Legal Requirements for Selling Common Shares in Cooperatives

Groups interested in forming a cooperative that is structured as a for-profit corporation often have questions about how shares are issued, who can purchase shares, and whether non-members can purchase shares as an investment in the cooperative.  In this second post of the series, we discuss the requirements for selling shares.

New cooperatives are typically eager to begin selling common shares to members for several reasons, including growing their membership and raising capital for the cooperative.   While requirements for selling common shares are typically easier for cooperatives than for typical for-profit corporations, it is still important to understand what these requirements are since some cooperatives may still need to meet them.

A typical for-profit corporation must meet federal and state securities requirements to issue shares, with the extent of such requirements depending on factors such as the amount of capital the corporation wishes to raise and the location and status of the shareholders.  Requirements range in difficulty from a public offering of securities by a publicly traded company to a simple notice filing by a small corporation.  Determining whether and how the federal and state security requirements apply requires assistance from someone with securities expertise, and meeting those requirements can be time consuming and expensive.

Cooperatives typically have an easier path to issuing shares.  Although no federal statute plainly states that shares issued by a cooperative are not required to meet federal securities requirements, the U.S. Securities and Exchange Commission (SEC) has issued guidance over the years indicating that common shares issued by a cooperative are not “securities” if the cooperative imposes certain restrictions on those shares.  The purpose of these restrictions is to make sure that common shares have the sole purpose of signifying ownership in the cooperative and do not have the features of an investment.

These restrictions are included in the cooperative’s bylaws, which will provide that common shares do not pay dividends, can be transferred from a member to someone else only with board approval, and give a member only one vote regardless of the number of shares owned.

In addition to federal securities requirements, there are state securities requirements, which are often referred to as “blue sky laws.”  Blue sky laws regulate the offering and sale of securities in a state, and these laws vary from state to state.  Fortunately, almost all blue sky laws include exemptions for cooperatives.  However, cooperatives who may have members in multiple states must ensure that their offer and sale of shares meet the applicable exemptions in each state.

Federal and state securities requirements are complex, so we recommend that any cooperative obtain legal advice before beginning its membership drive and offering shares for sale.  A properly drafted set of bylaws and an understanding of how common shares work can save the cooperative and its members from future headaches and expense.