As for share capital, investor motivation in debt securities will be biased in favour of a project that is seen as having value to the community. As in any crowdfunding campaign, the interest of the community must be piqued. The attractiveness of any offer of debentures or CCUs will be measured against the thoroughness and clarity of any disclosure and the robustness or veracity of any financial projections.
Investors will commit when they are both interested and satisfied as to the risk. If the risk is high, they will commit less, if the risk is low they may invest more.
To date, co-operatives in Australia have not utilized this fundraising power to any great extent. There is little research to indicate why this method is not well used.
The power to issue debt securities is not limited by any investment cap (either per member or in total). The board of a co-operative is required to manage the co-operative’s affairs according to standard corporate duties of care and diligence. They may also bear liability if the co-operative operates in circumstances where it may become insolvent. These duties dictate prudence in the decision to issue debentures.
The Registrar does have a power to make directions regarding the obtaining of ‘financial accommodation’ under s335 CNL. The Registrar’s power is very broad and extends not only to a power to direct that a co-operative cease obtaining finance in a particular manner, but may also require repayment of any funding received and a direction about how the funding is to be used by the co-operative. The ‘safety net’ of Registrar oversight on fundraising has been rarely, if ever, used in practice. This may be because of the role of the Registrar in approving disclosure statements prior to any offer of debentures or CCUs.
There is no information available to indicate the circumstances when a Registrar might exercise his or her power nor any policy guidelines as to its use. It would be prudent for a co-operative seeking to raise funds from its members via a debenture issue to be aware of the existence of the Registrar’s oversight of these matters. It is imperative that boards do not abuse the fundraising power by issuing debt securities that would compromise the stability and sustainability of the co-operative.
In the context of community investment, issuing debentures to members and employees is a good way for either distributing or non-distributing co-operatives to raise funds to pursue their objectives. Providing a door to investment to members will have the added impact of increasing member engagement with the co-operative. Members will quickly develop a stronger interest in their co-operative when there is an investment risk even if it is for a small amount. Similarly, employees will have a strong commitment to a work ethic when they also have an investment in the co-operative.
It is expected that the level of funding required for a community based enterprise would be relatively small. A modest fundraising target will mean that the co-operative can appeal to a membership by asking for investments in small units. In the theme of crowdfunding campaigns, a large number of small ‘investments’ will amount to a large overall amount of funding.
Of course, a co-operative with a large membership will achieve a better fundraising outcome than a co-operative with smaller member numbers. This raises the question of whether a co-operative should seek to increase its membership or whether it should seek to raise funds from beyond its membership.
Increasing membership of a co-operative depends upon the purpose of the co-operative and its active membership requirements. A co-operative with an objective to provide community services and a simple active membership requirement of paying a nominal annual fee may consider promoting its services to increase membership before it seeks to raise funds through a debenture issue.
By contrast, a co-operative that is formed to provide a narrow set of objectives, such as marketing services for blueberry growers in a particular location, may find it difficult to increase its membership significantly.
It is important therefore, to consider the membership profile of a co-operative and any scope for increase in membership when determining whether to use a debenture issue to members and employees.
A co-operative that seeks capital to fund growth may do so by increasing promotion of its membership offers in tandem with a debenture or CCU offer, provided that the offer is clearly restricted to members only.
Investments by communities who want to retain or build services within their community will be attractive to community members who have never considered investing in securities. Having a ‘share portfolio’ is often considered to be for wealthy or retired people with advice from a stockbroker. The size and remoteness of enterprises run by larger public companies is a disincentive for small or inexperienced investors. Despite this attitude, small or regional communities have strong social and support networks. There is potential to encourage a willingness to become a member of and lend to an enterprise that is owned and governed by a community of members when that investment will secure its ongoing operation and sustainability as a community service provider.
There are different processes for the issue of debentures and CCUs.
The cost of issuing debentures or CCUs to members and employees is comparatively small. Preparation and drafting the disclosure statement may require professional input, however, it may well be within the skillset and capability of the co-operative’s board to be able to prepare it without specialist or professional costs.
Regulatory lodgement fees are modest, although the approval process can take approximately 28 days. This time frame, including any additional requirements from the Registrar, should be factored into the co-operative’s business and fundraising plans.
Process and disclosure for debenture offers to members
The following Flowchart shows the procedure for an offer of debentures to members. The same process applies to all co-operative types.
Disclosure for debenture offers to members
- Information about the purpose for raising the funds;
- the rights and liabilities attaching to the debentures (terms of issue);
- the financial position of the co-operative;
- any interest that the directors or officers of the co-operative might have in the issue including any compensation they may receive in respect of the issue63;
- other matters directed by the Registrar.
A co-operative wishing to issue debt securities will be an existing entity. It is usual in any lending situation that the lender will require evidence of the borrower’s capacity to repay. For a co-operative to issue debt securities, it is important that it is able to provide reliable information in its disclosure statement about its ability to repay capital under the terms of the security and to service any interest payments. Just as a lender would require evidence of this, the co-operative should be prepared to provide this information to potential investors.
Conversely, the disclosure statement should include information about the risks in investing in the securities offered.
Where the risk is high, the co-operative may need to consider whether to secure the debentures against specific assets of the co-operative. Issuing secured debentures can provide a greater level of comfort for investors, but will necessarily involve the preparation and lodgement of security documents under the Personal Property Securities Act, and may possibly require the appointment of a trustee for debenture holders64.
An example of a disclosure statement for the issue of debentures to members is included in Part 5 of this Handbook.
Where the debenture issue seeks to raise a substantial sum, the Registrar may require that the disclosure statement contains expert opinion regarding the basis for any forecasts or statements about the viability of the enterprise to be funded.
Once the disclosure statement is approved, then it is usually valid for a period of six months. The co-operative needs to set up administrative processes for receiving any investments and issuing any certification of the debentures. Investment monies received by the co-operative are generally held in trust until the debenture security is issued. Thereafter the cost of servicing the debenture issue is minimal other than the cost of making any interest payments and maintaining statutory records of debenture holders.
Because debentures are a form of debt, the co-operative will be able to deduct the costs of issue and interest payable from its taxable income.
Process and disclosure for issuing CCUs to members
CCUs issued by a co-operative are a different class of security from debentures or shares. They are described at 3.7.2 of this Handbook.
Depending on how the CCUs are structured as to priority or interest payment and perhaps whether they can be converted to shares or other securities, they may appear to have characteristics of equity or debt.
When considering whether to issue CCUs, co-operatives should look at how the structure of these securities might be of value to the entity’s balance sheet if they bear equity characteristics and whether the issue of this special hybrid security can be marketed in a similar way to equity. In other words, if it can look and behave like share or risk capital, it may satisfy the community investor’s desire for ‘ownership’ of the enterprise, whilst not providing a vote.
The following Flowchart shows the procedure for a CCU issue to members, for all co-operative types.
The regulatory process for issuing CCUs requires more steps than a debenture offer. This is because they are part of the capital of the co-operative and they are capable of being quoted on the ASX. The CNL provides that
- The Registrar must separately approve the terms of issue for CCUs, and a statement that sets out the terms of issue, rights of CCU holders, redemption terms and how they may be transferred,
- The members of the co-operative must approve the issue by special resolution,65 and
- The same disclosure statement as though the issue was a debenture issue.66
The terms of issue must include:
- details of entitlement to repayment of capital;
- details of entitlement to participate in surplus assets and profits;
- details of entitlement to interest on capital (whether cumulative or non-cumulative interest);
- details of how capital and interest on capital are to rank for priority of payment on a winding up;
- whether there is a limit on the total holding of CCUs that may be acquired by persons who are not members of the co-operative and, if there is a limit, what the limit is;
- the terms upon which they can be redeemed, and
- the manner in which they can be transferred.
The restrictions on how a co-operative may redeem CCUs, puts these securities in a position akin to share capital as they are not able to be redeemed except out of profits or a fresh issue of shares or CCUs. It is possible to place a clear restriction on their redemption through repayment by allowing the board of the co-operative a complete discretion to repay.
As CCUs can be traded on a stock exchange (see 3.7.2) they have free transferability and may be structured to look like permanent risk capital. Still relatively new securities, CCUs may require further research and testing for a community investment issue67.
The cost of any approval of the terms of issue for CCUs is modest. The criteria for approval of terms of issue in s350(4) CNL is expressed as a “bottom line” test that ensures at least that the CCUs comply with the co-operative principles and they are not contrary to the co-operative’s rules. There is no other guidance material published on what criteria the Registrar will adopt in this process.
The second step in a CCU issue is to seek approval for the issue from the members of the co-operative by a special resolution. Special resolutions require a majority vote of two thirds of members and a general meeting or using a postal ballot process.
This additional step is required because CCUs as hybrid capital, arguably, have rights to the capital or surplus and this will have an impact on the rights of shareholders if the co-operative is wound up.
By contrast, the decision to issue debentures, is a decision that can legitimately be made by the co-operative board without referral to the membership.
The disclosure statement for a CCU issue to members must cover the same ground as a disclosure statement for debentures. The disclosure statement is also subject to approval by the Registrar prior to issue. The terms of issue and disclosure material can be combined in the one document.