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4.7: Equity Redemption Program Choice Has Implications for the Balance Sheet

  • Page ID
    8775
  • Patronage refunds retained by a board of directors may be redeemed in the future if the board decides it no longer needs that equity. Allocated equity is created through retention of patronage refunds, while redemption of retained patronage refunds can be thought of as destroying allocated equity. This has implications for a cooperative’s balance sheet.

    There are two situations in which a board must have a policy to handle retained patronage refunds. The first is when a member stops being a member. Cooperatives universally operate on the philosophy that if a member stops being a member, any equity that member has in the form of retained patronage refunds should be redeemed. In general, consumers are no longer members of a cooperative if they move geographically from the community or some period of time elapses in which they no longer patronize the cooperative. Farmers are no longer members of an agricultural cooperative if they retire or exit their farming operation. Obviously, consumers and farmers are no longer members when they die. The second situation is a determination of much equity is needed by the cooperative. If a cooperative continues to create allocated equity each year by retaining patronage refunds, the cooperative may have excess allocated equity that may not be needed for asset investment or replacement of existing assets.

    Boards of directors have set up various practices to handle these situations. First, a board must determine whether it has the ability to redeem this allocated equity without disrupting its existing loan covenants or asset expenditures. If a member dies, the board of directors typically redeems the allocated equity, which is that member’s retained patronage refund. This might be done monthly or annually. For a member who is alive but no longer a member, the board creates a policy to redeem that equity. A common policy is to redeem a portion of the allocated equity over a period of time, which could be four or five years in the future.

    The second situation is where the board considers redeeming retained patronage refunds for a member who is still an active member. Once the board makes the determination that it does not need additional equity, boards must create a policy to handle this situation. The universal practice is to redeem the allocated equity based on the birth year of the patronage refund, with the oldest equity being redeemed first. This practice is fair since there is no dividend being paid on the allocated equity which was created when the patronage refund was retained. There is no trigger to redeem the equity, but in practice, many boards of directors try to manage member expectations by redeeming the retained patronage refunds in a timely manner with a pattern of behavior. For cooperatives that operate on a pooling basis where the deduction of a per capita retain is analogous to the retained patronage refund, these deductions may be significant, and the board seeks to have a rapid redemption period in perhaps five to ten years. In cooperatives where the retained patronage refund may not be as high, a redemption period may be longer. For example, a member of an electrical utility cooperative may have a redemption period of decades, since the member uses electricity for the span of their lifetime. In general, however, boards of directors try to redeem these retained patronage refunds as quickly as possible without compromising the balance sheet.