A low-profit limited liability company (abbreviated L3C) is a legal form of business entity that was created to bridge the gap between
non-profitand for-profit investing by providing a structure that facilitates investments in socially beneficial, for-profit ventures while simplifying compliance with IRSrules for Program Related Investments.
A low-profit limited liability company is a legal form of business entity that can currently be formed only in the state of Vermont. The L3C is a hybrid business structure that combines the business advantages of the limited liability company LLC with a social mission.
An L3C is run like a regular business and is profitable. Unlike a for-profit business, however, the primary aim of the L3C is not to make a profit, but to achieve socially beneficial purposes, with profit a secondary goal. The L3C thus occupies a niche between the for-profit and charitable sectors.
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 meet the IRS requirements for qualifying as a recipient of PRIs.
PRIs are IRS-sanctioned investments made by private foundations, often into for-profit business ventures, to support a charitable 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 purposes—and, as a result, receive special treatment under the federal tax law. Federal tax law generally requires private foundations to distribute 5% of their capital each year for charitable purposes. Foundations usually accomplish this by making grants. However, they also are permitted to make PRIs and count funds so invested toward the 5% distribution requirement.
PRIs usually 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.
Presently, few foundations choose to make significant PRIs, in large part because of the perceived difficulty and expense of ensuring that a proposed investment will qualify as a PRI. The L3C’s unique structure mitigates this concern because the company, by design, must be organized and operated at all times to satisfy the IRS rules for qualifying as a PRI. This should enable a foundation’s proposed investment to qualify as a PRI and streamline the approval process.
As a type of LLC, the L3C enjoys a flexible ownership structure. Its members may be an assortment of individuals, government agencies, foundations, non-profit, and for-profit entities 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 tranching. 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 forego market-rate financial returns and instead accept part of their return in the form of enhanced social welfare.
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.
* Since the L3C is a defined entity organized under state laws (currently only in Vermont), it avoids necessary legal fees and organizational costs associated with PRIs.
* 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 saleable product by the financial industry
* 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.
* It specifically complies with IRS regulations regarding Program Related Investments (PRIs). Foundations may buy ownership shares, make loans to, or otherwise financially interact with the L3C, using all or part of that portion of its assets which would normally be given out annually as grants.
* 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.
* By making PRIs more accessible to private foundations, the L3C allows foundations to satisfy their charitable mandate and possibly generate a modest return in the process. This return must be could be used by the foundation to make additional PRIs or grants, thereby increasing the amount of foundation capital working to advance charitable purposes.
* The L3C also creates a desirable climate for the investment of private capital. 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.
* 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 James H. Douglas on April 30, 2008.
The bill was championed by Representative Michelle Kupersmith and Senator Susan Bartlett and cosponsored by Representatives Judith Livingston, Warren Kitzmiller, Bill Botzow, Ernest Shand, Michael Marcotte, Michele Kupersmith, Clement Bissonnette, Michel Consejo, Susan Davis, and John Clerkin.
Organizations testifying in support of the L3C before the committee include the Mannweiler Foundation, the Hartland Group, the Castanea Foundation, Ashoka, Deutsche Bank, and Caplin & Drysdale, Chartered.
* Proposed Legislation. Legislation allowing the formation of L3Cs is currently being considered in North Carolina, Michigan, Georgia, and Montana.
* [http://www.leg.state.vt.us/database/status/status.cfm Legislative text for Vermont House Bill 0775]
* [http://americansforcommunitydevelopment.org Americans for Community Development]
* [http://www.capdale.com Caplin & Drysdale, Chartered]
* [http://www.nonprofitsassistancefund.org/blog/2008/05/12/where-for-profit-and-nonprofit-meet Balancing the Mission Checkbook: Where For-Profit and Nonprofit Meet]
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