
and if it wants to broaden access to
capital.
New investors bring added capital
Of the four co-ops discussed above,
only Dakota Growers has sought outside
capital since its conversion. In
2004, MVC Capital provided $5 million
in equity financing to the pasta
company.
“We expect to use the funds to capitalize
on what we feel are excellent
opportunities to promote a healthy
lifestyle using the new Dreamfields
[low-carb] technology and to bolster
our position in the traditional pasta
market,” Dodd says.
“We missed out on some very
appealing opportunities, especially
when Borden Foods exited the pasta
business,” said Dakota Growers
Chairman Jack Dalrymple in 2002
when the co-op converted. “We’re
now in a position to attract new
investors and additional capital,” adds
Dalrymple, who is lieutenant governor
of North Dakota.
Neither SDSP, USPB nor Golden
Oval plans to raise outside capital now,
but their new structures allow for the
possibility. Says Golden Oval’s Staley:
“Farmers make up less than 2 percent
of the population. We can’t continue
to go to farmers for equity in order to
grow or keep strong.”
“It puts us in a position to protect
ourselves from difficult times when
prices might go down,” adds USPB’s
Hunt.
Of the four co-ops examined above,
only USPB requires farmer control. At
USPB, owners of delivery rights hold a
majority of the seats on the board of
directors. “The premise of a producerowned
entity remains intact,” says
Hunt.
Neither Golden Oval nor SDSP
requires farmer control.
At Dakota Growers, the 10-member
board must include five North Dakota
residents and three agricultural producers.
Currently, nine board members
farm, while an MVC representative
holds the tenth seat.
“We’re still a farmer-owned business,
just not a farmer co-op,” Dodd
says.
Caution urged
Many co-op advocates take a dim
view of co-op conversions, especially
those that don’t require a majority of
farmers to control the business.
The National Cooperative Business
Association (NCBA) in Washington,
D.C., opposes conversions even when
members retain control.
“We think the co-op form of business
remains the best model for producers
and consumers,” says Paul
Hazen, NCBA president and CEO.
NCBA represents all types of co-ops,
including farmer, food, housing and
insurance co-ops as, well as credit
unions. “When any non-member has
ownership, that’s not a co-op.”
James Baarda shares that view. “My
overall concern is when farmers start to
think of their own organization as an
investment,” says Baarda, an agricultural
economist with the Cooperative
Services branch of USDA Rural
Development in Washington, D.C.
In cases where the business has outside
investors, it is those investors who get
paid first, he notes. “Farmers get whatever’s
left. That’s why farmers formed
co-ops in the first place [to ensure that
producers come first]!”
Baarda says co-ops on both sides of
the “success spectrum” can wind up as
candidates for conversion. If the business
is unsuccessful, leaders may be
desperately looking for some way to
save the business. If a co-op is successful,
farmers may not be able to capture
the co-op’s value, and can seek another
business form that would allow them
to tap into the value.
“Some successful co-ops, rather
than generating equity to farmers, put
their dollars into unallocated reserves,”
he says. “How does a farmer cash out
their value if they can’t get their hands
on it?”
Hanson points to GoldKist Inc., the
nation’s largest integrated chicken
company, as an example of a traditional
co-op that converted so that members
could access enterprise value growth
and public market liquidity. After the
conversion, he says, the 2,300 former
farmer-members converted $360 million
of patronage equities to stock, plus
added cash and stock of $140 million.
GoldKist issued publicly traded stock
as part of the conversion, and farmerheld
stock will be publicly tradable as
well after a holding period.
E.G. Nadeau expresses disappointment
in co-op conversions, including all
the examples cited above. “But I understand
some of the motivations,” says
Nadeau. “Some co-ops have converted
for the wrong reasons: based more on
financial benefits to management and
board members than on benefits to
members,” he says. He notes that some
former members of Minnesota Corn
Processors are suing the former manager,
alleging that he “walked away with
more than $1 million as a result of his
support for the merger.”
In its Nov. 7 issue, the Chicago
Tribune ran a detailed account of how
MCP’s then-CEO began secretly
meeting with its chief rival — Archer
Daniel Midland Co. — to lay the
groundwork for the sale of the co-op
to ADM, and that he agreed at these
meetings to try to convince farmers to
accept a lower price than most thought
the co-op was worth, while focusing on
how much he would receive from
ADM. “The case has fed long-standing
resentments among independentminded
farmers against the consolidation
of agriculture into the hands of a
few global titans, such as ADM,” the
article says. [Editor’s note: this was an
outright acquisition, not a co-op conversion,
but many of the same issues
arise in each type of transaction.]
Nadeau likes new co-op laws passed
in Minnesota and similar laws being
developed in other states that allow for
non-member investors but preserve
majority member control. These laws
apply to the formation of new cooperatives
and do not affect existing co-ops.
They require that patrons retain at
least 50 percent of decision-making
power.
“These laws retain the important
co-op provision of democratic member
control,” Nadeau says. “Attempts to
form co-op-like entities, such as Ccorporations
or LLCs, don’t share this
basic statutory protection and thus can
more easily be converted to investorcontrolled
businesses.”
Not a black & white issue
Terry Barr, an agricultural economist
with the National Council of
Farmer Cooperatives (NCFC) in
Washington, D.C., thinks critics
should avoid viewing co-op conversions
as a black or white issue, considering
the complex challenges facing
farmer co-ops.
“NCFC supports all farmer-owned
organizations that seek to enhance
farmer returns,” says Barr. “We should
worry less about what we call the form,
and more about whether members
understand the implications of the
change and whether it truly serves the
interest of the farmers in both the
short and the long term.”
Other business forms continue to
change as well, he says. “The corporate
business form arose in the early
1800s because of the lack of venture
capital,” he says. “Today, there is no
shortage [of venture capital], and
there’s an active equity market. At the
same time, the cost of regulatory burdens,
spurred by corporate scandals
such as Enron, have increased dramatically.
In this environment, many corporations
are evaluating conversion.”
Barr adds that most traditional ag
co-ops already modified their structures
or capital plans to deal with a
changing global marketplace. “Many
farmer-owned co-ops are building relationships
with companies throughout
the food chain,” he says. “Most are
involved in joint ventures. Most have
subsidiary LLCs. None are the same.”
Barr agrees with co-op attorney
Hanson that the changing structure of
food and agriculture presents a transitional
challenge for most co-ops.
“When co-ops were formed, the idea
was that current patrons would replace
the capital of prior patrons,” Hanson
says. “But co-ops have fewer patrons
today. Without outside capital, that
points to a train wreck in the future.”
Study: co-op conversions rarely member-driven
According to a study commissioned by the National
Cooperative Business Association, co-op conversions
are rarely driven by members or by perceived benefits
to members. Rather, conversion is more often driven
“by co-op staff, leadership or outside consultants”
who stand to gain from a switch, according to the
report, Strengthening Cooperative Business Structures:
Lessons Learned from Demutualization and
Cooperative Conversions.
Cooperatives that have high voting thresholds, that
engage their members in their activities, and that stay
connected to the community are less likely to fall prey
to even the most aggressive conversion tactics, the
study says. The report, issued last year, was commissioned
by a coalition of organizations including the Consumer
Federation of America, Credit Union National
Association, CUNA Mutual Group, National Cooperative
Bank, National Cooperative Business Association, and
the National Rural Electric Cooperative Association.
It was co-authored by E.G. Nadeau, a director with
Cooperative Development Services in Madison, Wis.,
and Rod Nilsestuen, long-time president of the Wisconsin
Federation of Cooperatives and now Wisconsin
Secretary of Agriculture, Trade and Consumer Protection.
“The best way to avoid demutualization is to have
active members engaged in the cooperative who recognize
the role of the co-op in their economic wellbeing,”
says NCBA President Paul Hazen.
Even though conversions are relatively rare, the
report said they merit attention because of their impact
on their consumer-members. “The economic disadvantages
of co-op conversion for consumer-members are
obvious,” it says. “When the business is motivated by
profit, rather than by member service, most members
will pay more for the services or products they buy.” To
slow the conversion trend, the study recommends a
cross-sector campaign to communicate the benefits of
member-owned businesses and state and federal legislative
or regulatory changes to prevent co-op leaderships
from gaining financially from conversions.
The study says rural electric cooperatives and retail
food co-ops have a near total immunity to conversion,
while mutual insurance companies, particularly those
that offer life insurance, have the highest susceptibility
to conversion. Credit unions and housing cooperatives,
constrained by outdated laws and regulations from
dealing with increasing economic pressures, are
becoming conversion targets more often, the study
added.
Among the study’s sector-specific findings was that
lack of liquidity, financial difficulties and financial
incentives to management and directors have fed the
pressure on farmer-owned co-ops to convert. Members
of a converting farm co-op may enjoy short-term financial
gains, but they face longer term losses as they lose
control over the price they are paid for their products.
As a result, the market imbalance that led to creation of
the cooperative in the first place may reemerge.
Strengthening Cooperative Business Structures:
Lessons Learned from Demutualization and Cooperative
Conversions is available from NCBA, 1401 New
York Ave., NW, Suite 1100, Washington, DC 20005. Contact
Art Jaeger, (202) 383-5462 for more information.
