Alternative finance part 2: Co-op Capital

As I write this, financial markets are in turmoil again including big banks (Deutsche Bank) but what is important this time around is that central banks, the ultimate backstop in the 2008-2009 recession/financial crisis, are far more impotent, having already injected trillions from quantitative easing rounds. The QE will continue but may have little effect as far as market psychology. This fomenting crisis will fundamentally change global finance and capital markets as we know it, as there will be little to stop the onslaught this time around.

We seek to develop ideas for local financial innovation, expanding upon our introductory post (here) in order to work toward a new financial system, one that may rise from the coming ash heap of the current global order. Decentralization and the reduction of fragility is a key theme here and this is one way we seek to reduce or even invert the fragility of financial systems.

How can one hold assets and/or generate a return on investment locally? Here are some tips. While in the past it has been difficult for non-accredited investors, the SEC has recently eased restrictions on private placements – but this is only a start. Yet there are many strategies to fund locally besides direct investment.

Enter Cooperatives

The cooperative is traditionally though of as a socialist or syndicalist (anti-capitalist) construct, but in the 21st century should be view as a method of pooling capital in a decentralized manner with direct accountability to the stakeholders and no more per se. There are two types that are of importance to local financial innovation. First is the consumer coop. These can generate a return in many ways but are not an asset per se. The most basic example is of a produce coop that allows local residents to buy shares in the harvest at a discount. Other structures may allow one to purchase membership at a coop store and receive discounts on purchases as well as a yearly share of profits (example: Sevananda in Atlanta).

The second, and in our view more powerful model is that of the worker-owned cooperative. A shining example is here with the Evergreen Cooperative Laundry. Think of it as a mirror image of the Zaibutsu model in Imperial Japan, with a core business unit (in this case an industrial laundry, in the case of Zaibutsu generally a bank) that finances and grows other units around it. The difference of course is that ownership, rather than being a familial hierarchy is collectively through  labor such that labor and capital are as one. This, in our view, has many benefits beyond philosophical.

Skin in the Game

Here is some fun reading.

One has a different set of incentives when there is “skin in the game” with respect to any undertaking. Simply put, if a worker has only employee status whereby they are purely at the whims of middle management, they can be expected to work at or below a level of their fixed pay. When there is incentive to outperform and add to the economic bottom line, workers will do so. Key to this is that there IS downside risk to the worker-owner, rather than in the case of the employee with the bonus who only has upside they can harvest without exposure to the downside. This is important in that perverse incentives – such as employees manipulating results for short term gain to the long term detriment of the company (i.e. quarterly bonuses) – are eliminated.

Decentralization of capital

Often worker cooperatives will have equity limits. One can accumulate equity but cannot buy up shares to the moon. Why is this important? In the corporate sector, especially ones exposed to public markets, there is risk of capital concentration by capitalists that have incentives anathema to the vast majority of the organization. While this can be useful in creating efficiencies within otherwise inefficient companies, it can also hold the entire lives of countless individuals hostage to the games of a few mega-capitalists (i.e. corporate raiders / asset strippers).

At a smaller scale, such as “Main Street” businesses where the founder is the largest capitalist, concentration of capital creates the risk of complete dependency on individual solvency- so if the founder were to say, owe too much in back-taxes or go through a harrowing divorce, he or she is also inadvertently putting everyone in the operation at risk. Yet if there are multiple sources of additional capital, concentration risks go away. A shortfall in working capital need not be funded by a founder or a sale of shares to outside investors, but can be funded from within by the many owners. Risk is decentralized. The same pitfalls can occur to any given individual – back taxes, divorce, medical bills – and do little to no harm to the whole operation and thus the livelihoods of others.

Role of the Entreprenuer

True to our title, we must elucidate upon the role of the entrepreneur. While in the worker cooperative a single large capitalist is not needed, an organizer of all elements to create a firm is – the entrepreneur. The entrepreneur would, as in any business, design the model and coordinate resources to execute. He or she would be the first worker-owner and would recruit one or two others to start and grow accordingly. It is preferable that a cooperative – especially one following the Cleveland / Evergreen model – start out in an established field with a relatively predictable rate of profit. This is because innovation is more in the organization of the firm itself rather than the product. With talented people product innovation will follow, but in our view it can be far too risky and unworkable to have democratic organizational structures and untested innovative products. This is especially true with products that have a long delay until revenue is generated (such as many a tech startup). Sometimes, a creative strongman is needed.

Socialist, smocialist

Socialism and capitalism are so 20th century, at least as commonly articulated and executed. Markets and will always exist, and it is futile to try and do more than perhaps harness or temper their waxings and wanings. We believe there is significant room for innovation in economic and financial structuring in the 21st century and that we must try and think beyond the constructs of the past two centuries. How shall markets be organized? Let the entrepreneur and risk-taker be at the forefront of the unknown.

 

 

 

 

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