By Joseph P. Glackin
March 2017
In a world where choosing the right legal structure can result in various repercussions in how your business is formally run, it is important to understand the differences between the multitude of entities that one can choose from. One legal structure in particular that is often overlooked and thus not often considered is the L3C.
L3C stands for a low-profit, limited liability company, and is often described as a hybrid like structure comprised of both non-profit and for-profit attributes.[1] This hybrid entity is designed to attract private investments and philanthropic capital in ventures designed to provide a socially beneficial objective.[2] Even though the L3C has an explicit primary charitable mission and a secondary profit concern, it is free to distribute the profits to its members just like the standard limited liability company.[3]
Also like the standard limited liability company, the L3C has the same limited liability protection for its members, the same management structure, and the same pass-through tax status and flexibility in ownership, while also having some of the advantages associated with being a non-profit organization. One of these major advantages of the L3C is the myriad of funding options coming from foundations and their program related investments.
Program Related Investments
The IRS mandates by law that foundations have to direct 5% of their assets every year to charitable purposes to keep their tax-exempt status.[4] Foundations have two viable routes for spending this 5%: they can make program related investments, or they can make grants.[5] Grants offer no return on investment, while program related investments offer a potential return. Taking this into consideration, it is easy to understand why program related investments would be the preferred options for foundations. Program related investments means a foundation can make investments in entities with a charitable or educational purpose where making a profit is not a significant goal, which essentially describes the functionality of the L3C structure.[6] This means that funding an L3C can be treated as a legitimate program related investment by foundations.
Therefore, choosing the L3C as a legal structure can provide an influx of funding sources from a myriad of foundations looking to keep their tax-exempt status.[7] These sources of funding are not available to for-profit entities, as a foundation would lose its tax-exempt status if it were to invest in a for-profit business venture. To give you an idea of how large these PRIs can potentially be, the Gates Foundation in 2011 set up a $400 million program related investment fund.[8]
Disadvantages
Even with their seemingly obvious advantages there are also many disadvantages to choosing a L3C. One of the most prominent disadvantages is that only 8 states recognize the L3C as a business organization under their applicable state law; these states being Vermont, Michigan, Wyoming, Utah, Illinois, Louisiana, Maine, and Rhode Island.[9] North Carolina was previously a part of this list, but repealed its recognition of the business organization in 2013. However, as is an option for many other entity structures, one can choose to form their L3C within one of these states, and register as a foreign LLC doing business in that state, but this can definitely be a deterrent for many social entrepreneurs outside of the previously listed states.
Another rather large disadvantage of the L3C is the associated uncertainty of whether the entity would qualify as a program related investment according to the Internal Revenue Service (IRS). This potentially hinders the large pool of investments from foundations, as they do not want to risk losing their tax-exempt status. This often calls for a private IRS letter ruling on whether the L3C would qualify for program related investment status.[10] These private letter rulings can take time and are potentially costly to obtain, so foundations may be hindered from going through with this process entirely. However, L3Cs are required by law to outline their program related investment qualified purpose within their operating agreements. This make the IRS rulings somewhat straightforward, and the process a little easier for foundations to make program related investments in social ventures while ensuring their tax-exempt status remains in place.
Is it Right For You?
The L3C has become a small tool for achieving socially beneficial objectives within society. With this being said, the L3C structure could be a good route for entrepreneurs with socially beneficial objectives, and a limited concern on making a return or profit.[11] If this sounds like you or your business, maybe the L3C structure is the right option for you. However, make sure to take into consideration both the advantages and disadvantages of choosing this entity structure.
Some examples of successful L3C companies are the following:
SEEDR is an Atlanta based L3C dedicated to global health, infrastructure and financial innovation. In 2009 the Gates Foundation gave SEEDR a $539,566 investment to fund the development of “a new line of insulated containers for transporting and storing vaccines and other medicines in developing countries.”[12]
Disruptive Innovations for Social Change is a Michigan based L3C formed with the intent to “help workers, employers, and communities succeed.” In 2010 Disruptive Innovations received a $420,000 investment to document and replicate a model of employer resource networks.[13]
Univicity is a California based L3C organized under Wyoming State law that utilizes information technology to improve the efficiency and effectiveness of humanitarian aid NGOs.[14] In 2011 Univicity received both a $1.32 million investment and an additional $250,000 invesment from the Kay Family Foundation to support the development of their software.[15]
Other L3C entities that have been created throughout the years have been based around “alternative energy, food bank processing, a multitude of social services, social benefit consulting and media, arts funding, job creation programs, economic development, housing for low income and aging populations, medical facilities and practices in developing countries, environmental remediation, and medical research.”[16]
[1] http://www.nonprofitlawblog.com/l3c/
[2] Id.
[3] Id.
[4] https://www.forbes.com/sites/annefield/2012/05/04/irs-rules-could-help-the-fledgling-l3c/#3127621c2970
[5] http://www.triplepundit.com/2009/01/the-l3c-a-more-creative-capitalism/
[6] See https://www.forbes.com/sites/annefield/2012/05/04/irs-rules-could-help-the-fledgling-l3c/#3127621c2970
[7] See http://www.intersectorl3c.com/blog/104163/7726/.
[8] https://www.philanthropy.com/article/The-Gates-Foundation-Reveals/191365
[9] http://cullinanelaw.com/what-is-a-l3c/
[10] http://www.dmlp.org/legal-guide/should-you-form-l3c
[11] http://www.intersectorl3c.com/blog/104163/7726/
[12] https://nonprofitquarterly.org/2014/05/27/social-responsibility-or-marketing-ploy-the-branding-of-l3cs/
[13] Id.
[14] Id.
[15] Id.
[16] http://www.triplepundit.com/2009/01/the-l3c-a-more-creative-capitalism/