By Shaina Robinson, Communications & Technical Assistance Analyst at Local Enterprise Assistance Fund (LEAF). For Small Business Week, LEAF weighs in on developing transactions for cooperative small businesses.
Small business financing is tough, and if you’re a cooperative, it can seem especially unattainable. Finding the right solution for financing a co-op is different every time, and often depends on a variety of factors, such as industry, size, co-op type, and transaction type. For example, the conversion of a business from a sole proprietor to a worker-owned cooperative requires a common understanding among the lender, the selling owner, and the new worker-owners. Designing transactions for co-op businesses have a unique set of considerations compared to traditional small business lending.
LEAF is a CDFI founded in 1982 with a mission to promote human and economic development by providing financing and development assistance to cooperatives and social purpose ventures that create and save jobs for low-income people.
Cooperatives often face unique challenges in raising equity due to the limited number of equity financing options available to co-ops that are able to maintain the member-ownership structure intrinsic to the co-op governance model. If a co-op pursues traditional financing methods for raising equity, it risks undermining its owners by taking ownership and equity away from its members. LEAF found itself confronting this very problem when a start-up worker cooperative, Wellspring Harvest, sought to raise capital for the construction of its hydroponic greenhouse—and reached out to LEAF for assistance.
Wellspring Harvest Cooperative is a hydroponic greenhouse that provides natural produce to local institutions and commercial businesses in Western Massachusetts. The project was incubated by a worker co-op developer, Wellspring Cooperative, which has two other worker co-ops in the Springfield, MA area. The greenhouse uses 90% less water than traditional growing methods while occupying less space—perfect for crowded populous areas where food usually travels hundreds (if not thousands) of miles to reach stores. The business just completed construction and began production with five worker-owners, hired from the immediate, low-income neighborhood in Springfield.
After signing a purchase and sale agreement for a location owned by the Springfield Redevelopment Authority (SRA), Wellspring was excited to move one step closer to building their greenhouse. However, Wellspring had to raise around $1 million in debt and equity-like financing before the agreement to purchase expired to build and operate the greenhouse.
At this point, Wellspring reached out to LEAF and asked for help in raising the financing necessary. After working with Wellspring on their business plan, LEAF coordinated with another CDFI, CEI, to provide $500,000 of senior debt to finance the greenhouse. This senior debt financing was contingent on Wellspring being able to raise $400,000 in subordinate financing. The trick became how to raise subordinate, patient debt or equity-like funds to fill this $400,000 gap and move the transaction forward. LEAF suggested Wellspring raise their subordinate financing partly through a Direct Public Offering (DPO) and partly through a preferred share offering.
A DPO allows a business to offer an investment opportunity directly to members of the public as opposed to relying solely on accredited investors and institutional lenders. The option of pursuing a DPO gave Wellspring the opportunity to raise a significant chunk of capital without compromising the decision-making power integral to their cooperative’s member-ownership business structure. Terms of the DPO were minimum investments of $5,000 for accredited investors and $1,000 for unaccredited investors with a 3.0% interest rate. Through holding community events and leveraging their local network of community-minded residents, Wellspring was able to raise around $250,000 in DPO subordinated debt.
LEAF and Wellspring came up with the idea for a preferred equity instrument for a final pool of capital, otherwise known as Class C Preferred Stock (“Preferred Shares”). Wellspring decided to market their preferred equity tract primarily towards high-net-worth individuals who were clients of SRI wealth managers. These preferred shares supplied necessary equity, but do not entail voting rights and have elements similar to both debt and equity, with caps placed on potential equity returns to preserve worker’s equity.
Investors in the preferred shares expect a fixed annual return of 3.0% for the first five years. In years six through ten, Wellspring will start to repay principal in equal installments of fifths each year. As Wellspring replaces investors’ preferred shares with retained earnings of the business, worker-owners’ personal wealth will increase. During these subsequent five years, preferred shares’ returns are based on Wellspring’s profitability and capped at one-third of total profits. These strict limits successfully share in the upside for investors while balancing the need for internal governance control in the worker cooperative structure.
After several months of marketing, Wellspring successfully completed its financials goals and secured the purchase of land from the SRA for the Wellspring greenhouse. In total, Wellspring raised $253,000 from forty-nine investors for its DPO, and $150,000 in preferred equity. In November 2017, Wellspring held a ribbon-cutting ceremony for its greenhouse and the greenhouse is currently growing lettuce and bok choy. In two years time, they aim to double the yield of crop production and add new worker-owners.
LEAF’s role in this project extended past what a CDFI might normally do by providing extensive technical assistance in preparing the capital stack required for the project. The different instruments used in order to leverage the senior debt shows the need for innovative solutions to meet the requirements of co-ops. In the end, we believe going the extra mile to make these transactions a reality is worth it given the potential for worker empowerment, the quality and stability of the jobs, and the potential for low-income workers to build wealth through equity in a business they own.