Meet Cathy, the Cooperative Development Institute’s new answerwoman! She can take on any co-op questions you might have, big or small. Today we address the questions: “What are the legal difference between nonprofits and cooperatives? Can you run a nonprofit cooperatively?” See all of Cathy’s answers and ask your own on her home page. This blog post was written by Chris Tittle of Sustainable Economies Law Center, an Oakland, CA, nonprofit providing legal education, research, advice, and advocacy for just and resilient economies.
What follows is a very general discussion of the legal similarities and differences between cooperative corporations and nonprofit corporations, and some suggestions on how to structure and operate a nonprofit in a democratic way. This is not legal advice though! It is important to consult with a legal professional to discuss the specific laws of your state.
To realize our vision of a cooperative economy, we will need a diversity of cooperative forms and institutions working together at multiple scales. Cooperation already takes many shapes within our current economy, from worker-owned factories to producer-owned agricultural businesses to resident-owned housing to consumer-owned energy utilities. What about nonprofit organizations? Can they be operated democratically? And what’s the difference between a coop and a nonprofit anyway? It’s beyond the scope of this article to discuss all the entity formation factors worth considering, so we‘ll discuss two legal forms that are designed to limit private wealth accumulation and promote social benefit: the cooperative corporation and the nonprofit corporation.
What’s the legal difference between a cooperative and a nonprofit?
The terms “cooperative” and “nonprofit” often refer to specific types of corporations recognized under state law, and the rules and requirements for incorporating under either vary by state. To simplify this discussion, let’s focus on the legal distinction between a cooperative corporation incorporated under state law and a nonprofit organization tax exempt under Section 501(c)(3) of the Internal Revenue Code. Both entity types primarily exist to benefit their constituencies rather than shareholders. And both cooperative and nonprofit corporations can be governed democratically and generate a profit.
One primary difference between a cooperative corporation and a tax-exempt nonprofit corporation is how money flows back into the community: a tax-exempt nonprofit organization cannot distribute profits to members or investors, while a cooperative corporation generally distributes profits based on members’ participation in the cooperative (through patronage dividends). The primary source of funding may also be different: whereas a cooperative corporation generates most or all of its revenue through the sale of goods and services, a nonprofit can receive tax-deductible donations from community members and foundations, and is limited in the amount of business activity it conducts unrelated to its charitable purpose.
Speaking of charitable purposes, another distinction is that a 501(c)(3) tax-exempt nonprofit may have more limits on its activities than a cooperative corporation, as it must be organized and operated exclusively for charitable, educational, or other exempt purposes. Exempt purposes can include (in the words of the IRS) relief of the poor, distressed, or underprivileged; combating community deterioration; eliminating prejudice and discrimination; and education, to name a few. These tax-exempt purposes must benefit the broader public and a charitable class of people (such as low-income, distressed, marginalized, etc). Thus, a 501(c)(3) nonprofit is primarily accountable to the public, though, like a cooperative, may choose to have a membership to which it is accountable.
So the primary differences are how the organization is capitalized and who it is directly accountable to, both of which have to do with how the organization interacts with outside stakeholders. Internally though, nonprofits and cooperatives can actually be structured in very similar ways to ensure democratic control by workers and other important constituencies.
Again, this is not a complete overview of the laws governing 501(c)(3) public charities or cooperative corporations. For much more of cooperative and nonprofit law, visit two of SELC’s online legal resources libraries: Co-opLaw.org for cooperatives and CommunityEnterpriseLaw.org for nonprofit law.
So, how can we run a nonprofit cooperatively?
A cooperative is not just a legal entity or tax category though. We can also think of a cooperative as a set principles and practices that ensure democratic control by members. In this sense, a nonprofit organization can very much operate cooperatively. So what do you get when you cross a worker cooperative with a 501(c)(3) nonprofit? A worker self-directed nonprofit! At least, that’s what we are calling it at the moment. Read more about worker self-direction on SELC’s website.
Internal policies and practices: In our own 501(c)(3) nonprofit organization, we have enshrined various democratic principles and practices into our organizational structure and operate largely as a collective. Some of these practices are operational, such as i) delegating many decisions to program committees instead of centralizing decision-making in an Executive Director or Board, and ii) distributing many administrative responsibilities throughout the organization. Others are structural, such as i) paying all staff the same wage, and ii) allowing any staff member to bring a proposal to change an organizational policy or program through a defined decision-making process. See all our organizational policies and practices here.
The role of a Board of Directors: According to most state laws, a board of directors has ultimate authority for running a nonprofit corporation. However, there are many ways that a nonprofit organization can delegate the day-to-day operations, and even the strategic direction, of the organization to workers while still maintaining appropriate Board oversight. SELC’s Board of Directors has passed a board resolution delegating such authority to staff, which it reviews annually to ensure the organization is fulfilling its mission and complying with all relevant laws. Here’s a sample Board resolution that an organization might adopt. Depending on what state you choose to incorporate in, the organization’s bylaws can also clearly dictate that certain decisions be made by staff or other community stakeholders, with the Board functioning primarily as an auditor of the organization’s activities and effectiveness. At SELC, we have expressly limited the Board’s functions to financial, governance, mission, and legal oversight. The staff as a collective have thus assumed the responsibilities of a traditional CEO or president, delegating many responsibilities to smaller groups within the organization and reporting back to the Board on a regular basis.
Another option is to democratize the Board of Directors itself by incorporating as a membership organization with specific membership classes for staff and other important community stakeholders that select specific Board seats. This model is used by many nonprofit organizations such as ONE DC, a grassroots community organizing nonprofit working to create and preserve racial and economic equity in Washington, DC. Whatever system of democratic management an organization adopts, it should be clear, in writing, and available to all staff, stakeholders, and Directors.
In conclusion
Cooperative corporations and nonprofit corporations are just two legal forms that can be used to build democratic organizations. There are pros and cons to choosing each, but they are each specifically designed to limit profit maximization as a primary motivator and to create broad social benefit. We can and should use both of these legal forms to simultaneously embody the more democratic and inclusive world we want to see, and to change the larger systems of injustice and inequality that exist all around us.
Just as building a cooperative economy is in some ways a challenge to the dominant corporate economy, creating a more democratic nonprofit organization runs against many conventional ways of acting in the nonprofit sector. However, there is nothing legally preventing nonprofit organizations from managing themselves democratically. Particularly for nonprofits working to create a more just, equitable, and cooperative world, perhaps there is an argument to be made that creating democratically-run nonprofit organizations is a charitable activity itself!
Ask Co-op Cathy a Question