Choosing the Right Legal Entity for Your Business - Exploring Cooperatives (Co-Op)
- Choosing the Right Legal Entity for Your Business - Exploring Cooperatives (Co-Op)
- What Are the Best Types of Businesses to Operate as a Cooperative?
- Who Is Eligible to Operate as a Cooperative in the US?
- How to Register a Cooperative
- What are the Key Advantages of a Cooperative?
- What Are the Key Disadvantages of a Cooperative?
- Partnership vs. Sole Proprietorship vs. LLC vs. Corporation vs. Cooperative
- How is a Cooperative Taxed?
- Pros and Cons of Cooperative Taxation
- How to Convert a Cooperative

Cooperative companies benefit the entire team. In many ways, a co-op business structure differs from other business forms, such as corporations, sole proprietorships, partnerships, and LLCs. Choosing to structure your company as a co-op takes planning and strategy. Before establishing a cooperative company, you must understand its benefits and drawbacks.
According to the National Cooperative Business Association, there are over 40,000 cooperative businesses in the U.S. in various industries, some large and others very small. These businesses include agriculture, education, financial services, grocery, healthcare, housing, insurance, utilities, workers, and purchasing. These co-ops provide over $25 billion in wages and comprise 350 million members.
Cooperative businesses are structured very differently, and the goals are often to benefit members rather than maximize profits. They run on a strict set of guidelines designed by the founding members. There are pros and cons to running a co-op. Further down this page, you can learn about what a cooperative business is, how it works, how they are taxed, and the unique features and benefits of a co-op.
What is a Cooperative?
A cooperative business is owned and democratically controlled by its members. These members are typically the users (customers) or workers who run the business, but they may also be a combination of both users and workers. Every member has an equal say in how things are run. Often, co-ops elect a board of directors to vote on essential aspects or decisions.
The purpose of a co-op is to control prices or provide fair wages and favorable working conditions. Those who benefit from the business also get to say how it is run, how much people will be paid, and how much goods will cost.
Co-ops are run according to a set of principles, including voluntary and open membership, democratic control, member economic participation, autonomy and independence, education and training, cooperation among co-ops, and concern for the community.
Consumer co-ops include grocery stores or housing. Producer co-ops are farms, and multi-stakeholder co-ops involve consumers, workers, and local communities.
Key Features of Cooperative
Regardless of their investment or when they join, each member in a cooperative business is treated equally and has as much say in the business as the next person. Each member has exactly one vote when issues come up. Many of these companies reinvest profits for long-term sustainability. The key features of a cooperative business are:
What Are the Best Types of Businesses to Operate as a Cooperative?

The most effective cooperative businesses often revolve around shared needs and goals among members, such as consumer co-ops, worker co-ops, and producer co-ops. Consumer co-ops can be successful in industries like grocery stores and retail, while worker co-ops are common in the retail and service sectors. Producer co-ops, particularly in agriculture, can benefit from collaborative efforts in production and marketing.
- Consumer Co-ops:
These are owned and operated by their members, who are also the customers. This structure allows members to set prices, share earnings, and focus on community needs and goals. Some examples are grocery stores, retail shops, and movie theaters.
- Worker Co-ops:
Worker co-ops are owned and controlled by the employees. They offer a unique blend of traditional employment and ownership. Members work for the co-op, managing operations, but they also share in making decisions and sharing profits. These are typically retail and service organizations.
- Producer Co-ops:
Producer co-ops are formed by those who produce products, like farmers, and they collaborate on marketing, processing, and distribution of goods to streamline operations and increase efficiency, market reach, and profits.
- Purchasing Co-ops:
Small businesses band together to leverage collective purchasing power by bringing a larger offering to the table. In return, they receive lower prices and deals for members and customers.
- Multi-Stakeholder Co-ops:
These types of co-ops include a diverse member group with customers, users, workers, and investors who share control of the company. They are typically formed to serve the community. These types of organizations work in healthcare, education, or food systems.
- Social Co-ops:
Social co-ops are focused on social goals such as employment or community service and often combine different structures into one organization.
- Platform Co-ops:
This is when a company with a digital platform operates as a co-op with shared ownership and democratic decision-making.
Who Is Eligible to Operate as a Cooperative in the US?
In the United States, cooperatives, or co-ops, are businesses owned and democratically controlled by the people who use their services. Their structure distinguishes them from other types of companies owned by shareholders or stockholders.
To be eligible to operate as a cooperative, you must:
- Comply with State-Specific Requirements:
Co-ops are typically formed under state laws, so the specific requirements for their structure, governance, and operation can vary from state to state. There is no federal law governing their formation.
- Follow Cooperative Principles:
Cooperatives typically adhere to principles like voluntary and open membership, democratic member control (one member, one vote), and member participation.
- Operating for the Benefit of Members:
A co-op's primary purpose is to serve its members' needs, rather than solely generating profit for outside investors.
- Meeting Specific Legal Requirements:
Depending on the type of cooperative and the relevant state and federal laws, there may be specific requirements related to:
You should consult a legal professional specializing in business formations to ensure you can legally operate as a cooperative. Learn all you can about state and federal laws governing co-op business entities.
Who Can Be a Member of a Cooperative?
Generally, anyone who is willing to accept the responsibilities of membership and can utilize the cooperative's services is eligible to become a member. Some cooperatives may have specific membership requirements outlined in their bylaws, such as requiring an upfront investment. However, ownership percentage is not tied to the amount of the investment. Everyone has an equal say. Cooperative membership is typically voluntary and open, without discrimination based on factors like race, religion, gender identity, or social status.
You should consult a legal professional specializing in business formations to ensure you can legally operate as a cooperative. Learn all you can about state and federal laws governing co-op business entities.
How to Register a Cooperative
To register a cooperative, you need to complete a few steps. They are as follows:

1. Incorporate Your Organization
First, you must incorporate your organization through the Secretary of State or another agency responsible for business filings. Co-ops are essentially corporations. Follow each of the steps below to do that.
As with any business, the first step is to choose your business name. Keep the name simple, impactful, and related to your business purpose. Don't choose a name that is too long or hard to remember or spell. The goal is to make it easy for your patrons to find you and remember your name.
Check with your Secretary of State to ensure the name is available. You cannot use an existing name or one close to your chosen business name. Also, check the U.S. trademarks database to see if your proposed company name is already in there. You do not want to infringe on anyone's trademark.
You can incorporate your company in any state within the U.S. Take some time to learn about the corporate laws, taxes, and fees to find a state that works best for you. Consider how easy or hard it is to incorporate in that state and how much it will cost. Some states offer a more business-friendly environment.
Have an attorney draft your Articles of Incorporation, including the co-op's name, purpose, and structure. File the completed and signed Articles of Incorporation with your state agency, which is most often the Secretary of State. Consult with your state agency and comply with the specifics in your state.
Along with your Articles of Incorporation, have your lawyer draft your corporate bylaws detailing the operational rules of your cooperative business, including membership requirements, duties, responsibilities, and procedures. Ensure that your bylaws comply with all federal and state laws.
You should also obtain an EIN to file wage reports and other tax documents required by the IRS. This crucial step is easy to accomplish. Log onto the IRS.gov website, register your cooperative, and get an EIN within a few days. You will need this EIN when you apply to open a business bank account.
Find a corporate business insurance agent and purchase policies that protect you against catastrophic financial loss in case of legal issues or other problems. You will also need commercial auto insurance if you use vehicles in your business.
Apply for as many business bank accounts as you need to keep all business activities in one place. According to corporate laws, you must keep the nonprofit's money separate from any board member's or members'.
2. Form a Board of Directors
Find individuals willing to sit on your board and help govern the co-op, make decisions about the purpose, and direct operations.
Once your co-op is fully formed, you can hold your first board meeting. During the meeting, the initial "incorporators" will discuss the business plan and other topics of interest. The first order of business should be to discuss, approve, or amend the bylaws.
3. Register for State Filings
Your business may be required to file regular reports to a state agency. You may also be required to register with the state Attorney General's office. Follow all state-level guidelines and file reports when necessary. Check with your state tax office to learn more about this step.
4. Obtain Licenses and Permits
Obtain any licenses and permits needed to conduct business in your state and local area. Because these laws vary tremendously, do some research to ensure you have everything you need.
5. Secure Funding and Recruit Members
Explore financing options and secure funding to support the business for at least the first year. Actively seek new members to join the co-op and contribute their unique skill sets to improve the company.
What are the Key Advantages of a Cooperative?
Cooperatives offer some unique advantages that make the structure very desirable. These benefits make operating in this type of business structure ideal. The key advantages of a cooperative business are:
What Are the Key Disadvantages of a Cooperative?
As with all business types, a cooperative has some critical disadvantages. The entire structure is so drastically different from other business entities that there are bound to be some issues. The key disadvantages of a co-op include:
As with all business types, a cooperative has some critical disadvantages. The entire structure is so drastically different from other business entities that there are bound to be some issues. The key disadvantages of a co-op include:
Partnership vs. Sole Proprietorship vs. LLC vs. Corporation vs. Cooperative
A co-op differs significantly from other business entities. Review the chart below to learn about the different types of business formations and how they compare to see which structure makes the most sense for your business.
A co-op differs significantly from other business entities. Review the chart below to learn about the different types of business formations and how they compare to see which structure makes the most sense for your business.
Characteristic | Sole Proprietorship | Partnership | LLC | S-Corp | nonprofit (C-Corp) |
---|---|---|---|---|---|
Formation | Quick and simple with no filing requirements with any government agency. | Simple to create with no legal filing requirements. | More expensive to create and requires filing with the state. | An S-Corp is more costly to establish, and it requires state filing. | It is more expensive to establish and requires filing with the state. |
Cost of Formation | None | None | The cost of the state filing fee is usually between $100-$150. | The cost of registering an S-Corp with the state can be anywhere between $20 and $800. | The average cost to register a C-Corp in the United States is $633. |
Business Name | Can operate under the owner's name, or a fictitious name using a DBA. | Can operate under the owner's name, or a fictitious name using a DBA. | Must register an official company name with the state that is established and secured. | Must register an official company name with the state that is established and secured. | Must register an official company name with the state that is established and secured. |
Taxation | Pass-through taxation, where all everything is filed under the owner's personal taxes. | Filed under the partners. Each partner claims their income and losses on their personal returns based on their percentage of the business. | Pass-through taxation, where everything is filed under the owner's personal taxes. If there are multiple owners, taxation is treated like a nonprofit. | Each owner declares their share of profits/losses on their personal returns. Income is allocated based on owner percentage. Owners can use corporate losses to offset other types of income. Fringe benefits are limited to owners who own more than 2% of the shares. | The C-Corp is a separate taxable entity that must file returns. Owners split profits and only declare their portion on personal income tax returns. Owners can deduct fringe benefits as business expenses. |
Liability | The owner is personally liable for all business actions, liabilities, debts, and damages. | Owners are personally liable for all business debts. | Business is its own entity; therefore, the owner(s) are protected against personal liability. | Owners have limited liability for personal debts, and business legal issues. | Owners have limited liability for personal debts and business legal issues. |
Operational Requirements | No operational requirements are necessary. | No operational requirements are necessary. | More formal requirements than an LLC but not as strict as a C-Corp. | Much easier to maintain than a nonprofit. Annual member meetings and a report are required. | Annual meetings are required, and members must vote on changes. Shares of stock must be sold to raise capital. |
Management | Full control of all decisions, management, and operations. | Each partner has equal control and decision-making ability unless it's a limited partnership. | An operating agreement outlines how each member can manage the company. | Managed by a group of directors that shareholders vote in. | Managed by a group of directors that shareholders vote in. |
Raising Capital | Can be challenging and the owner often has to invest his/her own money. | Each partner can invest, and more partners can be added to raise additional capital. | Managers can sell interest in the business to raise capital based on operating agreement restrictions. | Can sell shares of stock to raise capital. | Can sell shares of stock to raise capital. |
Transferability of Interest | No | No | Possible based on the operating agreement restrictions. | Yes, as long as IRS regulations about who can own stock are honored. | Shares of stock can be easily transferred. |
How is a Cooperative Taxed?

In keeping with a cooperative's uniqueness, it is taxed based on Subchapter T of the Internal Revenue Code. Members are taxed only once using pass-through taxation. That means the entity itself is not taxed separately, but each member is taxed on the income they receive from it.
Additionally, cooperatives can deduct certain distributions and allocations made to their members, known as patronage dividends. Patronage dividends are rebates based on a member's usage of the cooperative's services or products. These are deductible for the cooperative, which reduces its taxable income.
Each member must report patronage dividends as income on their personal tax return. However, some cooperatives have exceptions to this rule. Individual members generally don't owe taxes on patronage dividends received for personal purchases.
Some cooperatives, like agricultural organizations, may qualify for tax-exempt status under Section 521. Cooperatives that don't qualify for or choose not to operate under Subchapter T are taxed as C corporations.
State taxes for cooperatives vary based on the state and local area. Some states offer co-op tax incentives or exemptions.
Pros and Cons of Cooperative Taxation
The pros of cooperative taxation are that members are taxed individually, and the co-op itself is not, avoiding double taxation. It also offers flexible profit distribution to members and potentially lower taxes through incentives and exemptions.
The cons, however, are that cooperative taxes can be complex, especially regarding patronage dividends. Members have to report dividends as income, and most will also have to pay self-employment taxes, which can be high.
Use the table below from the IRS to be sure you are filing the correct forms:
The pros of cooperative taxation are that members are taxed individually, and the co-op itself is not, avoiding double taxation. It also offers flexible profit distribution to members and potentially lower taxes through incentives and exemptions.
The cons, however, are that cooperative taxes can be complex, especially regarding patronage dividends. Members have to report dividends as income, and most will also have to pay self-employment taxes, which can be high.
Use the table below from the IRS to be sure you are filing the correct forms:
How to Convert a Cooperative
Converting a cooperative to another entity type can be complex and have significant tax implications. A cooperative starts out as a type of corporation and may be taxed using pass-through or C-Corp tax rules. There may be instances where it makes sense to convert the co-op to a different kind of business structure.
Some of the reasons you may want to convert include:
- Attracting Investors:
Attracting investors with a co-op can be challenging because ownership is not tied to the investment amount. Converting to another type of entity may assist with attracting investors and help with funding.
- Raising Capital:
Converting to a more traditional structure can help raise capital by selling shares of stock, which is not available with a co-op.
- Business Growth and Scaling:
The democratic approach in co-ops may not work well when the business reaches a specific size. An LLC may offer more flexibility.
- Simplify Operations:
Another entity may be easier to operate and retain records for since a co-op requires extensive record-keeping.
- Limited Participation:
If members are uninvested, it might be time to switch to another type of business to move forward.
Converting a Cooperative to an LLC
Converting to an LLC offers members more flexibility, structure, and options. The process to convert from a co-op to an LLC is as follows:
- Plan: Develop a plan for the conversion, including how the assets and liabilities will be transferred and how members will be moved from co-op status to LLC status.
- Vote: Hold a meeting and vote with the majority agreeing to switch the company type.
- File: File the appropriate documents with the state's Secretary of State office, such as a certificate of conversion or a statement of conversion. You will also have to file Articles of Organization for the new LLC.
- Dissolve: Dissolve the cooperative and move the assets and liabilities over to the new LLC.
- Consult: Consult with a tax professional to ensure you do everything correctly and avoid any issues with the IRS.
Converting a Cooperative to a For-Profit Corporation
Converting from a cooperative to a standard corporation also makes sense for many reasons. To go about it, follow the steps below:
- Assess the Tax Situation: Consult with tax and legal professionals about the process and any tax and legal implications for switching the business type.
- Draft Articles of Conversion: Hire an attorney to draft your Articles of Conversion and other necessary documents to make the change.
- Vote: Call for a vote and get a majority to agree to the conversion.
- File: File your Articles of Conversion with the Secretary of State.
- Transfer: Transfer the assets from the co-op to the corporation.
- Update: Update the cooperative's bylaws to reflect the changes with the new corporate structure.
Check with your state office to review the specifics of corporate law and how to change your nonprofit into a new business entity.
- Choosing the Right Legal Entity for Your Business - Exploring Cooperatives (Co-Op)
- What Are the Best Types of Businesses to Operate as a Cooperative?
- Who Is Eligible to Operate as a Cooperative in the US?
- How to Register a Cooperative
- What are the Key Advantages of a Cooperative?
- What Are the Key Disadvantages of a Cooperative?
- Partnership vs. Sole Proprietorship vs. LLC vs. Corporation vs. Cooperative
- How is a Cooperative Taxed?
- Pros and Cons of Cooperative Taxation
- How to Convert a Cooperative