“I’ve got a great idea…”
“I’ve got a great idea/business concept that I think would be best manifested as a co-op and I need advice on how to design it”.
This is the gist of more than 10 inbound emails we receive each month. Saying nothing of the quality of the concept and business model, we see a wide spectrum of functional understanding of legal entity models, particularly cooperatives. In this post, I want to unpack why that is, and what founders should do to prepare to speak with a lawyer for real-time advice on the ownership/entity/business design that will eventually be formed under the laws of a particular jurisdiction.
The overwhelming body of literature, start-up advice, entrepreneurship eco-system, and venture capital market is designed around the Delaware (and now, just about any other state) C-Corp, colloquially. This means a general business corporation formed under Title 8 of the Delaware Code, which is or will be taxed under the Internal Revenue Code as a “C-Corp”, or subject to double taxation. The reasons for this vastly simplified and over-normalized default are myriad: from Milton Friedman’s now infamous 1970 NYTimes Article, to the Qualified Small Business Stock gain exclusion (which has been accelerant for venture capital), to our over-emphasis on form standardization (read: over-reliance on NVCA model documents, to the (amazing) call-out that traditional start-up culture is an extension (pun intended) of the patriarchy.
This amounts to a dominant norm of perceived simplicity, capital access, optionality, scale pathways, and agility. What the proponents of this model don’t say out loud is that falling back on the default is in fact a choice to rely on liquidity-oriented capital, growth-oriented equity incentives, centralized control, a high-permission operating system, and runway to an enterprise liquidity event. This makes #exittocommunity all but impossible.
If you want to design for different outcomes, around different stakeholders, for different values and principles, and to embody a different ethos, there is a dearth of resources, literature, and trodden protocols to mimic the comparative simplicity of the Delaware C-Corp. There are a few capital providers, yes. There is a co-op focused accelerator, yes.
Now, how will you know you’re ready to speak to an attorney and optimize your time, resources, and energy on a viable legal structure? Here are a few criteria:
1. You have a written business plan. Not just a “pitch deck,” but a fully fleshed narrative summary of the material elements of the business strategy, personal and financial goals, structure, its values, principles, addressable market, key competition, and a summary of your cracker-jack team.
2. You are dedicating more than half of your work time to the business concept. Nights and weekends, or hobby start-ups are perfectly fine, but in our experience, you and your team need to devote more energy than that to building not only a viable product/service-based business, but a community around it that is willing to invest and contribute (either as a co-op or crowd-funded endeavor).
3. You have iterated through at least three (3) versions of your “Ownership, Stakeholder, Governance, Capital” diagram. And, you can explain succinctly the basis and reasons for each revision.
4. You can clearly map the short, medium, and long-term goals, scale, and functional lay-out of the business concept, with milestones.
5. If you are a technology-focused start-up, you can succinctly describe the product, revenue model to actual positive cash flow and profitability (not endless growth and liquidity, which is fine, just not a good fit for a co-op).
a. You can also describe why the chosen entity should own the technology and/or related trademark intellectual property. If you are leaning to a multi-entity design, you should be able to explain which entity will own the tech and related IP and why.
b. You should be able to explain the functional relationship (process flow, $ trail, and maybe even basic terms) between the holder of the platform tech, IP, and the community-contributed data.
6. If a cooperative is central to or even a part-of your concept, you should have an understanding and can clearly define the following aspects:
a. Who will be the members;
b. Qualifications of membership;
c. Characteristics of members;
d. How many classes of membership will there be? You will have already consolidated this list to the minimum viable degree of design complexity.
e. How will “patronage” (yes, we’ll assume you know what that means) be calculated for each membership class? Conceptually at this point, even you don’t know the units of computation.
f. You can clearly define revenue streams, which at least materially and substantially derive from or relate to member patronage.
g. You have a model for or can explain the projected expenses of the co-op.
h. You can estimate annual profit/surplus pool for at least 2–3 years out.
i. You have a general sense of how much of such profit/surplus will need to be retained/reinvested/reserved.
j. You have a working understanding of how the patron-source net margins will be divided between membership classes and have an idea of the % allocation of patron-source net margins.
k. You have read up on the differences with Sub-chapter T and partnership tax systems within cooperatives.
7. You have a written summary of not only why you want to design a cooperative, but how it would viably function according to the elements described above.
8. You can explain at a basic level an example or two of how contributors, members, or other stakeholders will flow through or work with the business design, including tracing how $ will flow through and will be allocated and distributed.
While this may sound daunting, it is important that you take ownership of these decisions. We are here to give professional advice. Each and every concept is different and warrants tailored advice and feedback. There is no one-size-fits-all legal structure for a start-up, particularly when principles of democracy, community, Equity, and justice are involved.
— Jason
Psst!! Here at JWPC, we have developed a guided program to enable founders and organizing teams to self and co-design a “validated” legal business structure. Our CELD (Community Enterprise Legal Design) course is free of charge and available on our website.
