Segregating Local Equity to Reflect Regional Patronage
Phil Kenkel
Bill Fitzwater Cooperative Chair
Last week I discussed an innovative use of non-qualified stock as semi-permanent capital. Another innovative use of non-qualified stock involves regional investment. The non-cash (stock) patronage issued by regional cooperatives creates equity management issues for local cooperatives. In order to avoid taxes on the regional cooperative the local cooperative must pass the total regional income on to their members. This can create an immediate cash flow issue if the local’s cash patronage percentage exceeds the cash percentage of the regional patronage. It also creates an equity management issue since the timing of the regional equity redemption may not match the local cooperative’s system. An obvious case would be when the local cooperative is on an age of patron and the regional cooperative uses an age of stock system. While rare, instances of the write down of total loss of value of regional stock also creates issues for local cooperatives who have, in effect, issued local stock reflecting the original value of the regional stock. (need I mention Farmland Industries?)
A few local cooperatives have experimented with issuing non-qualified stock to their members to reflect the member’s share of the regional stock patronage. Since non-qualified stock is not deductible until it is redeemed this does create taxable income for the local cooperative. The advantage is that the redemption timing of non-qualified can be linked to the redemption of the regional equity. Perhaps one rationale for the use of non-qualified is that the members should not be over concerned with the redemption timing since they do not incur any tax liability until it is redeemed.
Many cooperative advisors argue that segregating regional patronage is unnecessary and overly complex. If the local cooperative uses balance sheet management to determine their equity redemption budget, the impact of regional redemptions or lack of redemptions can be considered. Most local cooperatives patronage multiple regional cooperatives so a single category reflecting regional patronage does not completely solve the redemption timing issue. The best argument for this use of non-qualified may be that the qualified versus non-qualified decision is not an all or none decision. Local cooperatives and members may find they like a mix of the two choices.