L3C: Pot of Gold or Space Invader?
For-profit companies seek foundation grants and government tax exemptions that presents risks and challenges to the nonprofit sector.
L3Cs are profit-making corporations, but their owners don’t identify profit as their primary purpose.
For-profit companies continue to seek ways to obtain two benefits that are usually reserved for nonprofits: Foundation grants and government tax exemptions. These efforts are led by both well-meaning individuals as well as those that simply want funding without community accountability. Regardless, they present risks and challenges to the nonprofit sector as we know and celebrate it. Rick Cohen tells us of one such effort that appears — in the absence of opposition — to be headed for adoption.
The hot topic in foundation circles is the L3C: the low profit limited liability corporation, the latest development in social enterprise. Several states are legalizing L3Cs and accompanying tax and philanthropic benefits, and its backers are pitching them for federal approval.
L3Cs are profit-making corporations, but their owners don’t identify profit as their primary purpose. The mission of an L3C is a social benefit, doing socially productive and useful things, and only then earning a profit.
At the national level, the Council on Foundations has been actively promoting L3Cs, on Capitol Hill for the past two years. Already in four states and two tribes, individuals can form L3Cs and attract various types of investors, and, because of their charitable missions, tap into foundation loans and guarantees. At least they will be able to if Congress passes legislation giving blanket approval for such loans, or if the Internal Revenue Service (IRS) issues a ruling authorizing them.
There may be some sound reasons for the creation of hybrid models melding features of nonprofits and for-profits, hopefully helping localities and states attract new sources of capital for critical economic and environmental ventures. But states, Congress, and the nonprofit sector might want to be cautious about this social enterprise innovation.
Foundations funding for-profits
Foundations that see nonprofits as vehicles for meeting the foundation’s goals have been using the term “sector agnostic” to describe grantmaking that should look only at a grantee’s ability to meet those goals rather than at the charitable status of a prospective grantee.
L3Cs are part of a movement to expand the scope of charity, eventually including foundation grants and individual donations beyond 501(c)(3) public charities. An increasing number of commentators such as bike ride fundraiser Dan Pallotta advocate changing the tax code so that contributions to (or purchases from) socially minded for-profits would be tax deductable. Opening up private foundation PRIs (Program Related Investments) to L3Cs is part of a dynamic of ostensibly public or social benefit businesses, including B Corporations, to expand the scope of charitable thinking and ultimately charitable support for for-profit corporations as well as nonprofit charities. In the public’s mind and in some of the press commentary, the various states passing L3C laws are seen as conferring something like nonprofit status on for-profit business entities. It isn’t true, but it’s hard not to imagine this as the direction that the movement is headed.
And foundations can already fund for-profits. They can already make Program Related Investments (PRIs), low- or no-interest loans and loan guarantees to entities other than nonprofits if they either get an IRS letter ruling or take “expenditure responsibility” for the investment. They can hire for-profit firms through contracts the same way they “hire” nonprofit organizations through grants. And in the same way that they can invest their capital in less-than-socially-minded companies through the stock market, they can make “mission-related investments” (MRIs) in socially-minded for-profits.
So if foundations can already make loans to nonprofits (including their subsidiary business ventures) through PRIs and can make investments in socially responsible companies through MRIs (getting market returns), why are foundations pushing so hard for the ability to make PRIs to L3Cs?
Why are foundations promoting L3Cs?
Notwithstanding the economic development potential of the L3C model, we think there are two superordinate reasons relating to legitimizing and expanding the “charitable” interactions of foundations with for-profit entities:
First, foundations are looking for more ways to invest in alternatives to the nonprofit sector. Sadly, some foundation executives and social entrepreneurs express, often sotto voce, limited belief in or frustration with nonprofits, despite their public statements to the contrary. One foundation and association leader recently challenged the “assumed exclusive” relationship between foundations and nonprofits. Ralph Smith and his colleagues believe they are in the “solutions” business, eager to find and fund groups with solutions to social problems, with no predisposition that nonprofit foundations ought to be obliged to support nonprofit organizations.
Second, it’s complicated to do PRIs for for-profit businesses (because of the need for IRS letter rulings), but PRIs do count toward required foundation 5% payouts. On the other hand, if a foundation wants to invest in a for-profit, an MRI is easier to do than a PRI, but the MRI doesn’t count toward payout. The L3C innovation, if the IRS gives its blessing, means that a PRI to an L3C would count toward foundation payout.
L3Cs versus 501(c)(3)s
Social entrepreneurs will come through the walls at criticisms of the L3C model and the suggestion that foundation interest in L3Cs isn’t entirely unanimously high-minded and benevolent. They cite instances where the spigots of foundation investments in for-profit ventures may be crucial for economy recovery in areas of high unemployment and desperate economic conditions.
Such a place is Michigan. Michigan’s new L3C statute has resulted in 14 approved and 3 pending L3Cs which see themselves as alternatives to automobile production in struggling areas of the state. In North Carolina, a state senator has been promoting L3C legislation aimed at shoring up the state’s faltering furniture building companies.
At the national level, a big interest of L3C promoters is to attract major foundation investments into the faltering newspaper industry. Senator Benjamin Cardin of Maryland introduced S.673 to make newspapers federally tax exempt if the newspaper is seen as achieving an “educational purpose” and “follows methods generally accepted as educational in character.” There has been plenty of positive commentary within journalism circles of commercial (failing) newspapers as candidates for L3C status.
The upshot for nonprofits
First out of the gate in 2008, Vermont has already recognized 68 L3Cs. Utah has approved only one (the Salt Lake City Ballet Conservatory) with one more pending (the Full Curl Society, a sheep-hunting program reportedly with initial capitalization from former Utah Jazz star Karl Malone). Wyoming has approved one L3C. Illinois just enacted its L3C law. Legislation is moving toward approval in a half dozen other states.
On the positive side, L3Cs could be formed by nonprofits to attract support from people who don’t want to make charitable gifts, but might “give” in return for a minimal rate of return. In an era of declines in charitable giving, low-return investments might be a useful substitute revenue source for some nonprofits.
Maybe L3Cs could get private foundations, normally skittish about mission-related investing, to do so by counting their MRIs toward required foundation payout. For example, an alternative energy program that is having difficulty finding investors in the conventional capital market might be able to get foundation investments.
But the noisy cheerleading for L3Cs may lessen the attention paid to the cautionary issues about these new social enterprises:
- There is no “ceiling” on profit in these “low-profit” entities as one advisor to the L3C movement has commented, or even any real definition of “low profit.” Is it appropriate to have no controls on profit margin? When does some profit become too much profit, if ever?
- What would keep a coffee shop (community building), a soap company (health) or an insurance company (disaster protection) from becoming an L3C and thereby potentially getting tax exemption benefits?
- An L3C requires a profit-making business model, regardless of its socially beneficial goals. While some nonprofits could form L3Cs, many are nonprofits precisely because their activities and functions do not lend themselves to profit.
- In states where L3Cs have been authorized, the state agencies in charge appear to be simply registering them without digging into their bona fides. As a result, the L3C lists, which include remarkably creative and witty corporate names (such as Peace Meals, Coolpass, Explorience, Ecozoic, the Vermont Haunters Club, Badasset, Tails on Trails, and many more), include a number of registered entities whose social missions and programs look, at first glance, somewhat dubious.
- Some foundations might find it easier or more attractive to make PRIs to profit-minded entities than their usual nonprofit partners. Will nonprofits end up competing against L3Cs for PRI dollars?
Pardon us, but we’re not sold on L3Cs. Community nonprofits — arguably the most critically needed and the most innovative segment of the nonprofit sector — will be largely left out of these new financing schemes.
Diversion of foundation funds from nonprofits to for-profits is likely to result in declining health of the nonprofit ecosystem. And notwithstanding their interesting potential for attracting capital investments to struggling newspapers, faltering furniture makers, and new environmental and energy companies, the L3C scheme feels ideologically geared to expanding for-profit options for foundation loan-makers and, potentially in the long run, to foundation grantmakers as well.
Editor’s note: Have the state or national nonprofit associations to which you belong taken up this issue for study and potential advocacy? We need our leadership organizations to be raising debate and making sure that the voices of nonprofits — not just those of foundations and entrepreneurs — are heard in that debate.
See also:
- Social Innovation Fund: Where is the Money Going?
- How to Take a Public Policy Stand, with Sample Criteria
About the Author
Rick Cohen‘s investigative reporting appears in every other issue of Blue Avocado. His articles on the Decline & Fall of the Vanguard Foundation recently won a Min Award for journalism. A memory from his days as Director of Housing and Economic Development for an unnamed city in New Jersey includes giving a conference speech in Atlantic City on real etate tax abatements, and then playing blackjack at the “cheapo $5 table” the rest of the day while waiting for the mayor so they could go home.
Articles on Blue Avocado do not provide legal representation or legal advice and should not be used as a substitute for advice or legal counsel. Blue Avocado provides space for the nonprofit sector to express new ideas. Views represented in Blue Avocado do not necessarily express the opinion of the publication or its publisher.
32 thoughts on “L3C: Pot of Gold or Space Invader?”
Leave a Reply
Related Posts
How does the issue of ownership of the organization/corporation affect this? There is a difference between a furniture company owned by a single individual and a food bank. My common sense approach was that what separated nonprofits was that no entity owned it and therefore profits could not be "swept out" to an owner.
"Will nonprofits end up competing against L3Cs for PRI dollars?" That’s a rhetorical question, yes?
The number of non-profits more than tripled from 1990-2005, from 455,000 to 1.4 million. We make it ridiculously easy for anyone to form a NP, irrespective of the relevancy of a NP’s mission or the ability of its founders to truly fulfill the promise people give to support. And if anyone believes giving has kept pace with this NP proliferation, they’re living on another planet. A shrinking funding pie is being shared by more and more NPs.
I can see L3Cs spelling the end to many NPs. That’s not altogether a bad thing. There are far too many fly-by-night NPs as it is; the field could stand some pruning. But it’s a smack in the face to the focused, hard-working NPs who DO make a tremendous difference in their communities to now be forced to compete with for-profit ventures pretending to serve the public good. The local car wash serves the public good– let’s sign them up!
Dear Anonymous: You’re making some interesting points. The latest IRS databook says that there are 1.8 million tax exempt organizations, about 1.2 million of them 501(c)(3)s. The word I hear from some sources is that despite the recession, the rate of formation of nonprofits is still high, notwithstanding plummeting charitable donations. No nonprofit ought to simply rest on its nonprofit laurels for credibility, there are some clearly dubious ones out there. But the L3C phenomenon isn’t just a matter of L3Cs per se, but of the movement of for-profits angling for charitable benefits and designations. I recall a statement from a senior IRS TEGE official a couple of years ago at a hearing of a House Ways and Means subcommittee that they viewed the development of hybrid organizations as a major accountability challenge. There’s an issue of organizations serving the public good–both nonprofit and other-than-nonprofit–but there’s also an issue of accountability and responsibility to the communities they serve and to the public at large.
Recently, a "leader" in the nonprofit community in our town talked publicly about the challenges posed to NPs by the explosive increase in their numbers combined with a stagnant/shrinking giving base; creating an environment of fighting over "ever thinner pieces of the pie".
It seems that leadership would (should) be focused on exploring ways to "make the pie bigger" to address this issue. Social entreprenuerism, L3Cs among them, provides additional options along the continuum of earned income within NPs, to full 4th sector for-profit organizations providing the economic engine to propel their social missions.
I appreciate the light shed on the potential weaknesses of the L3C model by this article (e.g. profit limitation, potential innapropriate assignment – like insurance companies). I would hope that these discussions would help to shape the development of this model; not throw the baby out with the bathwater.
Dear Anonymous: You’re right, we need discussion of both strengths and limitations of all ideas, including the ideas promulgated by social entrepreneurs, so that we can see what they might contribute to social progress, what they might contribute to enlarging the “pie”, and what they might not do as well. One of the things that happens in our sector is that we don’t do enough thinking and unemotional dialogue around the pros and cons of new ideas. Let’s not throw babies out with the bathwater, but let’s not assume that all new ideas with neat nomenclature and taglines automatically lead to social progress.
You mentioned that two tribes had included L3Cs in their corporation codes. Please tell me which tribe these are. I’m doing research on tribal corporation codes, taxation, and economic development. thanks, sj
SJ,
The Crow Nation and Oglalla Sioux allow for the organization of L3Cs. The Oglala Sioux Tribe formed their first L3C in September, 2010 – Maza Kute L3C. Please contact me if you need additional information.
Rick Zwetsch, Principal Partner
interSector Partners, L3C
1st L3C operating in Colorado
www.interSectorL3C.com
Is the designation LC3 or L3C? thanks, sj
Dear SJ: It’s L3C. Sorry about the typo. Though I saw one writer say that what makes more sense is 3LC–but then where’s the “P”?
What would be the upside/downside of a 501c3 reorganizing as an L3C? Could an educational institution go into a quasi-for profit status by attracting investors? Would the return need to be monetary or could it be a service or product type of return?
EX: as an investor, you would get the service of a certified technician or instructor who has graduated from that institution for an agreed-upon time period as your return on your investment.
Dear Anonymous: I’m not sure about the example you cited, but I would imagine that a nonprofit would view L3C status as enabling it to attract multiple categories of investors expecting different, albeit in most cases low rates of return. Essentially, people who don’t want to donate their money but would be willing to invest it at variously low rates of return in business ventures might invest in a formerly nonprofit L3C whereas they wouldn’t simply grant the money to the nonprofit per se. Of course, an investment is different than a grant, the investor expects some return. On the other hand, unlike a loan, a business investment is not guaranteed, the investor could lose his or her money in the deal. In addition, there’s more latitude in the range of activities an L3C might pursue on a business basis than a nonprofit-sponsored business activity (which if it strays too far from the nonprofit’s charitable purposes triggers UBIT and more). However, that raises one of the problems of L3Cs. So far, the states aren’t exercising much stringency about what constitutes a social purpose in an L3C, so many look like less than stunningly beneficial community activities, though they all aver that they have made profit a secondary purpose. I’m sure Blue Avocado readers know how much can be done with and through the vehicle of a nonprofit (they are nonprofit, but that doesn’t mean that they aren’t supposed to generate revenue; “nonprofit” shouldn’t be seen as synonymous with “red ink”). Some of the L3Cs on the list I’ve seen look like nonprofits and may well have been (I should check IRS publication 78 to see if I can find similar or overlapping corporate names), but it strikes me that some may be looking to an L3C structure as a mechanism of getting “investment” to replace charitable giving that in this recession is not easily captured.
It’s good to see a clear and critical look at L3Cs. Still, a couple of comments on points that might not be clear enough in the original post:
* Currently, L3Cs are for-profit, just like existing LLCs, and so do not enjoy tax exempt status. Likewise, investors do not benefit from any tax deductibility of their contributions. Sure, there are efforts to change that, but the existing legislation is consistent on this point across all states.
* Barriers to use of PRIs are high – letters can cost thousands or tens of thousands, and the presumption by the IRS is that PRIs are not valid unless proven otherwise. That deters foundations from using them even for non-profits today. If it becomes easier to make PRIs, certainly that would cut into available grant dollars. At the same time, PRIs get repaid over time, so that foundations can commit the same money again to social good, while grants are spent and gone (in terms of $, not impact). So there is some element of “increasing the pie” not just redistributing the wedges.
P.S. Crow Indian Nation and Oglala Sioux Tribe.
P.P.S. Check out http://www.americansforcommunitydevelopment.org/ for the advocate’s view, but again, it’s important to keep the critic’s view in mind.
Dear Anonymous: I don’t think the PRI Makers Network thinks that PRIs are that difficult for nonprofits regarding their legality or IRS tax status. See http://www.primakers.net/home for their site. I think the challenge for foundations in making PRIs for nonprofits is the challenge of underwriting a loan or loan guarantee, which is fundamentally what a PRI provides. Having worked with community development financial intermediaries for a significant portion of my professional life, and having sat through interminable loan review meetings looking at construction loans, bridge financing, recoverable grants, lines of credits, loan guarantees, and predevelopment loans, I think that underwriting is a discipline different than making grants. Many writers describe foundations as risk-averse with their grantmaking, you can imagine what many foundation boards think about loaning money to nonprofits. Typically, I think, foundations make PRIs to nonprofits they know well and trust, and many run PRIs through intermediaries (like two that I used to work for) essentially buying their underwriting expertise. Making PRIs for for-profits is a different issue, but for nonprofits, foundations have yet to step up to the plate the way they should (though I hear the Gates Foundation is making a major new commitment to PRIs and Kellogg, by the way, has made a major commitment to MRI investments).
Hello Rick and Anonymous,
First, thanks for your work Rick.
@Anonymous, you ” At the same time, PRIs get repaid over time, so that foundations can commit the same money again to social good, while grants are spent and gone (in terms of $, not impact). So there is some element of “increasing the pie” not just redistributing the wedges.”
Correct me if I am wrong but the phrase “PRIs get repaid over time” should be written as “PRI’s MAY get repaid over time” for two reasons. One, the entity could default. Second and more importantly in the context of this conversation, is that Rick pointed out that PRI’s are a soluntion for foundations to satisfy their 5% requirement. Instead of giving just a straight grant to a 501(c)3, they could give a “PRI grant” to a L3C. This allows for L3Cs to compete for this money which may or may not have to be paid back depending upon the terms that the grantor demands. Is this correct?
That is correct, PRIs may not be paid back if the business deals fall through and PRIs do count toward a foundation’s qualified distributions or “payout.” So, the notion that L3Cs would be prequalified for foundation PRIs does position L3Cs to compete for a portion of foundation payout that would otherwise go to nonprofits and to compete for funds that, if the deals don’t pay out, would be written off by the foundations. They aren’t the same as grants, in that the PRI is supposed to be underwritten against the business deal that is presented by the nonprofit or the L3C, but if the deal goes bad, the PRI is not paid back.
What’s not mentioned here is the devastating impact that a proliferation of L3Cs might have on federal income tax revenues — which will mean continued cuts in government funding for basic human services. For decades, not-for-profits have been expected to "take up the slack" for the declining role of goverment in addressing basic human needs. However, the wealthy never rose to the promise of providing the philanthropic support necessary to compensate. Why? Because they really don’t care about meeting people’s basic human needs.
Now, the wealthy want to make tax advantaged investments in "for profits" that serve purposes more to their liking. It’s double jeopardy for the poor.
Dear Anonymous: Your note raises several good questions. While we always need solid economic analyses on many issues proposed for (or to) charity and philanthropy, I tend to doubt that at least at the moment the L3Cs pose a threat to federal income tax revenues, certainly at their current numbers. Foundations have hardly been putting big PRI dollars into nonprofits, their “presumed” constituency and partners, a pittance compared to their grantmaking totals, in part because they’re often concerned (sometimes unnecessarily) about how the IRS will view their PRIs, so I can’t imagine that there will be huge flow of capital into L3Cs once foundations feel that the IRS is more comfortable with the notion of PRIs into for-profit entities. You have raised an important point, though, about the philanthropic generosity of the wealthy in this nation. I was always a fan of the late Claude Rosenberg’s data. Rosenberg routinely would show that for middle-income families, their charitable giving (itemized on tax returns) was generally pretty close to maximizing what they could afford to give, but he would demonstrate that for higher income and very affluent taxpayers, their charitable giving as a proportion of their incomes was low (and the higher up the income ladder, the lower the proportional charitable giving). As President Clinton left office, his Council of Economic Advisors released a study that looked at charitable giving as a percentage of income and of wealth, demonstrating for the lowest quintile of families with positive net worth, the percentages in both categories were very high. For the remaining top 4 quintiles, the percentages were very very low. The most charitable people you will find, especially in times like these, are often the people who are closest to the people and communities in need of charitable support. It’s the old story of the widow’s mite. I don’t think that is an L3C issue, it’s an issue of how this nation thinks about wealth–and sometimes how our sector does as well (see the responses of many nonprofit and philanthropic “leadership” organizations to President Obama’s proposal to reduce the value of itemized deductions–including but not limited to the charitable tax deduction–as part of his overall plan for financing national health care reform).
Hello Rick, With regards to what you wrote below, it doesn’t take academic research to know this but is nice to have it confirmed. Anyone who has ever worked in a tipped industry knows this. I have worked in Food and Beverage for many years, 11 of them in banquets for a very luxury hotel. The particular niche of banquets at a hotel allows one to see different neatly segregated subsets of society(ethnic, professional, social, etc) and how they act. There are many cultural differences to be observed. The more affluent the group that is attending the tips are less to the point of ZERO for multiple bartenders on multiple bars. The zero figure is VERY common with financial bankers, the people who make the most money. If someone does tip in this group, it is because they have a working man’s background and probably was in the service industry. Doctors, lawyers, financial bankers librarians all tip poorly to NO tips. It really is ridiculous. All areas of tipped employees are able to see these differences: doormen, bell captains. We all talk about it and it is common knowledge. What is ironic is that those who can barely afford to stay at the luxury level, tip the most. They may be there due to a wedding of a rich relative or have a unique opportunity to be there because the company sent them to a conference. One can observe cultural differences in tipping based on religious affiliation. This not against a particular religion but there are cultural differences. Catholics tip the best by far followed distantly by protestants. Jews basically don’t tip. Not anti-semitic. It is a cultural difference for a variety of reasons: e.g some may believe it as an insult to the host to tip when the bar is hosted. The above vary greatly based on the country of origin as well. The Irish and Italians are the best tippers. The Italians will actually compete who tips better..sometimes the Irish do this. It is funny when the Irish or Italians are in one of the subsets above(only observed this in the financial banking subset) and someone doesn’t tip…and they humiliate their colleagues into tipping. Other unrelated observations related to alcohol consumption: Irish and italians drink the most beer in that order. Asians drink the most juice. Indians the most scotch. Jews the most martinis. Rick wrote: "I was always a fan of the late Claude Rosenberg’s data. Rosenberg routinely would show that for middle-income families, their charitable giving (itemized on tax returns) was generally pretty close to maximizing what they could afford to give, but he would demonstrate that for higher income and very affluent taxpayers, their charitable giving as a proportion of their incomes was low (and the higher up the income ladder, the lower the proportional charitable giving)."
Good point that just as lower-income and middle-class people often tip better than wealthy people, they also give larger percentages of their income to nonprofits. After that I can’t say I agree with all the generalizations you make, though!
It is interesting how many writers like you who should do fact checking and interviews before making off the cuff statements do not care as long as they get in “print” somewhere. If you had called me I would have been glad to explain the L3C to you and answer all the question raised above and given you the real facts. Why should you have called me? Because I created the L3C and I could write 5000 words here trying to undo much of what you and others say above but I do suggest that you read our website http://americansforcommunitydevelopment.org/ and then feel free to email me and we can set the record straight. One comment I have to respond to because it is not covered on the website is the one about competition for dollars. First competition for money is the American Free Enterprise system. Nonprofits compete with each other for dollars every day and they compete with other for profit alternatives too. People choose to go out to dinner rather than donate to a food bank. Are they bad? Should restaurants be banned? The L3c is another tool in the tool box and yes it is IRS “approved.” You will find that explained on the website if you read the July 8, 2009 “Caplin & Drysdale Response to Ronald Schultz, Senior Technical Advisor, Tax Exempt & Government Entities Division of the Internal Revenue Service” in the legal section.
Robert Lang, CEO
Mary Elizabeth & Gordon B. Mannweiler Foundation Inc.
rlang@fabriquecosmetique.com
Dear Mr. Lang,
I congratulate you on the creation of the L3C.
It fills a need perfectly.
There are Schools of Philanthropy, such as Indiana University’s.
I wonder if you foresee the establishment of educational programs for L3C ‘s?
Kind Regards,
L.W. Gordon
Dear Mr. Lang: Thank you for your comments. Yes, we had seen the letter from Marc Owens of Caplin & Drysdale taking issue with the representative of the IRS on this issue. Having run the TEGE division of IRS, Owens is of course very knowledgable and influential, and Caplin & Drysdale is a law firm and lobbying entity that organizations representing major nonprofits such as the Council on Foundations have recruited for representation and advocacy.
But we haven’t seen a letter on IRS stationery rather than Caplin & Drysdale stationery suggesting that PRIs for L3Cs are quite as easy as one might hope, thus the effort of the Council and others to get legislation earlier this year that would make the IRS approval clearer and cleaner. We understand that the Council put its advocacy effort for national legislation (as contained in the 2009 Legislative Agenda for Philanthropic Partnership) on L3Cs on hold to see what and how the IRS would actually treat PRI proposals for L3Cs. We’re eager to see that too and we’ll monitor.
We’ll also inquire of the IRS too. Not everyone is quite so sanguine that the IRS has sort of automatically accepted PRIs for for-profit L3Cs as basically the equivalent of PRIs for nonprofits, but we’ll inquire of the IRS directly. Thanks for the tip! We also appreciate your support of the free enterprise system. I don’t think we suggested that restaurants–or L3Cs–should be banned. In fact, we were intrigued with the idea of L3Cs targeted at economically distressed areas and issues, such as the troubled economy of Michigan which needs to progress past dependency on automobile manufacturing or the challenged textile/furniture sectors of North Carolina. Maybe we didn’t make that clear.
But the proof is in the pudding. Regarding competition for nonprofits, yes, nonprofits do compete with each other and with for-profits as well. I don’t think that we suggested that we should put restaurants out of business in order to maximize support for food banks, for-profit housing developers out of business to help nonprofit CDCs, or the like. Not all nonprofits, by any stretch of the imagination, are automatically "good" simply because they possess 501(c)(3) corporate status, not even all the food banks. But we think that there’s a lot more that can and should be done to strengthen the nonprofit sector at a time when nonprofits are facing increasing demands for their services and decreasing resources due to plummeting charitable contributions and troubled state and federal budgets.
One would hope that the L3C phenomenon, as it gets replicated around the nation as it appears headed to do, will strengthen the nonprofit sector, support progressive social justice causes, and expand the resource pie for the social sector.
Rick,
Thank you for your comments clarifying your position. However, I think it is important to note that you will not get (or should not get) anything on IRS stationary because they do not make statements like you are suggesting. Their power is limited to approving or disapproving individual PRI investments after the fact. The only way they actually get notice of same is when a foundation reports one on a 990. In that case it is only investigated if the IRS happens to find it and decides to investigate further. The IRS was never charged with the authority to make prior approval or disapproval of a category of use of grant funds like PRIs into L3Cs. The key point that Marc Owens was trying to make was that in private letter rulings the IRS has approved situations that used LLCs of which the IRS is a variant form hence it has not found any reason to object to LLCs categorically so has no reason not to accept an L3C if in fact it met the rest of the criteria in that particular case. The criteria include looking at the investing foundation’s mission. So, for example, a foundation that had feeding hungry children as its mission would have a lot of trouble justifying a PRI into the rehabilitation of a factory in Detroit even while a foundation that specialized in economic development might have no problem with the IRS.
The key here is that there is no provision in the law requiring foundations to get prior approval from the IRS before making a PRI. There are specific regulations with examples to follow and a good lawyer should be able to navigate that terrain without difficulty. But to do so is to put the lawyer out on the end of the limb so to speak. So since 1969 many attorneys have suggested the private letter route for their foundation clients as it relieves the attorney and the foundation officers of responsibility.
One of my primary objectives with the L3C was to make the process easier by creating a branded template. I think we are slowing seeing positive movement in that direction. COF has worked with us on crafting the PRI Promotion Act of 2009 because it will make that process even easier and because for the first time it would bring true transparency to the PRI process. As strange as it may seem there is no current way for you or anyone else to easily find out what PRIs now exist. To do so you would have to go to GuideStar and look at the 990s for every foundation in the US. The PRI Promotion Act would provide for voluntary registration of PRIs and in effect put them on a par with the registration of a nonprofit. This is only equitable because in essence the registration of a PRI or a nonprofit is merely a statement of intention. The IRS judges the worthiness of an organization to get nonprofit status based almost solely on what it says on its application. After it has received its "approval" foundations are free to give it money without fear of retribution from the IRS.
So why should not L3Cs or other organizations wanting to receive a PRI be able to make similar application to the IRS and received simple approval based on an application form? In both cases what they actually do is what counts. Like a nonprofit the bill would require an organization receiving a PRI to make a social annual report to the IRS. GuideStar has agreed that if our law passes they will be happy to include these reports on their site
For 40 years great myths have grown up about PRIs until the reality has been obscured. Foundations are supposed to decide among a wide variety of alternatives how to achieve various goals they have set for themselves. Sometimes they make good decisions and sometimes they do not. All the alternatives come with various rules and regulations and it is their responsibility to follow them. In the future they are always vulnerable, no matter what they have done, to IRS scrutiny and possible sanction and penalty if the IRS feels they have not complied with the rules and regulations. Even giving to a registered nonprofit does not provide a foundation with blanket immunity from review. So the PRI is just another option already in the rule book and the L3C is a tool designed to facilitate use of that option and make the process less expensive, more transparent and simpler. To that end we also hope it will encourage participation by smaller foundations without the resources to climb the present mountain.
The lack of information on foundation PRIs has always been distressing. The occasional Foundation Center studies on PRIs provide some illumination, but clearly not enough. But the studies do indicate a huge upside to the ability of foundations–large and small–to do PRIs for multiple purposes (the community development intermediaries I’ve worked for have been significant beneficiaries of PRIs, so I’ve seen lots of variety and creativity in how they can be used). I’ve long advocated greater use of PRIs to be sure. Do keep us informed of your progress with L3Cs and PRIs. Thanks.
Dear Mr. Lang: Thank you for your comments. Yes, we had seen the letter from Marc Owens of Caplin & Drysdale taking issue with the representative of the IRS on this issue. Having run the TEGE division of IRS, Owens is of course very knowledgable and influential, and Caplin & Drysdale is a law firm and lobbying entity that organizations representing major nonprofits such as the Council on Foundations have recruited for representation and advocacy.
But we haven’t seen a letter on IRS stationery rather than Caplin & Drysdale stationery suggesting that PRIs for L3Cs are quite as easy as one might hope, thus the effort of the Council and others to get legislation earlier this year that would make the IRS approval clearer and cleaner. We understand that the Council put its advocacy effort for national legislation (as contained in the 2009 Legislative Agenda for Philanthropic Partnership) on L3Cs on hold to see what and how the IRS would actually treat PRI proposals for L3Cs. We’re eager to see that too and we’ll monitor.
We’ll also inquire of the IRS too. Not everyone is quite so sanguine that the IRS has sort of automatically accepted PRIs for for-profit L3Cs as basically the equivalent of PRIs for nonprofits, but we’ll inquire of the IRS directly. Thanks for the tip! We also appreciate your support of the free enterprise system. I don’t think we suggested that restaurants–or L3Cs–should be banned. In fact, we were intrigued with the idea of L3Cs targeted at economically distressed areas and issues, such as the troubled economy of Michigan which needs to progress past dependency on automobile manufacturing or the challenged textile/furniture sectors of North Carolina. Maybe we didn’t make that clear.
But the proof is in the pudding. Regarding competition for nonprofits, yes, nonprofits do compete with each other and with for-profits as well. I don’t think that we suggested that we should put restaurants out of business in order to maximize support for food banks, for-profit housing developers out of business to help nonprofit CDCs, or the like. Not all nonprofits, by any stretch of the imagination, are automatically "good" simply because they possess 501(c)(3) corporate status, not even all the food banks. But we think that there’s a lot more that can and should be done to strengthen the nonprofit sector at a time when nonprofits are facing increasing demands for their services and decreasing resources due to plummeting charitable contributions and troubled state and federal budgets.
One would hope that the L3C phenomenon, as it gets replicated around the nation as it appears headed to do, will strengthen the nonprofit sector, support progressive social justice causes, and expand the resource pie for the social sector.
Rick, As a British organisation, with origins in the US, one of the things that we’d not be able to do in the CIC form of incorporation is the activism and lobbying we engage in to raise awareness of human rights issues.
In our founding paper, we described an economic paradigm rather than a business model, in which “profit for purpose” business could be replicated by a trust fund investment. The same mechanism described as a social investment fund was a feature of more recent work in 2006 with the delivery of the ‘Marshall Plan’ strategy paper to leverage social enterprise.
In the Summary and Conclusions you’ll see our pitch to the US Senate for a social investment fund.
Profit as far as we’re concerned isn’t a question of how much but how deployed for social benefit. Formal CICs have share distribution capped at 35% for instance.
We’d started in 1999 with our founders investment to research and source a development initiative annd microfinance bank in Russia.
I’d use the term surplus revenue rather than profit because as a small business we break even while reducing our incomes to a minimum to provide core funding for the social objective. On the business website, I summarise what progress has been made.
http://people-centered.net/About.aspx
Regards,
Jeff
In Tennessee, a “Low Profit Limited Liability Corporation” bill has been introduced and will be up for a vote when the legislature reconvenes next January. I have been talking with funders, nonprofits and other stakeholders (all of whom were ignorant of the legilsation, most of whom unaware of the L3C LLC) about the potential good, as well as potential pitfalls of the L3C as your “Pot of Gold/Space Invaders” describes.
While I believe the L3C LLC can be beneficial for some nonprofits and social entrepreneurs and their clients and communities, I agree that key stakeholders (funders, nonprofits, regulatory agencies and elected representatives) should work together in crafting the legislation to ensure it does what is intended and is not abused. That is part of my messsage to stakeholders. I have also been encouraging dialogue between local foundations and nonprofits about funding infrastructure and capacity-building as part of the solution to the bigger issue of unsustainable nonprofit business models. We have to find better ways to create sustainable social change and as a community organizer I’ve witnessed good, responsible and accountable outcomes if we can leave our agendas at the door and work together to solve the problem.
Dear Mission Max: Good job on all counts. I just ran across two articles highlighting both the potentials and the pitfalls of L3Cs. A very interesting article from Crain’s Detroit Business (“As L3Cs form, lack of clear criteria leaves room for confusion,” October 11th, sorry the link requires subscriber access) points out some of the problem areas that our article did (some proposed L3Cs with questionable socially beneficial purposes, questions about accountability and transparency, competition between L3Cs and nonprofits, etc.), but another article from the Bangor Daily News (“True Yankee ingenuity launches MOOMilk,” October 10th, http://www.bangordailynews.com/detail/124751.html) describes an L3C established by 10 organic milk producers trying to salvage their locally-owned and -operated farms in Maine. The MOOMilk L3C farmers are trying to raise $500,000 in equity to launch their united business operations. One significant area of attractiveness of L3Cs is where they can serve as mechanisms to boost troubled economic sectors such as family farms in Maine or alternatives to the bygone manufacturing of southeastern Michigan. But instances where L3Cs seem to pop up offering basically the same range of services as existing nonprofits (see the Crain’s article) require the kind of collaborative planning of key stakeholders as you’ve described in Tennessee. Congratulations on your good work.
In Tennessee, a “Low Profit Limited Liability Corporation” bill has been introduced and will be up for a vote when the legislature reconvenes next January. I have been talking with funders, nonprofits and other stakeholders (all of whom were ignorant of the legilsation, most of whom unaware of the L3C LLC) about the potential good, as well as potential pitfalls of the L3C as your “Pot of Gold/Space Invaders” describes.
While I believe the L3C LLC can be beneficial for some nonprofits and social entrepreneurs and their clients and communities, I agree that key stakeholders (funders, nonprofits, regulatory agencies and elected representatives) should work together in crafting the legislation to ensure it does what is intended and is not abused. That is part of my messsage to stakeholders. I have also been encouraging dialogue between local foundations and nonprofits about funding infrastructure and capacity-building as part of the solution to the bigger issue of unsustainable nonprofit business models. We have to find better ways to create sustainable social change and as a community organizer I’ve witnessed good, responsible and accountable outcomes if we can leave our agendas at the door and work together to solve the problem.
Dear Mission Max: Good job on all counts. I just ran across two articles highlighting both the potentials and the pitfalls of L3Cs. A very interesting article from Crain’s Detroit Business (“As L3Cs form, lack of clear criteria leaves room for confusion,” October 11th, sorry the link requires subscriber access) points out some of the problem areas that our article did (some proposed L3Cs with questionable socially beneficial purposes, questions about accountability and transparency, competition between L3Cs and nonprofits, etc.), but another article from the Bangor Daily News (“True Yankee ingenuity launches MOOMilk,” October 10th, http://www.bangordailynews.com/detail/124751.html) describes an L3C established by 10 organic milk producers trying to salvage their locally-owned and -operated farms in Maine. The MOOMilk L3C farmers are trying to raise $500,000 in equity to launch their united business operations. One significant area of attractiveness of L3Cs is where they can serve as mechanisms to boost troubled economic sectors such as family farms in Maine or alternatives to the bygone manufacturing of southeastern Michigan. But instances where L3Cs seem to pop up offering basically the same range of services as existing nonprofits (see the Crain’s article) require the kind of collaborative planning of key stakeholders as you’ve described in Tennessee. Congratulations on your good work.
While L3Cs can be formed in about 10 states now, does anyone know of a resource that compares the legislation of the different states. If one can form L3C in any one of them, what state is the most advantageous the L3C legislation and the tax code of that particular state?
thanks in advance
Great question. It might be not just what state has the most advantageous legislation re the tax code, but which states have the most restrictive and least restrictive L3C standards. Which ones put some or any definition on the notion of “low profit”? Which ones try to put some standards to the social purposes that L3Cs are supposed to meet? Which ones try to control for situations in which a person or group forms an L3C, attracts foundation or charitable investment, and then converts from the L3C to a regular for-profit business structure? I think that a couple of the law professors who have been writing about L3Cs for various law journals–not in the employ of the foundations, nonprofits, and trade associations plumping for L3Cs–might have done something along these lines. I’ll look. Thanks.
Rick,
I might be missing it but does this page have an RSS feed? If not, please would you see about adding one. I would like to subscribe to this page. Thanks.
Yes, if you look in the upper right corner, just below the names of Blue Avocado’s sponsors, you’ll see the words "RSS feed" and the RSS icon. Just click on the icon to subscribe via RSS.