Co-operative Capitalism:
A Very British Revolution
Summary
The unintended consequences of UK Partnership legislation
have created, for the first time, a Corporate body with
collective limited liability which is also a Partnership
the UK LLP.
Firstly: a Partnership is an inherently Co-operative model.
Secondly: such LLPs may be made Open by
extending Membership to all stakeholders. Thirdly: through
Temporary Equity a proportional share
owned for a defined period of time a new form of
Open Capital may be created outside the current
paradigm.
The incorporation of Co-operative Principles gives us a
Co-operative Corporate Partnership: this entity is capable
of underpinning a truly Co-operative Society.
Introduction
If it is true that the road to Hell is paved with good intentions,
then perhaps the road to Heaven is paved with bad ones.
The story begins in that bastion of democracy Jersey.
In the early 1990s major professional partnerships
such as Andersen became increasingly concerned at the risks
run by individual partners of bankruptcy caused by their
unlimited liability for actions or omissions by their fellow
partners and unsuccessfully lobbied the UK government for
legislation.
Two of the leading UK professional partnerships commissioned
a major City law firm at a rumoured cost in excess
of £1m - to draw up an Act of the Jersey States
Parliament establishing a new form of Limited Liability
Partnership (LLP). Suitably placed UK press
articles raised the spectre of a mass migration by professional
firms to Jersey and the Conservative Minister Michael Heseltine
then in office ordered the commencement of the consultative
and legislative process subsequently continued by New Labour
which eventually resulted in the UKs Limited Liability
Partnerships (2000) Act which came into effect on 6 April
2001.
In the December 2002 Journal Cliff Mills set out the challenge
inherent in protecting public or community assets so that
they are safe and committed to a common purpose.
His article was a masterly analysis of the inadequacy of
current Companies Law, and related legislation covering
Industrial and Provident Societies. The author believes
that the far-reaching and entirely unintended consequences
of this recent innovation in UK Partnership Law not only
solves the problem of which Cliff wrote but has enormous
potential for the Co-operative movement in particular and
Society in general.
Enterprises Generally
Definitions
An Enterprise is defined for the purposes of
this article as any entity within which two or more
individuals exchange Economic Value which, like Beauty,
is in the eye of the Beholder and is defined for the purposes
of this article as:
* Material Value such as Land, Commodities,
Goods and Services;
* Intellectual Value such as music, video,
the written word and software, which exists in the form
of data, electronic or otherwise;
* Emotional Value at its most basic,
the need to love and to be loved, but extending into the
concept of Society;
* Spiritual Value who am I? Why am I
here? Questions in relation to God and the relationship
with the eternal.
Three forms of Enterprise are identified:
* the Charitable Enterprise where Material
and Intellectual Value are exchanged for the Spiritual and
Emotional Value of giving;
* the Social Enterprise a Public
Enterprise open to all, where Material and Intellectual
Value is freely exchanged;
* the Commercial Enterprise a closed
or Private Enterprise where Material and Intellectual
Value is exchanged between a limited number of individuals
but may be retained or distributed in whatever way the Members
agree.
A Brief History of the Enterprise
Early enterprises were partnerships and unincorporated associations.
However, the need for institutions which outlived the lives
of the Members led to the development of the Corporate body
with a legal existence independent of its Members. In the
UK the earliest Corporates were created by Royal Charter
a possibility which exists to this day.
The key development in the history of Capitalism was the
creation of the Joint Stock Corporate with liability
limited by shares of a Nominal or Par
value, typically £1.00. The UK Industrial Revolution
was fuelled by Capital raised through Joint Stock Corporates
largely created by Act of Parliament. From 1844 onwards,
the creation of Corporates through registration under Companies
Statutes further streamlined the process and over the next
150 years the Limited Liability Corporate evolved into the
Public Limited Liability Corporate at the heart of the malaise
deriving from the process we know as Globalisation.
The Closed Public Corporate
In his essay Economies for Life (1)
the Economist David C Korten characterises the PLC as a
key component of a Suicide Economy:
This corporate form is legally structured to allow virtually
unlimited concentration of power to the exclusive financial
benefit of absentee shareholders who have no knowledge of,
or liability for, the social and environmental consequences
of the actions taken on their behalf. It is a legally sanctioned
invitation to benefit from behavior that otherwise would
be considered sociopathiceven criminal.
The problem with the Closed Corporate - as I
propose to term it due to its essentially proprietary character
- is the fundamental conflict between the interests of the
owners of the "closed" or Fixed Capital base
inaptly denominated Equity and the interests
of all other stakeholders such as suppliers, customers,
management, staff and in the case of major global corporates,
the public at large.
The latter are essentially costs external to
the (absentee in the case of a Public Corporate) owners
of the Enterprise and the resulting drive to maximise Shareholder
Value through a combination of cutting costs
and growth at any price has brought us the Wall Street/City
analyst-driven management excesses typified by Enron and
Global Crossing.
There is a fault-line within the Closed Corporate.
It has the characteristics of what biologists call a semi-permeable
membrane in the way that it allows Economic Value
to be extracted from other stakeholders but not to pass
the other way. So while Capitalism may not, as its critics
aver, be broken Capital most certainly
is and always has been - through the discontinuity between:
* Fixed Capital in the form of shares ie Equity;
and
* Working Capital in the form of debt finance,
credit from suppliers, prepayments by customers and obligations
to staff and management.
Due to this discontinuity between permanent Capital and
Capital of defined duration the exchange of Economic Value
in a Closed Corporate is made difficult and the true sharing
of Risk and Reward which constitutes a true partnership
- rather than a joint venture, supplier/customer relationship
or strategic alliance - is simply not possible.
Society is crying out for a Third Way between
the co-operative/collaborative and the competitive: the
public and the private: the paradox of the modern world:
that humans have never been more inter-dependent in our
needs, or more individualist in our outlook. No Enterprise
Model has been capable of resolving this dilemma. Until
now.
Open Corporate Partnerships
The UK Limited Liability Partnership ("LLP")
From 1844 onwards in the UK it has been mandatory for partnerships
with more than 20 partners to be incorporated the
result being Corporate Partnerships with unlimited liability.
In 1907, it became possible for Partners to limit their
partnership individually rather than collectively within
a UK partnership at the cost of being unable to participate
in the management of the partnership. This model routinely
continues in the USA where it is the normal structure for
professional partnerships.
In the late 1990's UK professional partnerships, faced with
the prospect of individual bankruptcy as a result of litigation
against the firm, successfully lobbied for protection, which
arrived in the shape of the Limited Liability Partnerships
Act 2000 and came into effect on 6 April 2001. Since then
over 7,000 UK LLP's have been incorporated, for the most
part from conversions of partnerships previously with unlimited
liability.
The UK LLP is supremely simple and remarkably flexible.
The only requirements are for two "Designated Members"
to complete an Application Form obtainable at the Companies
House web-site and to return it with the requisite fee of
£95. There is no requirement for the mandatory and
arcane Victorian vintage Memorandum of Incorporation and
Articles of Association the prescriptive Contracts
between Members laid down by Statute and no need
for a supplementary Shareholder Agreement tailoring these
Contracts to the precise present day needs of the Members
in the relevant Enterprise. All that is needed is a simple
Member Agreement a legal protocol which
sets out the Aims, Objectives. Principles of Governance,
Revenue Sharing, Dispute Resolution, Transparency and any
other matters which Members agree should be included. Amazingly
enough, this Agreement need not even be in writing, since
in the absence of a written agreement Partnership Law is
applied by way of default.
While a UK LLP should be a business run "With a View
to Profit" the proposed Enterprise Model redefines
the relationship between stakeholders in a way that literally
removes the very concept of Profit and Loss a subject
to which we will return. The ease of use and total flexibility
enables the UK LLP to be utilised in a way never intended
as an Open Corporate partnership.
The Open Corporate Partnership
There are two innovative concepts which characterise the
Open Corporate Partnership. Firstly: the realisation
that it is now possible for any stakeholder to become a
Member of a UK LLP simply through signing a suitably drafted
Member Agreement: this puts the Open in the
Open Corporate. So instead of a supplier signing contractual
terms of business negotiated adversarially or an employee
being confronted with a Contract of Employment they may
instead become true Partners in the Enterprise with their
interests aligned with other stakeholders. The result is
that there are no externalities in an Open Corporate
Partnership, which therefore means that Economic Value may
be exchanged within the Enterprise in conformance with the
Member Agreement.
The second innovation is the concept of Open Capital
itself. This concept arose out of the realisation that proportional
shares (such as one half, three fifths, five millionths)
in an Enterprise constitute an infinitely divisible, flexible
and scaleable form of Capital capable of distributing or
accumulating Value organically as the Enterprise itself
grows in Value or chooses to distribute it. Furthermore,
proportionate shares may be sold to raise Capital either
outright for an indefinite period or, through
a Sale and Repurchase (Repo) agreement, for
a defined period of time creating Temporary
Equity. Where an Equity share is repo'd
in this way the investor participates in the increase in
Value whether distributed as dividend or not, but retains
the risk that his Equity stake may in fact decrease in Value
over the period. In simple terms: Debt and Interest are
replaced by Equity traded forward: the result is Temporary
Equity and the fault-line dividing the Closed
Corporate disappears.
Open Corporate partnerships in practice
The optimal nature of the UK LLP is already becoming apparent,
and a number of technology start-ups have utilised the form.
Moreover, a transaction entered into in late 2002 by the
Hilton Hotel Group serves as an example of how Temporary
Equity may operate in practice (although it is extremely
doubtful that the parties realised quite how ground-breaking
their transaction was to be).
The Hilton Hotel Group sold a portfolio of 10 hotels for
some £350m to an LLP in which Hilton (the Occupier)
hold 40% and the balance of 60% is owned by another LLP
linking the 3 Investor Members - one of whom is Bank of
Scotland. The Investors receive for 27 years 28.8% of the
gross revenues from these hotels plus a further £3m
pa all subject to a floor of £17.5m pa or 5%.
Note firstly that there is no Debt and no Interest in this
structure and the risks and rewards are shared as in all
true partnerships. The outcome is therefore to create Temporary
Equity with a 27 year term. Note secondly that it
is in the interests of both Occupiers and Investors to co-operate
in order to create the maximum flow of revenue over the
period of the agreement. The Hilton transaction is a close
relation of the Property Investment Partnership
set out below which was created as an Islamically sound
method for property purchase.
Property Investment Partnership (PIP)
A PIP constitutes an Open Corporate LLP between
and one or more Investors in the LLP and one or more Occupiers
of the property it acquires.
eg a property purchased for £100,000, of which £80,000
is financed:
* the Occupier/Investor receives 20 shares and the Financier/Investor
80 shares at a value of £1k each. (or 200/800: 2000/8000
etc - it is the 20%/80% proportions which matter, there
being no par or nominal value to these shares)
* there is an Exchange of Value: in return for the use of
the Property, the Occupier(s) pays a Rental to the LLP which
in turn pays the Investor (s) for the use of the Capital.
* so a rent of £6,000 pa is agreed for two years for
the above property: the Occupier pays net £4,800 pa;
the Investor receives net £4,800 pa.
After two years, the Occupier wishes to invest £12k
in the Property: at £120k valuation he buys a further
10%; at £96k valuation he purchases 12.5% and so on.
Note:
* there is no Debt and no Interest (hence the Islamically
sound nature);
* because a PIP is specific to a property, it need never
again be sold; merely a change of Occupier or of Investors;
* repossession only takes place when continued failure to
pay rental erodes the Equity held in the property;
* increases in Value arising from agreed improvements would
be apportioned between those providing the necessary Investment;
* an Occupier may build up a portfolio of investments in
the properties in which he lives, which may then be flexibly
liquidated upon his retirement. ie a vast improvement on
current "equity release" schemes;
* partners who choose not to marry may yet protect their
interest in a property (and indeed other assets) through
a suitably framed Member Agreement thereby solving
a problem which has been vexing the Law Society for years.
Open Corporate Partnerships and Co-operatives
A Co-operative is not an enterprise structure: it is a set
of Principles that may be applied to different types of
enterprise structure. Considering firstly Limited Companies
operating under the Companies Acts:
* the For Profit Company Limited by Shares is
particularly unsuited to being a Co-operative for reasons
outlined above;
* the mutual company Limited by Guarantee is
restricted in its ability to raise Capital or pay dividends.
Enterprises operating under the Industrial & Provident
Societies legislation, while better able to comply with
Co-operative Principles:
* suffer from the asset locking defect identified
by Cliff Mills;
* in that they favour the interests of other stakeholders,
are relatively restricted in accessing investment;
* are arguably deficient in incentivising innovation.
Consider Partnerships however: the very word partnership
is redolent of collaboration and co-operation in the mutual
pursuit of maximising value. Partners do not
compete with each other they collaborate together,
sharing risks and rewards, rather than seeking to maximise
reward and minimise risk at each others expense. We
are daily bombarded by marketing material referring to partnerships
which are nothing of the kind, being rather supplier/customer
relationships, strategic alliances, joint ventures and the
like.
While a partnership is an inherently Co-operative model
in the way that risks and rewards may be shared, the crippling
factors in practical terms have been, inter alia:
* the liability to which Member partners are exposed from
the actions of their co-partners on their behalf;
* limited ability to raise capital.
The new LLP was expressly created to solve the
former problem by limiting the liability of Member partners
to those assets which they choose to place within its protective
semi-permeable membrane. However, through the
phenomenon described as Temporary Equity the
author believes that the ability to raise capital without
borrowing at Interest confers this new entity with a property
which may render it superior to others.
Furthermore, the Open nature of the LLP - in
terms of the way that any stakeholder may become a Member
allows a resolution of the Asset locking
problem. The relationships between the LLP and its Members,
and between the Members themselves, are covered by the LLP
Agreement which says whatever the Members agree.
In the absence of a written agreement, existing Partnership
Law applies, and this does not as the IT community
put it scale at all well so that for
instance:
* all Members have to agree to the admission of a new Member;
* all profits are shared equally;
both of which would give rise to problems in anything other
than a small partnership.
However, it will be seen that the creation of a Co-operative
Corporate Partnership (CCP) requires only
the drafting of a suitable LLP Agreement. Firstly, a CCP
would incorporate in its LLP Agreement the Statement of
Co-operative Principles published by the International Co-operative
Alliance. Secondly, the LLP Agreement would define the different
classes of stakeholder Members (eg supplier, customer, investor)
and then, through suitable provisions covering majorities
(>50%) or super-majorities (>(say) 75%), it would
be possible to ensure that certain events, such as amendments
to Aims and Objectives, or the disposal of key assets, could
not take place without the agreement of all constituencies
of stakeholder. Thirdly, as in all partnerships, the revenues
net of costs external to the enterprise (ie the surplus
of income over expenditure or profit)
would be divided among Members in accordance with the LLP
Agreement. This means that all Members share a common interest
in collaborating/co-operating to maximise the value generated
by the LLP collectively as opposed to competing with other
stakeholders to maximise their individual share at the other
stakeholders expense.
In summary, the new UK LLP form appears ideally suited for
use by Cooperative enterprises: however, there is one major
legal stumbling block against the widespread adoption of
the LLP, particularly in Social Enterprises
and that is that the legislation provides that a UK LLP
must operate With a View to Profit. The measure
of the importance of the use of the UK LLP as an Open
or Co-operative Corporate Partnership is that
it transcends the very concept of Profit and
Loss and obliges us to look again at exactly
what we mean by Social Enterprises and Charities.
With a View to Profit
A profit is a surplus of income over expenditure available
for distribution in Money to the owners of an
enterprise and in partnerships profits are distributed in
proportional shares as set out in the partnership agreement.
In closed limited liability Companies distribution
is by way of dividend. However, many companies choose not
to pay dividends and to retain the profits, which will be
reflected in the net assets of the company. A shareholder
may be able to realise such retained profits by selling
his shares, particularly where the company is a public company
listed on a Stock Exchange.
Mutual companies limited by Guarantee
and without a Share Capital are denominated Not
for Profit in that while many will retain very significant
accumulated surpluses both for capital investment and current
operating expenditure these reserves are not for distribution
to Members. Industrial & Provident Societies operate
in a very similar way except that a constituency of investors
may receive a limited return on their investment.
We are currently seeing a new wave of Social Enterprises
particularly in the fields of health, housing and transport
which will operate on a Not for Dividend basis.
In other words the objective is to allow service providers
and investors to cover costs and make a reasonable return
on their investment, but without yielding excess profits.
The conflict of interests between stakeholders outlined
above remains, however, and is manageable only by a complex
layer of statutory protection and prescriptive contractual
provisions or, in the case of Charities, a complex layer
of Trust documentation and case law.
The wave of Trusts which are for the
most part Industrial and Provident Societies or Public
Interest Companies - apply a Co-operative veneer to
an inherently divided and flawed form of Capital infrastructure.
At best this is a least worst solution: the
Open capital base of Open Corporate
Partnerships, on the other hand, creates an entirely new
capital paradigm.
Profit and the Open Corporate Partnership
If we open up the Membership of an LLP to include other
stakeholders who were formerly external to the
enterprise then profit takes on an entirely
new perspective. Firstly we can create a Charitable
Enterprise as defined above - quite simply by
allowing the beneficiaries to become Members. The result
is an extremely profitable enterprise in Money
terms since its income is donated. However, the LLP
agreement would specify that these profits will
be distributed only to a particular segment of Members.
Secondly, in a Social Enterprise, we see two
constituencies of Membership: a co-operative of service
providers and a co-operative of service consumers. The latter
will be open in that it is open to anyone in
the relevant community, and will pay an agreed amount in
return for an agreed level of service. Moreover, through
investment in Temporary Equity users
of Social Enterprises will be able to invest in the secure
income stream of such utilities, drawing down upon their
partnership capital account when they utilise the service
provided. A season ticket in a transport utility is an exact
analogy. Such Social Enterprise LLPs are again for
the mutual Profit of all Members, even though this may not
manifest itself in Money terms for all of them: for service
consumers, the dividend takes the form of the service provided.
Finally, there is the Commercial Enterprise
LLP where the object is for a closed group of individuals
to maximise the value generated in their partnership. There
are already over 7,000 of these.
`In essence, the Profit generated in a competitive economy
based upon shareholder value and unsustainable growth results
from a transfer of risks outwards, and the transfer of reward
inwards, leading to a one way transfer of Economic Value.
This, depending on the degree of imbalance in economic power
between the parties, will very often impoverish one or more
constituency of stakeholders materially, intellectually,
spiritually or emotionally. A partnership, however, involves
an exchange of value through the sharing of risk and reward.
Whether its assets are protected within a corporate entity
with limited liability or not, it will always operate co-operatively
for mutual profit.
Towards a Co-operative Society?
It is possible to envisage a Society within which individuals
are members of a portfolio of Enterprises constituted as
LLPs. Some will be charitable, or voluntary, to which
individuals give their time, Money or other value freely.
Others will be social where individual citizens
will invest in and subscribe to (say) health, education,
transport and other utilities through functionally decentralised
partnerships operating at the neighbourhood, community,
area, regional or national levels. These will essentially
be partnerships between co-operatives of service providers
and cooperatives of service consumers ie the public. Finally,
individuals will be Members of Commercial enterprises
of all kinds aimed at co-operatively working together to
maximise value for the Members.
A pipe-dream? In fact, the process has already begun. The
current form of competitive Capitalism was not planned:
it is what is known as an emergent phenomenon
which continues to exist because it has demonstrated itself
to be superior despite its manifest and documented
flaws to all other models, such as Socialism.
It can only be replaced by another emergent
phenomenon, which is adopted virally because
any Enterprise which does not utilise it will be at a disadvantage
to an Enterprise which does. By way of example of emergent
phenomena, we have seen how a 19 year old US programmer
has single-handedly destroyed the entire business model
of the global music industry through inventing on-line sharing
of music in a network which grew to 60 million users within
18 months. In the same way, the small but powerful community
of traders in physical oil moved their negotiations from
the telephone into Yahoo instant messaging chat rooms
without their management even being aware of the fact. They
did so because it was free, because they could, and because
it worked
The Open Corporate Partnership is: capable of
linking any individuals anywhere in respect of collective
ownership of assets anywhere; extremely cheap and simple
to operate; and because one LLP may be a Member of another
it is organically flexible and scaleable. The
phenomenon of Temporary Equity which
is already visible in the form of significant commercial
transactions - enables an extremely simple and continuous
relationship between those who wish to participate indefinitely
in an Enterprise and those who wish to participate for a
defined period of time.
Moreover, the infinitely divisible proportionate shares
which constitute Open Capital allow stakeholder
interests to grow flexibly and organically with the growth
of the Enterprise. In legal terms, the LLP agreement is
essentially consensual and predistributive:
it is demonstrably superior to prescriptive complex contractual
relationships negotiated adversarially and subject to subsequent
re-distributive legal action. Above all, the Open
Corporate Partnership is a Co-operative phenomenon which
is capable, the author believes, of unleashing the power
for good which the founding fathers of the Co-operative
movement strove for in the 19th Century, only to become
bogged down in the 20th.
So perhaps in the Co-operative Corporate Partnership
the unintended consequence of a 21st Century UK legislative
initiative arguably implemented for the wrong reasons in
the wrong way - we now have the means to create a truly
Cooperative Society.
Behind it all is surely an idea so simple, so beautiful,
that when we grasp it in a decade, a century or a
millennium we will all say to each other, how could
it have been otherwise? How could we have been so stupid
for so long? - John A Wheeler
Chris Cook
Published
in "Co-operative Intelligence" July 2004
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