A common question heard in the credit union industry is the difference between CUSOs and cooperative companies. The issue is even more confused since all credit unions are not-for-profit cooperatives, and CUSOs are owned by credit unions, but CUSOs are not required to be cooperative organizations or even not-for-profit.

This article will take aim at clarifying the legal distinctions between CUSO and cooperative businesses, and further explain when and how a cooperative model makes sense for CUSO companies.

Note: Information in this article only refers to CUSOs owned by natural-person credit unions, not corporate credit union CUSOs.

CUSO companies

A CUSO is a business entity that is owned by either federally chartered or federally insured, state-chartered credit unions. CUSOs provide a huge boon to the credit union industry by allowing credit unions to provide additional services to their members and can provide recurring revenue streams. Revenue generated by CUSOs can help financial institutions stabilize their balance sheet in years with uncertainty clouding interest rates and fee income. CUSOs can also save credit unions a great deal of money on service costs.

From a regulatory standpoint, CUSOs are required to be Class C Corporations (“Inc.”), Limited Liability Companies (“LLC”), or Limited Liability Partnerships (“LLP”). CUSOs are required to be formed and run as a separate entity. If the “corporate veil” is intact, meaning the credit union and the CUSO are legally distinct entities, the CUSO helps insulate the owning credit unions against risk by limiting the credit union’s losses to the amount loaned to or invested in that CUSO for whatever service the CUSO provides.

Credit unions may make an investment in or a loan to the CUSO, but aggregate investments in and loans for CUSOs by federally chartered credit unions may not exceed 1% of unimpaired capital. Credit unions can only invest in or loan to CUSOs that primarily serve credit unions and their members with a permitted service. State-chartered credit unions may have their own specific rules and limitations surrounding CUSO loans and investments.

CUSOs have some restrictions on what services can be provided. Part 712 of NCUA Regulations provides a list of permissible services. The NCUA can approve services not specifically enumerated in Part 712. CUSOs are expected to engage primarily in providing products or services to credit unions or credit union members, but the CUSO does not have to exclusively provide services to credit unions and their members.

CUSOs are subject to some of the same regulations as credit unions. For example, credit unions are required to have in their contracts a clause compelling the CUSO to meet the same Privacy and Security requirements of the Gramm-Leach-Bliley Act before the CUSO is permitted to have access to protected member information.

CUSOs must also agree in a written agreement to account for all of its transactions in accordance with GAAP before a federally insured credit union may invest or loan money to the CUSO. In general, however, CUSOs have more freedom and flexibility than financial institutions. This allows CUSO to focus on the pricing of services that are typically lower than you find on the open market.

Cooperative companies

Cooperatives stand apart from CUSOs. Every credit union is a cooperative, but not every CUSO is a cooperative. Cooperatives are organizations and businesses organized under a state cooperative statute. While different states may vary in how cooperatives are formed, cooperatives tend to have certain traits in common.

Cooperative organizations, including credit unions, require ownership and control of the business to be kept in the hands of the cooperative’s patronage. Because cooperatives operate under the principle of shared ownership and control, no matter the size of a particular ownership stake, each owner only receives one vote. This ensures that no single owner dominates the operation of the cooperative, and the cooperative serves all owners. Note that not every state has laws permitting the existence of cooperative companies.

Cooperative businesses are allowed, in general, to be for-profit, meaning these companies otherwise act in the same manner as they would as a corporation or LLC. Cooperative businesses receive all the benefits of corporate protection, such as limited liability for its owners and transfer of ownership. A cooperative plan is required for most cooperative businesses, where earnings of the corporation are distributed on the basis of, or in proportion to, services rendered by the cooperative.

A unique benefit of being a cooperative is the special tax treatment cooperative organizations receive due to their cooperative status. Under Subchapter T of the Internal Revenue Code, patronage dividends (amount paid to an owner of the cooperative on the basis of quantity or value of business done with the owner) are excluded from the cooperative’s taxable income. This rule reduces or eliminates the “double taxation” issue faced by regular corporations when issuing these dividends. In effect, surplus income generated by the cooperative is returned to members in proportion to their use of the services, usually capped at a certain percentage.

Cooperative businesses, including cooperative CUSOs, make a great deal of sense for owners who have common goals and are looking for a business that will serve credit unions and their members equally. There is less risk that owners will invest purely for financial gain, and a greater incentive to price services fairly. Cooperatives, even though governed as a corporation, tend to be much more sensitive to the needs of its patrons than regular for-profit businesses. For these reasons, cooperatives can be just as competitive, if not more than, for-profit businesses primarily interested in a return to their shareholders.

The downside of cooperative organizations includes the additional overhead needed to ensure the cooperative business is in compliance with the cooperative and federal tax laws. Cooperatives are also unattractive to outside capital who are expecting a high rate of return on their investment and/or a greater degree of control. Cooperative businesses also do not work as well when there are competing interests within the ownership, instead of shared goals.

Cooperative CUSOs prioritize credit union industry collaboration and member success. Many of the same reasons why a person should value the cooperative organization of a credit union apply to cooperative CUSOs providing services to those same credit unions and members. Cooperative CUSOs tend to be very mission-aligned with their credit union patrons.

Practice what we preach

All credit unions should look to form or invest in CUSOs whenever possible. Despite limitations on investment, CUSOs are an invaluable resource to attract and retain members through the provision of low-cost, competitive financial services products. Credit unions should consider the benefits of being a member of a cooperative CUSO.

Because credit unions themselves are cooperatives, there is a much greater chance of a shared vision and values among the cooperative ownership. In turn, cooperative businesses present special tax benefits and are incentivized to price services competitively. CUSOs are a benefit to the credit union industry in a general; cooperative CUSOs have their own special advantages that every credit union should consider when looking to invest.