The L3C (Low-profit Limited Liability Company) is a for-profit business entity that, as required under its organizing documents and state law, must have a primary goal of performing a socially beneficial purpose instead of simply maximizing profit. In addition, an L3C must avoid engaging in certain lobbying and political activities. Otherwise, an L3C is organized and treated like an LLC under the law of its state of incorporation.
The L3C’s creator, Robert Lang from the Mannweiler Foundation, came up with the idea for the legal structure while trying to think of ways to streamline and encourage private foundation investment into a for-profit entity which aims to make social impact. Generally speaking, a foundation may not make a monetary investment into a for-profit enterprise because such an investment will jeopardize the foundation’s ability to pursue its tax exempt purposes. The exception recognized by the IRS, known as a “Program Related Investment” (PRI), is an investment into a for-profit entity which is clearly pursuing a charitable endeavor. Therefore, state laws authorizing the formation of an L3C are drafted to dovetail with the federal IRS regulations governing PRIs; the socially beneficial purpose of an L3C must meet the definition of “charitable” under Section 170(c)(2)(B) and an L3C cannot engage in the lobbying and political activities defined in Section 170(c)(2)(D). By limiting the L3C’s activities to those suitable for PRIs, the idea is to encourage PRIs into L3Cs without an attendant private letter ruling from the IRS, which is typically a very costly endeavor.
As explained by Robert Lang, encouraging PRI into an L3C is an ideal way to finance a social business. Under Mr. Lang’s financing theory, a PRI would be the first round of investment into an L3C. Foundations do not seek a high rate of return (indeed, maybe not any return at all) from their investment, and they would be more willing to make a “high risk” investment into an L3C for the social impacts than a traditional venture capitalist. A PRI would provide the business with enough startup capital to prove its idea and gain some traction. After a year or so of operating and proving the business theory, the L3C would be better able to seek a second round of financing from angel investors, who seek a moderate rate of return. And if the business model was successful enough after these first two investment rounds, then potentially large scale venture capital investment, those investors who seek a market rate of return 15% or higher, might be willing to invest in the L3C.
Here’s a (completely fictitious) example. Suppose an entrepreneur has an idea for a unique mosquito net that folds to fit in your pocket. The net is both cost effective and highly efficient at keeping away mosquitoes. Because it’s better than all previous mosquito nets in cost, material, design, and function, the entrepreneur calls it the “Ubernet” and forms an L3C with the same name to seek seed money to fund startup production costs. The Gates Foundation hears of Ubernet and determines that Ubernet furthers its Global Health Program because the company will help eliminate Malaria across the globe. The Gates Foundation makes a $25,000 PRI for Ubernet to produce and deliver Ubernets in Chad. If Ubernet can manufacture and sell the nets for a profit in Chad, it will likely be able to scale that model in other countries. At that point, more traditional equity investors would be much more likely to fund Ubernet.
Currently, 9 states and 2 Indian Nations have adopted legislation to form an L3C within their jurisdiction: Illinois, Louisiana, Maine, Michigan, North Caroloina, Rhode Island, Utah, Vermont, Wyoming, the Oglala Sioux Tribe, and the Crow Indian Nation of Montana.
For more information, I recommend the Americanss for Community Development’s website. The Americans for Community Development is an association of L3C’s, nonprofit organizations, and professionals who created the L3C.
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The article provided above is for general information purposes only and should not be relied on as specific legal advice. This article does not form an attorney-client relationship. If you have any questions about this article, please feel free to contact Peter J. Smith at peter@apexlg.com