L3C – A new funding mechanism for usBy Jane Hexter
Thinking beyond 501(c)3’s.
The current economic turmoil is creating lots of questions about restructuring the way that we all do business. For some time I’ve been looking at the way that we fund social ventures and wondering if there are different more efficient and more effective options. I’m not alone. There are a many great minds thinking along the same track and some interesting ideas are sprouting up.
Introducing a 501(c)3 and LLC hybrid
One of the most exciting to me is a new legal option – the L3C. The L3C is based on the LLC structure and offers an option for a low profit company that is socially beneficial. In its essence it is a hybrid between a 501 (c)3 and an LLC.
The L3C is the brainchild of Robert Lang, CEO of the Mary Elizabeth & Gordon B. Mannweiler Foundation and was passed into law in Vermont in June 2008. Since it is legal in one state, L3C’s can now be formed in every state in the union for less than a few hundred dollars.
What’s new here?
L3C’s offer a legal structure for low-profit entities that can receive loans and gifts from the private sector as well loans from foundations in the form of Program Related Investments (PRI’s more about these later). It means that a museum and museum shop could be housed under the same legal structure, for example. It could open up avenues for investing in low-profit sustainable agriculture or housing ventures and a myriad other options. I see that this really opens up the options for organizations that are dedicated to the social good.
So does an L3C work?
The L3C is very similar to an LLC in that it is a for-profit entity and can have a wide variety of management and financial structures. However, in order for it to be an L3C it must satisfy 3 criteria:
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.”
Without getting too technical this means that foundations could give to an L3C as a Program Related Investment – a loan not a grant.
What’s a Program Related Investment?
Program related investments are loans made by foundations to organizations that serve the common good. The reason that we don’t hear about them very often is because they are rarely used. The IRS requires that foundations carry the burden of assuring that the PRI is for the social good and penalize the foundation if that is found out not to be the case. So, most foundations will only do a PRI if they get a private letter from the IRS – a costly and time-consuming endeavor.
Why is this significant?
This structure means that because the L3C is inherently formed for the social good, foundations can invest in them and count it as a PRI. This gives foundations another option when investing in organizations.
L3C’s can receive a mix of funding from investment individuals, corporations, or foundations. However, they can be established so that each entity’s initial investment does not have to mirror their equity stake or rate of return. So, for example you could have Foundation X loan $100k and Bank Y loan $100k. For their investment the foundation could choose to have a 30% equity stake and the bank 70% and the foundation could chose to have 1% rate of return and give the bank 6%. In this way, it creates attractive investment propositions for private investors to invest in socially responsible organizations.
And why would a foundation be interested?
Well, first they are making an investment not a grant so they will be able to return the principal to their endowment when they sell their equity stake in the future. Second, they could potentially make a low rate of return on their investment. Third, it broadens the scope of entities that they can invest in.
Want to know more?
This was a really short overview of the L3C legal structure. If it piqued your interest you’ll want to check out http://americansforcommunitydevelopment.org/. There’s a lot of excellent information about the structure on the site and it’s frequently updated.
I think that this structure, and other new funding mechanisms, is an exciting shift in our field that could really help social entrepreneurship flourish in the next decade. I’ll keep you posted on the highlights of other new options as I learn more about them.