Thursday, October 22, 2009

Creative Capitalism; L3C, Low-profit Limited Liability Company

From Wikipedia, the free encyclopedia

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".


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 and numerous consulting firms. [9]

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[10] as an amendment to the Michigan Limited Liability Company Act[11] by Governor of Michigan Jennifer Granholm. The bill was supported by the Council of Michigan Foundations[12], and the Michigan Department of Labor and Economic Growth[13].
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. [14]

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 will take effect on January 1, 2010. [2] 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. Chicago attorney and financial adviser Marc Lane of Marc J. Lane Wealth Group, who helped spearhead the Illinois legislation, said the L3C law could create new jobs by supporting social enterprises that otherwise couldn't exist. It's particularly timely given the credit crunch, he said.

The L3C: A More Creative Capitalism

By Jim Witkin | January 15th, 2009

During his 2007 Harvard commencement address, Bill Gates, now the world’s best funded philanthropist, called on the graduates to invent “a more creative capitalism” where “we can stretch the reach of market forces so that more people can make a profit, or at least make a living, serving people who are suffering from the worst inequities.”

It doesn’t take a Harvard grad (or Harvard dropout like Gates) to understand that traditional market forces mostly work against the notion of a socially beneficial enterprise (one that seeks social returns first and financial second). Existing for-profit corporate structures demand a higher financial return than a social enterprise can usually deliver; while non-profit organizations have limited access to capital and a tax-exempt format that limits a strong profit orientation. If the social enterprise field is to evolve and grow, what’s needed is a hybrid of the two forms, a structure that supports a “low profit corporation.”

Enter the L3C (low-profit, limited liability company), a new corporate structure designed to attract a wide range of investment sources thereby improving the viability of social ventures. In April 2008, Vermont became the first state to recognize the L3C as a legal corporate structure. Similar legislation is pending in Georgia, Michigan, Montana and North Carolina. But if the L3C seems like the right choice for your social enterprise, you don’t have to wait! L3Cs formed in Vermont can be used in any state.

Flexible Ownership Attracts a Range of Investors
The goal of the L3C form is to bring together a mix of investment money from a variety of sources. This process starts with investments from Foundations known as Program Related Investments (PRIs). Foundations are required to spend at least five percent of their assets in a given fiscal year in order to maintain their tax-exempt status. They have two basic options for spending their money: they can make grants, where there is no financial return on the money, or they can make program-related investments (PRIs) investing in for-profit ventures and potentially earn a return.
But to qualify as a PRI, the investment must relate to the Foundation’s mission and the risk/reward ratio must exceed that of a standard market-driven investment (ie, the risk must be higher, and the return lower). Surprisingly, the use of PRIs by Foundations is limited even with the potential to earn a small return. Because of burdensome and costly IRS requirements to verify PRIs, many foundations shy away from investing in for-profit ventures due to the uncertainty of whether they would qualify as PRIs.

Unlike the Limited Liability Corporation (LLC), the L3C is explicitly formed to further a socially beneficial mission. The L3C’s operating agreement specifically outlines its PRI-qualified purpose. This should make it much easier for Foundations to make program related investments in social ventures while ensuring their tax-exempt status remains secure.

Like the LLC, the L3C is able to form flexible partnerships where ownership rights can be tailored to meet the requirements of each partner. This flexibility permits a tranched or layered investment and ownership structure. The Foundation’s L3C membership stake provides for a very low rate of return and can be subordinate to the other investors. Because the Foundation can invest through PRIs at less than the market rate while embracing higher risk levels, this lowers the risk to other investors and increases their potential rate of return. So the remaining L3C memberships can then be marketed at risk/return profiles necessary to attract market driven investors.

The end result: the L3C is able to leverage Foundation PRIs to access a wide range of investment dollars through a flexible partnership structure. Additionally, profit and loss flow through the L3C to its members and are taxed according to each investor’s particular tax situation, making it easier for non-profits and for-profits to partner together.

Some examples of L3C entities that have been created or are in the process: carbon trading, alternative energy, food bank processing, social services, social benefit consulting and media, arts funding, job creation programs, economic development, housing for low income and aging populations, medical facilities, environmental remediation, and medical research.

L3C Advocacy
The L3C concept was formed by Robert Lang, CEO of the Mary Elizabeth & Gordon B. Mannweiler Foundation, Inc. Marcus Owens, a tax attorney with Caplin & Drysdale in Washington, DC, wrote the basic law. The Mary Elizabeth & Gordon B. Mannweiler Foundation has funded the Americans for Community Development whose purpose is to promote the L3C and the adoption of this new corporate form in all fifty states. Mr. Lang and others formed the first L3C, L3C Advisors, for the purpose of helping social ventures structure, organize & finance L3C’s.

The L3C is still in “proof of concept” form, but will be put to the test this year. Because the first L3Cs were formed in 2008, this means 2009 will be the first year that the concept will be tested with the IRS. Hopefully, the IRS will readily accept Foundation investments in L3Cs as valid PRIs. Steve Gunderson, CEO of the Council on Foundations, which supports the L3C approach says “we’re optimistic” that the IRS will also support this approach to PRI investing.

The economic realities of connecting social needs with capital markets is leading to innovations like the L3C form. As the problems that social ventures try to solve get bigger and more widespread, hopefully these types of innovations will keep pace.

Nonprofit Law Blog
L3C - Developments & Resources

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