Schedule Management and Evolution of Equity Management Programs - PowerPoint PPT Presentation

Introduction to Balance Sheet Schedule Management and Evolution of Equity Management Programs • Morning Session CHS Insight Meeting – CHS Management Report – Introduction to Balance Sheet Management Michael Boland Koller Professor of Agribusiness Management • Lunch Director of The University of Minnesota Food Industry Center • Afternoon Session E. Fred Koller endowed Chairholder in Agribusiness Management (funded by CHS, Land O’Lakes, Agribank, CoBank, Country – Evolution of Equity Management Programs Insurance and Financial Services, Koller Family, University of – CHS Director Report Minnesota Foundation, and friends) Session 1 Outline What are your issues? • Understanding of cooperative business model • Let’s lay out the issues and questions you have on these two topics to begin with. • Income distribution decision and board responsibilities • Board responsibility on balance sheet • Board responsibility for equity management • Group Exercise

Links to Cooperative Business Model and Some Key Board Responsibilities Proportionality Concept • Customers • Governing body for cooperative – Desire a transaction that leads to increased farm profits as • Recruitment, hiring, evaluation, co ‐ op is vertical integration of farming operation compensation, and retention of CEO / General • Patron – Desire distribution of residual income in proportion to Manager patronage • Decision of how much equity is on balance • Member – Desire to control the cooperative through its governance sheet • Owner – What to do with any “residual” cash or income – Desire for ownership, investment and redemption in proportion to patronage Relationship of Income Decision and Definitions Balance Sheet in a Cooperative Balance Sheet Category Source of income • Patronage – Patronage income arises from business done by members Cash Patronage Refunds Refunds – Non ‐ patronage income arises from non ‐ member business Qualified (revolving) Retained Type of equity • Allocated Patronage Refunds – Allocated income is subject to redemption by the board Non ‐ qualified Patronage ‐ sourced – Unallocated income is retained by the co ‐ op and not redeemable Taxability of equity Unallocated Not qualified • Net Income – Qualified Retained Allocated Not qualified • Excluded from co ‐ op’s taxable income Earnings • 20% must be paid in cash Nonpatronage (Permanent) – Non ‐ qualified Unallocated Not qualified • Excluded from member’s taxable income • No minimum requirement for cash payment Qualified distribution means patron pays all taxes on cash and non ‐ cash in distribution year. (Cobia textbook) • Non ‐ qualified distribution means the patron pays taxes only when cash is received. Allocated equity retains patron name on the equity.

Cooperative Generates Income Cooperative Generates Income from Operations from Operations • Board decision ‐ making with regard to risk exposure. • Once that decision is made, board must decide how – What decisions has the board made in its strategic thinking much income must be retained to meet target for process? equity. This income is typically placed in current o What does the industry analysis suggest for risk assets account. exposure? • Any “residual” income above that needed to meet o What does the firm analysis suggest for risk exposure? desired equity target can be used to o How much equity does board desire on balance sheet? o What type of equity? (member or non ‐ member, • Finance purchase of additional assets to generate allocated to the member or unallocated as future income retained earnings) • Redeem equity o Note that the taxability issue is a decision to be made later o What is appropriate equity ‐ to ‐ assets ratio? (capital structure) Key Board Decision: Solvency, as measured by adjusted equity to assets (total equity divided by (total assets minus current liabilities)) varies widely Appropriate Equity ‐ to ‐ Asset Ratio from state to state and co ‐ op to co ‐ op in 2008. • Dictated by need to maintain lender covenants WI SD • Board strategic thought process and assessment OH of risk. An annual board retreat is often used to NE generate this information. This information feeds ND MO into the business plan required annually by most MN lenders. MI – Future farm policy? KS IN – Volatility in prices and implications for risk IL management strategies used by cooperative? IA – Other factors CO 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Eversull, E. “Cooperative Equity Redemption.” Rural ‐ Business Cooperative Programs Research Report 220, June 2010

Key Board Decision: Evolution of Equity Management Decision to Acquire Additional Assets Philosophy Over Time • What is the purpose of additional assets? • Brookings Institute Report (late 1940s, Koller) – Generate future income – Co ‐ ops operating ‘at cost’ also unable to redeem equity (member unrest) – Meet members service and product needs • What is your mission statement? • Land grant university research (early 1960s) – Reduce costs – Lack of consistent profitability (governance issues) • Acquire new technology or process • GAO Report (1979) and USDA Report • Acquire market share to deepen footprint or add geography • This decision is predicated by board preference for – Inability to redeem equity (governance issues) • Merger studies, equity management and lack of – Greater debt on balance sheet • Seeing leverage among some larger co ‐ ops right now performance (late 1980s and 1990s) – Greater equity on balance sheet by financing with – Mergers are not always the solution and equity must be • Working capital valued at market rates rather than 1:1 to ensure success • Ask members to invest directly (Parliament, Barton). • Partner with another entity to acquire asset and share income/risk – Co ‐ op life cycle must be known (Barton) Evolution of Equity Management What have we learned about equity Philosophy Over Time management over time? • Key Board Decision: Cooperative must be profitable. • Regional co ‐ op bankruptcies and other write ‐ downs (early 2000s) – Mission statements • Key Board Decision: Pool all income from all sources – Many co ‐ ops unwilling to write down individual member because strategy and assets reflect risk tolerance and equity accounts which suggests what about how those income diversity. boards view allocated equity? – Non ‐ member business is different • Section 1099 Issue • Key Board Decision: Co ‐ op should adhere to • Why are more boards considering changes in equity cooperative principles management programs now? – High degree of allocated equity – Why is there a need for unallocated or permanent equity? – If unallocated retained earnings are used, communicate – How is this linked to working capital? why that method is being employed to members – Users of co ‐ op should have greater investment – How do we look at equity structure? • Need to operate the business day ‐ to ‐ day? • Thinking about takeover or dissolution?

What have we learned about equity Equity structure, measured by retained earnings to total equity, varies widely from state to state and co ‐ op to co ‐ op in 2008. management over time? • Key Board Decision: Think about WI communication with members and alignment SD OH with members NE – Need and desire for allocated equity ND MO • Users should be invested in co ‐ op MN • Younger producers must understand their MI responsibilities as well KS – Discuss why members pay cash on non ‐ cash IN patronage (qualified) IL IA – Consider having member pay tax on patronage CO paid in cash (nonqualified) 0% 20% 40% 60% 80% 100% Eversull, E. “Cooperative Equity Redemption.” Rural ‐ Business Cooperative Programs Research Report 220, June 2010 Key Board Decision: Exercise Decision to Redeem Equity Patronage income allocation and distribution • Here are the four perspectives of the – High customer ‐ patron ownership (allocated) or high retained earnings (unallocated). cooperative business model and the member – Allocated implies (to members) some expectation of future repayment while unallocated as retained earnings implies no expectation of self interest. How does the board manage these repayment. Taxes and Patronage refund four perspectives? • – Qualified or nonqualified Qualified cash patronage refund rate • – Low rates (below producer marginal tax rate) have been common in past in Customer (lowest price, highest level of service) certain regions but are not desirable. Patron (high cash patronage) – High rates reduce member investment in cooperative over time. Nonqualified cash patronage percentage rate • Owner (rapid redemption of equity) – Low rates are likely to be more common since co ‐ op incurs the tax liability. Member (high level of influence) – High rates reduce member investment in cooperative over time.