Agribusiness co-operatives – time to shine?

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A consistent stream of Murray Goulburn news, some scrutinising its hybridised co-operative model, combined with several prominent Australian agri co-operatives considering structural or governance changes, and a Federal Government showing some intent to promote the benefits of collective business models (including co-operatives), has brought the co-operative model into focus.

There is little doubt that co-operatives have the potential to offer some real benefits to a variety of agricultural enterprises, and if the government support originally flagged in the Agricultural Competitiveness White Paper becomes more tangible then it may be that co-operatives are set for a resurgence.

But the co-operative model does face some challenges, including a lack of broad-based understanding of what the structure offers, how co-operatives operate and how they are regulated.

What is a co-operative?

A co-operative is, in many respects, analogous to a company, being an incorporated body with an independent legal identity and conferring on its members the benefit of limited liability.

What distinguishes the agri co-operative is that it is a values-based organisation, predominantly (if not exclusively) used by its members (ie. members are customers).

Co-operatives are governed by State and Territory statutes and are generally not subject to the Corporations Act 2001 (Cth) (though some Corporations Act provisions will still apply).

Since 2014, to encourage consistency and reduce compliance costs for small co-operatives and those operating interstate, many State and Territory governments have introduced uniform laws regulating co-operatives. The Co-operatives National Law now applies in all jurisdictions apart from Western Australia (which as of 1 January 2017 has a consistent State Act) and Queensland (which is yet to adopt consistent legislation). Nevertheless, the essential characteristics of co-operatives under these regimes are consistent.

Key distinguishing features of co-operatives

The following are the distinguishing features of an Australian co-operative:

Democratic control:

  1. Equal voting rights – Members generally have equal voting rights ("1 member, 1 vote"), regardless of capital contribution or use of the co-operative (ie. greater shareholding does not equate to greater influence or control).
  2. Shareholding and membership limits –A co-operative must generally have at least 5 active members and no member can hold greater than 20% of the shares on issue.

Active membership and management: Co-operatives are owned and controlled by members who have a direct interest and involvement.

  1. Active membership – All members must be "active members" that participate in the co-operative's "primary activities" as specified in the co-operative's Rules. For example, farmers that sell their product to a processing or marketing co-operative.
  2. Representative governance – The majority of the board of directors must be or represent active members. For agri co-operatives, this generally means the board is controlled by farmers or suppliers with industry- and co-operative-specific experience, often with a minority of external or independent directors bringing special experience or skills.

Restricted activities and fundraising:

  1. Restrictions on fundraising – Co-operatives can generally only fundraise from active members or by debentures or subordinated debt. However, "co-operative capital units" (a creature of co-operative statute that can be held by members or non-members) can have debt or equity like characteristics without membership rights and provide some flexibility for fundraising by co-operatives.

    This means there are no non-member equity investors in a traditional co-operative. Equity funds are generally contributed by members for service or trading benefits, rather than with a view to a capital gain.
  2. Types of co-operative – Co-operatives are typically characterised as distributing or non-distributing co-operatives.
    1. Distributing co-operatives, the more common structure in agribusiness, issue shares and have Rules that allow distributions of surpluses and capital to members.
    2. Non-distributing co-operatives need not have share capital and their Rules prohibit distributions of income. Surpluses are reinvested in operations, equipment or infrastructure, or otherwise returned to users by way of rebate, and capital can be raised through regular member subscriptions.

A broader perspective:

Co-operatives are not motivated by financial performance and returns (at least not exclusively), but rather by member benefits and other broader, community-orientated objectives. This is reflected in several of the co-operative principles (enshrined in the co-operatives legislation) emphasising education and training for members, co-operation between co-operatives, and concern for the community. These matters are part of the DNA of a co-operative, as opposed to a corporate where such principles or values are sometimes adopted because it is "good for business" rather than more altruistic reasons.

It is worthwhile bearing in mind that co-operative principles can be enshrined in the constitution of a Corporations Act company, allowing the entity to behave in a co-operative manner while benefitting from the flexibility afforded by the Corporations Act in some areas. Murray Goulburn is an example of such an entity – a Corporations Act company operating under co-operative principles.

What do these differences mean for co-operatives?

In agribusiness, co-operatives are often used as processing and marketing entities, allowing farmer members to engage in the supply chain beyond the farm gate.

Their advantages include:

  1. Increased market position and influence – An individual farmer has limited bargaining power to negotiate farm gate prices with large domestic and multinational buyers. Co-operatives provide farmers with scale and therefore marketing power, and also economies of scale through collective purchasing, processing and distribution.
  2. Savings to members –Greater market presence, and the aim of providing member benefits rather than profit maximisation, means co-operatives can price more aggressively. Co-operatives set farm gate prices (and make distributions) to cover costs, passing savings onto members.
  3. Shortened and controlled supply chain – A co-operative's operations can reach further up the supply chain than an individual farmer's. Having a hand in these processes can allow farmers to integrate the marketing or processing stages into their business, saving transaction and other intermediation costs.

While a corporate model can create similar efficiencies, co-operatives also allow farmers to retain independence and ownership of their businesses. The democratic features of co-operative governance (ie "1 member, 1 vote") make it easier for members to prevent a small number of powerful shareholders taking control and re-directing operations.

Western Australian grain-handling co-operative CBH Group's 2016 rejection of an unsolicited privatisation bid is a good example of this protection in action. A GrainCorp-backed consortium proposed converting CBH into an ASX listed company. Supported by its members, CBH Group rejected the proposal, citing the desire to retain grower control of the supply chain, avoid ceding power to an industry competitor, and preserve value for members.

The co-operative structure can also have certain disadvantages, including:

  1. Growth and capital raising –Co-operatives have historically found it harder to attract investment than companies. Active membership requirements restrict trade in securities and democratic voting mechanisms tend to deter large investments.

    The capital raising challenge has given rise to innovative mixed co-operative / investment structures (or, in some cases, to outright corporatisations) for some agribusiness co-operatives, although as has been demonstrated by the Murray Goulburn example, the tension between co-operative and outside investor interests can sometimes be challenging.
  2. Market co-ordination issues – Farmers make supply decisions based on expected farm gate prices and distributions, which in turn will depend on other farmers' levels of supply to the co-operative. There is therefore a risk of farmers committing to supply against market trends, leading to low distributions and price drops. Proper management guidance on pricing serves to alleviate this risk.
  3. Structural challenges – Active member restrictions and democratic controls can make it harder to diversify operations in response to market developments, and thereby limit a co-operative's flexibility.

Co-operative structures can give rise to other challenges that companies or other economic structures are not susceptible to. Members may have different horizons (potentially shorter than the investment horizon for the asset that the co-operative is growing), and may have different expectations of the co-operative, given that value is not delivered in a purely empirical or financial manner. Shareholders in companies, which tend to have more homogenous expectations for their investments and more definitive economic and property rights attached to their shares, are capable of solving for these "horizon" and "portfolio" challenges more readily.

KWM has advised several prominent co-operatives across Australia, including Ricegrowers, CBH and Namoi Cotton, on a range of structure and governance issues.

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