Understanding low-profit limited liability companies
Low-profit limited liability companies—or L3Cs—are social ventures. They are businesses (rather than nonprofits) that place a higher priority on achieving a social mission than on making profits. Because they are businesses, they enjoy increased access to capital and can potentially offer their funders some return on their investments.
What does it take to be considered an L3C?
According to the U.S. Treasury, L3Cs must:
- Fulfill an educational or charitable purpose
- Have been formed specifically to further that purpose
- Have a primary purpose other than profit-earning
- Have no legislative or political purpose
Many L3Cs provide services to nonprofits. Examples include the Mission Center, a Missouri-based company that provides administrative services to nonprofits, and InterSector Partners, a Colorado company that helps nonprofits achieve sustainability.
How do L3Cs operate?
L3Cs aren't tax exempt. Instead, they're designated "pass through" entities for taxes. As such, L3Cs aren't subject to corporate income taxes but their proprietors pay individual income taxes.
L3Cs are structured according to a tranching system, which allows investors to invest at various levels according to risk. This allows program-related investments (PRIs) and other charitable investors to be accommodated at lower levels of risk, while conventional sources of capital, such as hedge funds, can invest at a higher level of risk. This system allows L3Cs to cultivate traditional sources of venture capital while seeking out investors searching for socially conscious opportunities.
In addition, acquiring funding from PRIs at the low-risk level can help L3Cs raise additional capital from more traditional sources, which can then lead to better returns on the initial investments.
What's the difference between L3Cs and PRIs?
The original L3C model was specifically intended to be compatible with U.S. Treasury regulations for PRIs, which offer investors the benefits of a charitable grant along with the possibility of an eventual profit while offering foundations an alternative to traditional grants. PRIs have commonly been used to fund community development efforts, with other uses requiring specific permission from the IRS.
Initially, PRIs were pioneered by smaller foundations — especially family foundations, which tend to have more flexibility to experiment with alternative funding models. With the growth of social enterprise, however, PRIs are becoming more common even with larger foundations. Recently, for instance, the Bill and Melinda Gates Foundation created a $100 million PRI fund.
By default, states that allow L3Cs automatically allow them to accept PRIs as funding — creating partnerships that offer a social benefit as well as a potential financial benefit.
What's the future of L3Cs?
Although L3Cs can operate in all 50 states, incorporation is currently allowed in certain states only: Illinois, Kansas, Louisiana, Maine, Michigan, Missouri, North Dakota, Rhode Island, Utah, Vermont, Wyoming and the federal jurisdictions of the Crow Indian Nation of Montana and the Oglala Sioux Tribe. Notably, the adoption of L3C legislation has slowed since the advent of alternative social ventures, such as benefit corporations and certified B Corps. It remains to be seen which of these ventures will be most effective at making sustainable, long-term social impact.
This article draws on the expertise of Grace Davies, a Minneapolis-based attorney with special interest in product liability, medical malpractice and employment discrimination.
Forbes: Another reason to become an L3C by Anne Field (2014)
Nonprofit Law Blog: L3C: Low-profit limited liability company by Gene Takagi (2008)
Linking Mission to Money: The L3C: Facilitating socially beneficial investing by Tom Moody
CNN Money: For L3C companies, profit isn't the point by Malika Zouhali-Worrall (2010)
Stanford Social Innovation Review: Benefit corporation and L3C adoption: A survey by Kate Cooney, Justin Koushyar, Matthew Lee and Haskell Murray (2014)