THE CAPITALIZATION OF COOPERATIVES November 18th, 2005

1. THE CAPITALIZATION OF COOPERATIVESNovember 18th, 2005

2. This document has been produced with the cooperation of the following organizations:Investment QuébecLa Caisse d’Économie solidaire DesjardinsFondactionFilactionLe Réseau d’investissement social du QuébecMCE ConseilsThis presentation was made at the CWCF 2005 Congress held in Montréal. A complete publication of the text will be shortly available through Investment Québec

3. PLAN – NOVEMBER 18th, 2005

4. INTRODUCTION The capitalization is an essential element to strength, development and sustainability of all kinds of enterprises, whether they are enterprises with share capital or of social economy. The capitalization allows the enterprise to achieve, develop and sustain its operating activities.

5. WHY CAPITALIZATION IS IMPORTANT To operate, the cooperative needs assets as equipment, accounts receivable, inventories, etc. To do so the cooperative incurs commitments towards its users, workers, members and financial partners.

6. WHY CAPITALIZATION ISIMPORTANT (cont.) For the financial partners, the capacity of the enterprise to meet its financial commitments is an essential factor. The generated funds should be sufficient to face these following elements: • Reimbursement of capital on the debt • Replacement of current assets • Purchase of new fixed assets • Buyout of social and privileged shares • Need for working capital required for development

7. WHY CAPITALIZATION ISIMPORTANT (cont.) The capitalization of the enterprise is the most secure way to face these commitments and the most direct way to increase the enterprise’s capacity to make its own choices and maintain its operating autonomy.

8. WHAT IS CAPITALIZATION The capitalization is the financial patrimony of the enterprise and is constituted of: • Amounts invested by the members • The accumulated surplus proceeding fromoperations These contributions provide a real capitalization which is mostly free of reimbursement commitments and of a specific return on investment without condition.

9. WHAT IS CAPITALIZATION (cont.) The more the enterprise is financed by capitalization, the less it gets commitments towards financial partners and the more it controls its strategic choices. Besides, its financing is less constraining and costly.

10. WHAT IS CAPITALIZATION (cont.) Then, some financial partners are able to provide enterprises with patient capital: “quasi-equity”. It is based on flexible conditions of reimbursement, but with a cost. The capitalization generated by the cooperative will allow reimbursing this patient capital on time.

11. THE ADVANTAGES OF A GOOD CAPITALIZATION The main advantages of a good capitalization are financial and strategic and help the enterprise to: • Ameliorate its financial viability: The enterprise is able to absorb the unpredicted events which could reduce its capacity to generate surpluses such as: • Reduction of the incomes • Arrival of a new competitor which affects theenterprise’s operations : reduction of quantities and/or selling price or increase of costs; example: improvement of the after-sales service

12. THE ADVANTAGES OF A GOOD CAPITALIZATION (cont.) • Increase of costs which can not be rapidly absorbed equivalent by the increase of incomes (example: raising of prices of the raw materials)  • Meet its financial commitments such as: • Reimbursement of capital of its debts • Refunding of quasi-equity • Buyout of the shares of members who leave • Replacement of fixed assets in order to maintain the capacity to develop products and services • Need of working capital in a context of growth

13. THE ADVANTAGES OF A GOOD CAPITALIZATION (cont.) • Seize opportunities such as: • Launching of a new product of service • Acquisition of assets • Other advantages are also important : • Increase of liberty of action and autonomy which allow the enterprise to negotiate with its financial and governmental partners • Real concretization of the cooperative mission • Reduction of the financial cost

14. Increase the capacity to solve operations problems Increase the capacity to replace the enterprise assets Increase the capacity to negociate with partners CAPITALIZATION Increase the capacity to fulfill its mission towards users, members and the partners IN SUMMARY

15. HOW TO BUILD A GOOD CAPITALIZATION IN COOPERATIVES Cooperatives are able to find financing from many sources: from its operations and other financing activities. Some of them are temporary and do not contribute to the strength of the enterprise, others are constructive solutions for the future.

16. IConstruction of the contribution IIFinancing and investment policy IIIManagement of operations IVManagement of liquidities • Contributions of members • Common or priviledged shares Improve gross margins • Fast collect of accounts • Optimal use of the inventory Choice of profitable project to realize • Contribution of organizations • Privileged shares • Immobilization grant • Fund-raising campaign • Sponsorship Control of costs • More liquidities available and less financial fees • Less loss of inventory • Choice of the financing mode • Debt/equity Increase ofsurpluses Output to contributors (workers, members and users) Determine the needs of capitalization The capitalization supports the investment policy Policy ofdistribution CAPITALIZATION

17. HOW TO BUILD A GOOD CAPITALIZATION IN COOPERATIVES (cont.) CONSTRUCTION OF CONTRIBUTIONS OF MEMBERS OR ORGANIZATIONS As of its starting, the enterprise has to foresee the mechanisms of capitalization thanks to the contribution of members or organizations operating in its community.

18. HOW TO BUILD A GOOD CAPITALIZATION IN COOPERATIVES (cont.) • THE CONTRIBUTION CAN COME FROM SEVERAL SOURCES : • Growth of the capital of members • Recruitment of new members who acquire shares • Growth of capitalization for all members • Fund-raising campaigns • Grants for assets financing • Sponsoring development

19. HOW TO BUILD A GOOD CAPITALIZATION IN COOPERATIVES (cont.) • FINANCING AND INVESTMENT POLICY  The chosen projects have to be profitable and should protect its level of capitalization in the medium term by determining:  • To do so the cooperative should make an accurate analysis of the projects: • Correlation of the project with the mission of the enterprise • Demonstration of capacity of growth or reduction cost • Generation of supplementary surpluses

20. HOW TO BUILD A GOOD CAPITALIZATION IN COOPERATIVES (cont.) • FINANCING AND INVESTMENT POLICY • Have an equilibrated financing policy • Part of financing coming from the debt • Part of financing coming from the equity

21. HOW TO BUILD A GOOD CAPITALIZATION IN COOPERATIVES (cont.) • MANAGEMENT OF OPERATIONS The management of operations aims at generating surpluses and improving margins (by rising incomes and controlling costs). If the surpluses are not distributed, they contribute to the capitalization.

22. HOW TO BUILD A GOOD CAPITALIZATION IN COOPERATIVES (cont.) • MANAGEMENT OF LIQUIDITIES For example : • Fast process of invoicing and fast collect of accounts receivable (reinforce the cash on hand and reduce the financial fees of line of credit) • Reduce the inventory (reduce the operational costs and generate liquidities)

23. HOW TO BUILD A GOOD CAPITALIZATION IN COOPERATIVES (cont.) POLICY OF DISTRIBUTION AND ASSIGNMENT OF THE GENERATED SURPLUSES The enterprise defines a policy of distribution of surpluses which should be balanced between the following elements: • The part destined to assets (growth) • The part destined to the reimbursement of detb The enterprise has to hold a significant share of the surpluses for its capitalization

24. THE CAPITALIZATION PLAN To carry out the objectives of capitalization the best way is to build a long-term capitalization plan so as to spread out the build up of the capitalization in time to ensure the financial safety. Here are the steps necessary before determining the objective of capitalization:

25. THE CAPITALIZATION PLAN (cont.) • Know the enterprise and its environment Before settling an objective of capitalization, the environment in which the enterprise evolves must be evaluated. The more the environment is risky (in which changes are important and abrupt), the more the required rate of capitalization must be high.

26. THE CAPITALIZATION PLAN (cont.) • Know its needs in future investments The capitalization objective to reach is not static. For example, the enterprise may have to reconsider completely its situation if its fixed assets must be renewed or it realizes an investment into a short-term project.

27. THE CAPITALIZATION PLAN (cont.) • How to achieve its objective of capitalization Once the objective of long-term capitalization issettled, it is necessary to give oneself a plan over a few years with clear targets, observable and realistic, which is easy to follow and which should be ratified and followed by the board of directors. • Increase its surpluses The cooperative must settle under-objectives regarding the level of profitability of the operations as well as funds search.

28. THE CAPITALIZATION PLAN (cont.) • Refund the loans Often, the generation of surpluses denote improvements of the cash on hand. If this situation is observed on a rather structural basis, and if it is possible without harming its situation of working capital (short-term balance sheet), this cash on hand can be used to reduce the debt and thus increase the weight of its capitalization in a "reduced" balance sheet.

29. THE CAPITALIZATION PLAN (cont.) • Abandon unnecessary assets The review of the assets is sometimes neglected by the enterprises but is useful to improve their rate of capitalization. They should examine the relevance to preserve them but especially check if their level is too high, and particularly the elements from the current asset of the working capital, such as the accounts receivable and the inventories.

30. THE CAPITALIZATION PLAN (cont.) Elements to consider: • Receipt and disbursements from operations • Level of disbursements to refund the loans • Needs for renewal of the production equipment • Commitments towards members now and in the future Choices to make: • Objective of capitalization in five years: • Envisaged incomes • Envisaged disbursements • Increase of the net worth in dollars • Evolution of the debt rate (% debt on asset) • Vis-a-vis this objective: • Measures of capitalization coming from the members • Objectives of capitalization coming from the operations (use of the surpluses) • Objectives into the financing management • Objectives of raising funds in the community • Control and managements tools • Follow-up plan (schedule, tasks)

31. CONCLUSION The cooperatives (like the others enterprises) lay emphasis on meeting their annual budget objectives. They also should provide themselves with long-term capitalization objectives: • Improve their capacity to absorb a sudden lower profitability due to important changes into their economic environment • Allow them to meet their financial obligations including the refunding of the patient capital, the replacement of the fixed assets and the refunding of the shares of members who leave • Seize opportunities to be able to consider projects of expansion and development

32. CONCLUSION (cont.) Important points: • The definition of the objective of long-term capitalization is crucial, as well as the definition of under-objectives regarding this following aspects: • level of profitability of the operations • funds search • refunding of debts • preservation of essential assets

33. CONCLUSION (cont.) These objectives must be established and integrated in the plan of capitalization. • The plan of capitalization must be adopted by the board of directors and is the subject of a periodic and rigorous follow-up. The capitalization is the key to strength and sustainability of the enterprise in terms of liberty of action and capacity to innovate.