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A low-profit limited liability company (L3C) is a legal form of business entity in the United States that was created to bridge the gap between non-profit and for-profit investing by providing a structure that facilitates investments in socially beneficial, for-profit ventures while simplifying compliance with Internal Revenue Service rules for "Program Related Investments".

Background

The L3C is a low-profit limited liability company (LLC), that functions via a business modality that is a hybrid legal structure combining the financial advantages of the limited liability company, an LLC, with the social advantages of a non-profit entity. An L3C runs like a regular business and is profitable. However, unlike a for-profit business, the primary focus of the L3C is not to make money, but to achieve socially beneficial aims, with profit making as a secondary goal. The L3C thus occupies a niche between the for-profit and charitable sectors.

As of September 6, 2010 an L3C can be formed in the states of Michigan, Vermont, Illinois, Wyoming, Utah, Louisiana, the Crow Indian Nation, and the Oglala Sioux Tribe. North Carolina passed L3C legislation with Senate Bill 308, signed by the governor on August 3, 2010. Maine has passed L3C legislation that will become effective on July 1, 2011. Once formed in any of these states, the L3C can operate legally in all 50 states.

The idea behind the L3C model grew out of a 2006 meeting convened by the Aspen Institute’s Nonprofit Sector and Philanthropy Program and titled “Exploring New Legal Forms and Tax Structures for Social Enterprise Organizations.” Legal, financial, and other experts gathered to discuss the myriad issues that the growing Fourth Sector faces. The key question that emerged was whether traditional business structures and nonprofit tax laws are hindering the growth of hybrid social enterprise models.

It was at this meeting that Robert Lang, who is also President of the Mary Elizabeth & Gordon B. Mannweiler Foundation; Marcus Owens, a partner with the Washington, D.C., law firm Caplin & Drysdale and former director of the Exempt Organizations Division of the Internal Revenue Service; and Arthur Wood, director of Social Financial Services for Ashoka, an international organization that promotes social entrepreneurship and socially responsible investing; met and after the foundation hired Owens for the project began collaborating to create a business model that would address, among other things, two key challenges for social enterprise development: federal tax law and “patient" capital.

Legal Structure

The L3C is a form of limited liability company (LLC) and possesses many characteristics of a typical LLC. Like a traditional LLC, the L3C is a for-profit entity. Like a traditional LLC, the L3C offers a flexible ownership structure, wherein each member’s management responsibility and financial stake may vary according to individual needs. Like a traditional LLC, the L3C’s members enjoy limited liability for the actions and debts of the company. And, like a traditional LLC, the L3C is classified as a “pass-through entity” for federal tax purposes.

However, there is one important distinction between the L3C and the LLC. Although both are profit-making entities, the primary purpose of the L3C is not to earn a profit, but to achieve a socially beneficial objective, with profit a secondary goal. Whereas a traditional LLC may be organized and operated for any lawful business purpose, the L3C must be organized and operated at all times to satisfy the following requirements:

1. The company must “significantly further the accomplishment of one or more charitable or educational purposes,” and would not have been formed but for its relationship to the accomplishment of such purpose(s);

2. "No significant purpose of the company is the production of income or the appreciation of property” (though the company is permitted to earn a profit); and

3. The company must not be organized “to accomplish any political or legislative purposes.”

These three requirements, which must be specified in the L3C’s organizing document, deliberately mirror the requirements in the Internal Revenue Code governing Program-Related Investments (PRIs). Thus, the L3C is designed to mirror the IRS requirements for qualifying as a recipient of PRIs. However, the IRS has not ruled on whether investments to L3C's will qualify as PRIs and has publicly stated that foundations may not rely on L3C status in determining whether or not an investment qualifies as a PRI. According to Robert Lang, this is because the IRS has no authority to grant blanket approval to a class of business entity. However, in private letter rulings on PRIs the IRS has approved PRIs utilizing the LLC of which the L3C is a variant form.

PRIs are investments made by private foundations, into for-profit business ventures, to support a charitable, educational, or religious project or activity. PRIs may involve high risk, low return, or both, but are made by foundations despite those apparent drawbacks because they are intended to achieve charitable, educational or religious purposes—and, as a result, receive special treatment under the federal tax law. Federal tax law requires private foundations to distribute approximately five percent of their assets every year in grants - or by making "Program-Related Investments". Program Related Investments have been part of the law since 1969.

PRIs often are structured as below-market-rate loans, but may take other forms as well, including loan guarantees, purchases of stock or other equity security (including membership in an LLC), and letters of credit. For example, the federal tax regulations governing PRIs describe a business enterprise in an economically disadvantaged area that will receive loans from financial institutions only after it receives a below-market loan from a private foundation, and conclude that the foundation’s below-market loan qualifies as a PRI. The tax rules governing PRIs also permit private foundations to join conventional investors in financing enterprises that might—but are very unlikely to—provide the foundation a market-rate return. The key to a PRI is the foundation's motivation in making the investment. The legal form of the recipient is not determinative.

Presently, few foundations choose to make significant PRIs, in large part because of the difficulty and expense of ensuring that a proposed investment will qualify as a PRI.

Capital Structure

As a new, hybrid business form, L3C can leverage foundations' program-related investments to access billions of dollars of market-driven capital for ventures with modest financial prospects, but the possibility of major social impact. An L3C enjoys a flexible ownership structure and can have different classes of investors—individuals, non-profits, for-profits, and even government agencies that have distinct investment goals and are willing to assume different levels of financial risk. Because members of an L3C are not required to assume equal stakes in the venture, the structure of the L3C allows for tiered financing, also known as Tranche. Tranching allows for the uneven allocation of risk and reward among investors, thus ensuring some investors a safer investment with lower returns.

At least two tranches of capital are involved in an L3C. The junior tier (or equity tranche)—the capital most at risk in the enterprise—is provided by foundations in the form of PRIs. The foundations holding PRIs in an L3C have the last claim on the assets of the enterprise upon dissolution and, for the reasons discussed above, are willing to accept a below-market rate of return. By allowing foundations to absorb excess risk and receive below-market returns, the junior tranche of PRI capital provides the financial backbone of the L3C, strengthening its balance sheet and positioning it to attract substantial additional capital from non-charitable investors.

The most senior tranche of capital in the L3C is provided by investors that need to generate market rates of return, but would like to invest in projects that provide tangible social benefits. With the PRI capital in place, the L3C can offer market rates of return at acceptable levels of risk to institutional investors (e.g., pension funds, banks, insurance companies, endowments) and other traditional investors. Thus, the L3C's investment structure can bring substantial new pools of funds to bear on problems normally only treatable by non-profit dollars, by providing socially beneficial investments that also are sound, market rate, and commercially viable.

In certain cases, an L3C’s capital structure may also include an intermediate tier, or “mezzanine” tranche, between the higher-risk/lower return junior tier designed for foundations’ PRIs, and the market-risk-and-return senior tier designed for profit-seeking investors. The mezzanine tranche is designed to attract socially-conscious investors whose definition of “return on investment” includes the achievement of socially desirable ends. Mezzanine investors are willing to forgo market-rate financial returns and instead accept part of their return in the form of enhanced social welfare.

Tax Implications

Although L3Cs are created to advance charitable purposes, they are not charities. Therefore, L3Cs are not exempt from federal or state tax and investments in L3Cs are not tax-deductible. While the L3C is designed to facilitate PRIs by private foundations, these foundation investments are governed by the federal tax rules applicable to PRIs.

Rather, an L3C—like a traditional LLC—is a “pass-through entity,” like a partnership or sole proprietorship. This means that no federal income tax is imposed on the L3C itself. Instead, items of income, expense, gain, and loss “pass through” the L3C to its members, are allocated in proportion to the members’ ownership shares, and are reported on members’ individual tax returns. Though L3Cs by their nature begin as enterprises that are expected to generate low overall profits, those profits are subject to taxation at the rates of tax that apply to their members.

As of July 2009, the IRS had not yet resolved several key questions with respect to the tax treatment of L3Cs. Foremost among these is whether investment by a private foundation in an L3C will constitute prima facie evidence of legitimate PRI. Another unresolved issue is whether profits flowing from an L3C to a tax-exempt member with a similar mission may be less subject to UBIT than if they had come from a traditional LLC.

Advantages

• The L3C is a defined entity organized under state laws.
• It would allow the use of the more efficient free enterprise system unburdened by nonprofit regulation.
• Its financial structure would allow the creation of a salable product by the financial industry
• Foundations may buy ownership shares, make loans to, or otherwise financially interact with the L3C, and if these investments qualify as Program Related Investments, all or part of those investments will count towards the foundation's minimum payout requirement. However, income from the investment must be added to the foundation's minimum payout requirement for the year in which it is received.
• The L3C embodies the operating efficiencies of a for-profit along with a reduced regulatory structure. As an LLC, it can bring together foundations, trusts, endowment funds, pension funds, individuals, corporations, other for-profits and government entities into an organization designed to achieve social objectives while also operating according to for-profit metrics.
• Under L3C status, a foundation (and its partner organizations) retains ownership and management rights in the L3C while possibly recovering its principal investment and potentially realizing a capital gain which, in turn, increases the amount of funds available to dedicate to the foundation’s charitable purposes.
• The L3C creates an opportunity for the investment of private capital to further a social purpose. Because of its tranching structure; an L3C could be partially funded by money intended for prudent investment only such as state pension funds. This opens the door to trillions of dollars not currently available for socially beneficial investment.

Applications

• Possible nonprofit structure for museums, concert halls, symphonies, recreational facilities and the hundreds of thousands of nonprofits that perform service for the government under contract, with the government as their primary source of revenue. As long as there is a definable revenue stream; the L3C is a potential vehicle.
• The L3C is also a possible business structure for newspapers. While the IRS has not accepted newspapers as nonprofits, the federal legislation mentions L3C especially and it lists newspapers specifically. The idea of the Newspaper L3C is to bring back those journalistic contributions like neighborhood reporting, music reviews, book sections and even ads and make them part of the community services. An L3C is sustainable because it can tap into foundation money, and because an L3C business must meet a social purpose, it realigns newspapers with their mission of community service.
• L3C's investors can also offer low-interest loans to needy students, finance low-income housing projects, provide credit to disadvantaged business owners, combat community deterioration, and help alleviate other social strains.
• An L3C allows its investors to buy, say, an abandoned factory, rehab it as a LEED (Leadership on Energy and Environment Design) green building, and lease it at below-market rates to an ambitious, but cash-strapped manufacturer. The entrepreneur could become a successful employer and a catalyst for sustainable urban development.

Legislation

• Vermont. The pioneer legislation approving the L3C as a legally-recognized form of business entity (House Bill 0775) was approved by the full Vermont House of Representatives on February 27, 2008 and by the Vermont Senate on April 11, 2008. It was signed into law by Governor of Vermont James H. Douglas on April 30, 2008. As of August 10, 2009 Vermont lists about 60 L3Cs in the state database, including a chess camp, theater, alternative energy companies, publishers, food companies such as Maine's Own Organic Milk Company, and numerous consulting firms.

• Michigan. Introduced by Traverse City Republican State Senator Jason Allen on July 24, 2008, Senate Bill 1445 was signed into law on January 16, 2009 as an amendment to the Michigan Limited Liability Company Act by Governor of Michigan Jennifer Granholm. The bill was supported by the Council of Michigan Foundations, and the Michigan Department of Labor and Economic Growth.

• Utah. February 2009 - State Senator Lyle Hillyard (Utah politician) from District 25 introduced the Low-profit Limited Liability Company Act S.B. 148 on February 2, 2009. The Act is sponsored in the House by State Representative Kraig Powell of District 54.On March 23, 2009, Utah Governor Jon M. Huntsman, Jr. signed the Low-Profit Limited Liability Company Act S.B. 148 into law.

• Wyoming. January 2009 - Wyoming State Representative, Dan Zwonitzer, introduced the L3C bill HB0182. On February 26, 2009 Wyoming Governor Dave Freudenthal signed the L3C Legislation into law.

• Illinois. August 2009 - Gov. Pat Quinn signed Illinois' L3C bill on August 4, 2009. The law took effect on January 1, 2010. The law aims to make it easier for social enterprises to attract capital, said Sen. Heather Steans (D-Chicago), who sponsored the bill. "Foundations have a growing interest to not only make grants that achieve a social purpose but also use investments to do that," Steans said.

• New York. February 2009 - State Senator William Stachowski from District 58 introduced the Low-profit Limited Liability Company Act S6726 on February 1, 2010. The Act is now sponsored in the Assembly by Assemblyman James F. Brennan of District 44.

• North Carolina. February 2009 – North Carolina State Senator Jim Jacumin introduced Senate Bill 308, which was passed by the N.C. Senate in July 2009. On July 9, 2010 it was presented to N.C. Governor Perdue for signature. It was signed into law on August 3, 2010.

• Maine. December 2009 – Maine Representative Charles Priest introduced Senate Bill 1580, which passed by the Senate on April 2010. On April 9, 2010 Maine Governor John Baldacci signed the Act To Replace the Maine Limited Liability Company into law.

• Louisiana. June 2010 - Louisiana Representative Landry introduced House Bill 1421, which was signed into Act No. 417 in June 2010. This act authorizes the formation of low-profit limited liability companies in Louisiana.

Proposed Legislation

Legislation allowing the formation of L3Cs is currently being considered in Georgia, Oregon, North Dakota, Tennessee, Arkansas, and Arizona. The Arizona legislation, proposed in February 2011 by Senator Adam Driggs as SB 1503, is part of an effort headed by Phoenix attorney Pouria Paknejad.

See also

• Community interest company (similar legal structure under United Kingdom law)
• Social entrepreneurship
• Triple Bottom Line business theory

References

1. http://www.cof.org/files/Bamboo/programsandservices/publicpolicy/documents/schultzletter.pdf
2. Meyer, Ann (Monday, December 28, 2009 “Nonprofits benefit from for-profit practices”. The Chicago Tribune.
3. Sally Duros (9 February 2009). "How to Save Newspapers". The Huffington Post. Retrieved 14 May 2009.
4. Meyer, Ann (Monday, August 10, 2009). "New corporate structure could give social entrepreneurs new funding stream". Chicago, IL: Chicago Tribune. Retrieved 10 August 2009. {{cite news}}: Check date values in: |date= (help)
5. http://www.michiganfoundations.org/s_cmf/bin.asp?CID=10388&DID=23108&DOC=FILE.PDF
6. http://www.crainsdetroit.com/article/20090222/SUB01/302229972/1069
7. http://www.michiganfoundations.org/s_cmf/sec.asp?CID=6766&DID=14917
8. http://www.michigan.gov/documents/dleg/Analysis_of_Enrolled_L3C_Bills_261198_7.pdf
9. http://le.utah.gov/~2009/bills/sbillamd/sb0148.htm
10. Lane, Marc (January 2010), "The Illinois Low-profit Limited Liability Company" | url = http://marcjlane.com/clientuploads/l3cbook.pdf. Senator Steans' Office.
11. http://blog.taragana.com/n/rc2-prices-public-offering-of-4m-shares-at-15-per-share-for-571m-in-proceeds-130787/
12. http://open.nysenate.gov/legislation/bill/A6116-2011
13. , State of Maine Legislature.
14. http://www.ncga.state.nc.us/gascripts/BillLookUp/BillLookUp.pl?Session=2009&BillID=S308
15. , General Assembly of North Carolina.
16. , Legislature of Louisiana.
17. http://www.azleg.gov/DocumentsForBill.asp?Bill_Number=SB1503&Session_ID=102
18. http://www.americansforcommunitydevelopment.org/legislativewatch.html

External links

• Americans for Community Development
• Reevaluating the L3C: Mistaken Assumptions and Potential Solutions
• L3C Tally - list updated weekly - who's organizing L3Cs and where
• White Paper: Who is the L3C Entrepreneur? The pioneers of social enterprise's revolutionary new suffix
• Who is the L3C Entrepreneur? Resource List
• Vermont's Early Social Hybrid Pioneers: Early Observations and Questions to Ponder
• Balancing the Mission Checkbook: Where For-Profit and Nonprofit Meet
• Legislative text for Vermont House Bill 0775

• Types of business entity
• Corporate taxation in the United States
• Social economy