The L3C, or Low Profit Limited Liability Company, is a new legal entity that can be legally formed in six jurisdictions. The concept started in Vermont and is quickly catching on in other states across the U.S. including Illinois.
How is an L3C different from an LLC?
The L3C’s primary purpose is to conduct activities that further a charitable or educational purpose. Earning a profit is its secondary purpose. Traditional corporate law requires that the owners’ interests are exclusively economic. This has been interpreted to mean that corporate directors have a duty to maximize profits for the company’s owners to the exclusion of virtually any other consideration.
The statutory framework of the L3C turns this traditional view on its head. Instead, the L3C statutes require the managers to pursue the accomplishment of a charitable or educational purpose. They can earn a profit while pursuing their mission, but earning a profit can’t be a significant purpose.
How is an L3C different from a charity?
Unlike a charity, the L3C is not eligible for deductible contributions and most private foundations will not make grants to it. An L3C is also subject to income, gift, and estate taxes. An L3C is, however, permitted to have owners and investors and is permitted to make distributions of profits to them.
Can’t the same result be achieved with a traditional LLC?
LLC statutes are very flexible. An LLC organizer can require a traditional LLC to pursue charitable goals in the governing documents. In fact, it is possible to create an LLC and gain exemption for it by doing just that.
It is also possible to include language requiring the company to pursue charitable goals and business goals and to specify that the company’s charitable purposes will outweigh its financial interest; however, it is unclear whether simply including the L3C language in the governing documents of a traditional LLC would alter the manager’s legal fiduciary duty to the owners of the LLC.
Why does it matter?
By embedding a social purpose into the statutory framework and authorizing the managers of the business to take a broad range of non-economic issues into consideration when making business decisions, the L3C statutes give the owners and managers of the L3C the ability to legally make achieving a charitable or educational mission the company’s overriding purpose without violating fiduciary duties to the company’s owners and investors. It remains to be seen whether the L3C statutory framework will withstand challenges in the courts.
Will it attract additional capital?
It depends. The L3C is not a tax-exempt nonprofit. It’s a for-profit which means it can’t raise funds from donors looking for a charitable tax deduction and it must pay taxes on its income. The L3C may also have trouble raising funds from traditional investors because L3Cs require investors to give up the expectation of profits without providing anything of equivalent value in return.
Still, part of the motivation for creating the L3C was to attract program-related investments (PRIs) from private foundations. Private foundations are generally prohibited from investing funds in overly risky investments.
The PRI rules are an exception to this general prohibition. A PRI is an investment that is higher risk but that furthers the foundation’s mission. Private foundations sometimes make PRIs due to the expectation of a mission-related benefit rather than an economic return.
The L3C legislation closely tracks the tax rules governing PRIs and there is a movement to try to change the tax rules to ensure that L3Cs automatically qualify to be recipients of PRIs.
It remains to be seen whether this movement will be successful. It further remains to be seen whether streamlining the PRI rules for L3Cs will help them to attract PRIs.
Private foundations are currently able to make PRIs in for-profits that meet the PRI criteria so it is unclear whether a streamlined process will motivate them to use this tool more frequently.
Who should consider operating as an L3C?
A company with a charitable or educational mission and little expectation of profit that wants to embed its mission into its governing documents and easily communicate this intent to the world should consider forming an L3C. If there is a possibility of receiving program-related investments that is a bonus; however, without a strong expression of interest from one or more private foundations, it should not be the motivating factor.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.