A low-profit limited liability company (L3C) is a legal form of business entity in the United States that was created to bridge the gap between non-profit and for-profit investing by providing a structure that facilitates investments in socially beneficial, for-profit ventures while simplifying compliance with Internal Revenue Service rules for "Program Related Investments".
The L3C is a low-profit limited liability company (LLC), that functions via a business modality that is a hybrid legal structure combining the financial advantages of the limited liability company, an LLC, with the social advantages of a non-profit entity. An L3C runs like a regular business and is profitable. However, unlike a for-profit business, the primary focus of the L3C is not to make money, but to achieve socially beneficial aims, with profit making as a secondary goal. The L3C thus occupies a niche between the for-profit and charitable sectors. As of September, 2009, an L3C can only be formed in the states of Michigan, Vermont, Wyoming, Utah, the Crow Indian Nation and the Oglala Sioux Tribe. On August 4, 2009, Gov. Pat Quinn signed Illinois' L3C Bill SBO239 and the law will take effect on January 1, 2010.
Robert M. Lang, the creator of the L3C, CEO of The Mary Elizabeth & Gordon B. Mannweiler Foundation Inc. and CEO of L3C Advisors, L3C the nations very first L3C recommends that you visit the web page for Americans for Community Development for frequent developments on the L3C. Legal Structure
The L3C is a form of limited liability company (LLC) and possesses many characteristics of a typical LLC. Like a traditional LLC, the L3C is a for-profit entity. Like a traditional LLC, the L3C offers a flexible ownership structure, wherein each member’s management responsibility and financial stake may vary according to individual needs. Like a traditional LLC, the L3C’s members enjoy limited liability for the actions and debts of the company. And, like a traditional LLC, the L3C is classified as a “pass-through entity” for federal tax purposes.
However, there is one important distinction between the L3C and the LLC. Although both are profit-making entities, the primary purpose of the L3C is not to earn a profit, but to achieve a socially beneficial objective, with profit a secondary goal. Whereas a traditional LLC may be organized and operated for any lawful business purpose, the L3C must be organized and operated at all times to satisfy the following requirements:
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.”
These three requirements, which must be specified in the L3C’s organizing document, deliberately mirror the requirements in the Internal Revenue Code governing Program-Related Investments (PRIs). Thus, the L3C is designed to meet the IRS requirements for qualifying as a recipient of PRIs. However, the IRS has not ruled on whether investments to L3C's will qualify as PRIs and has publicly stated that foundations may not rely on L3C status in determining whether or not an investment qualifies as a PRI.
PRIs are IRS-sanctioned investments made by private foundations, often into for-profit business ventures, to support a charitable project or activity. PRIs may involve high risk, low return, or both, but are made by foundations despite those apparent drawbacks because they are intended to achieve charitable purposes—and, as a result, receive special treatment under the federal tax law. Federal tax law generally requires private foundations to distribute at least five percent of their assets to social programs every year - or by making socially beneficial "program-related investments" of five percent or more of their assets every year in order to receive their tax benefits.
PRIs usually are structured as below-market-rate loans, but may take other forms as well, including loan guarantees, purchases of stock or other equity security (including membership in an LLC), and letters of credit. For example, the federal tax regulations governing PRIs describe a business enterprise in an economically disadvantaged area that will receive loans from financial institutions only after it receives a below-market loan from a private foundation, and conclude that the foundation’s below-market loan qualifies as a PRI. The tax rules governing PRIs also permit private foundations to join conventional investors in financing enterprises that might—but are very unlikely to—provide the foundation a market-rate return. The key to a PRI is the foundation's motivation in making the investment. The legal form of the recipient is not determinative.
Presently, few foundations choose to make significant PRIs, in large part because of the difficulty and expense of ensuring that a proposed investment will qualify as a PRI. Capital Structure
As a new, hybrid business form, L3C can leverage foundations' program-related investments to access trillions of dollars of market-driven capital for ventures with modest financial prospects, but the possibility of major social impact. An L3C enjoys a flexible ownership structure and can have different classes of investors—individuals, non-profits, for-profits, and even government agencies that have distinct investment goals and are willing to assume different levels of financial risk. Because members of an L3C are not required to assume equal stakes in the venture, the structure of the L3C allows for tiered financing, also known as tranching. Tranching allows for the uneven allocation of risk and reward among investors, thus ensuring some investors a safer investment with lower returns.
At least two tranches of capital are involved in an L3C. The junior tier (or equity tranche)—the capital most at risk in the enterprise—is provided by foundations in the form of PRIs. The foundations holding PRIs in an L3C have the last claim on the assets of the enterprise upon dissolution and, for the reasons discussed above, are willing to accept a below-market rate of return. By allowing foundations to absorb excess risk and receive below-market returns, the junior tranche of PRI capital provides the financial backbone of the L3C, strengthening its balance sheet and positioning it to attract substantial additional capital from non-charitable investors.
The most senior tranche of capital in the L3C is provided by investors that need to generate market rates of return, but would like to invest in projects that provide tangible social benefits. With the PRI capital in place, the L3C can offer market rates of return at acceptable levels of risk to institutional investors (e.g., pension funds, banks, insurance companies, endowments) and other traditional investors. Thus, the L3C's investment structure can bring substantial new pools of funds to bear on problems normally only treatable by non-profit dollars, by providing socially beneficial investments that also are sound, market rate, and commercially viable.
In certain cases, an L3C’s capital structure may also include an intermediate tier, or “mezzanine” tranche, between the higher-risk/lower return junior tier designed for foundations’ PRIs, and the market-risk-and-return senior tier designed for profit-seeking investors. The mezzanine tranche is designed to attract socially-conscious investors whose definition of “return on investment” includes the achievement of socially desirable ends. Mezzanine investors are willing to forego market-rate financial returns and instead accept part of their return in the form of enhanced social welfare. Tax Implications
Although L3Cs are created to advance charitable purposes, they are not charities. Therefore, L3Cs are not exempt from federal or state tax and investments in L3Cs are not tax-deductible. While the L3C is designed to facilitate PRIs by private foundations, these foundation investments are governed by the federal tax rules applicable to PRIs.
Rather, an L3C—like a traditional LLC—is a “pass-through entity,” like a partnership or sole proprietorship. This means that no federal income tax is imposed on the L3C itself. Instead, items of income, expense, gain, and loss “pass through” the L3C to its members, are allocated in proportion to the members’ ownership shares, and are reported on members’ individual tax returns. Though L3Cs by their nature begin as enterprises that are expected to generate low overall profits, those profits are subject to taxation at the rates of tax that apply to their members.
As of July 2009, the IRS had not yet resolved several key questions with respect to the tax treatment of L3Cs. Foremost among these is whether investment by a private foundation in an L3C will constitute prima facie evidence of legitimate PRI. Another unresolved issue is whether profits flowing from an L3C to a tax-exempt member with a similar mission may be less subject to UBIT than if they had come from a traditional LLC. Advantages
* The L3C is a defined entity organized under state laws.
* It would allow the use of the more efficient free enterprise system unburdened by nonprofit regulation.
* Its financial structure would allow the creation of a salable product by the financial industry
* Foundations may buy ownership shares, make loans to, or otherwise financially interact with the L3C, and if these investments qualify as Program Related Investments, all or part of those investments will count towards the foundation's minimum payout requirement.  However, income from the investment must be added to the foundation's minimum payout requirement for the year in which it is received.
* The L3C embodies the operating efficiencies of a for-profit along with a reduced regulatory structure. As an LLC, it can bring together foundations, trusts, endowment funds, pension funds, individuals, corporations, other for-profits and government entities into an organization designed to achieve social objectives while also operating according to for-profit metrics.
* Under L3C status, a foundation (and its partner organizations) retains ownership and management rights in the L3C while possibly recovering its principal investment and potentially realizing a capital gain which, in turn, increases the amount of funds available to dedicate to the foundation’s charitable purposes.
* The L3C creates an opportunity for the investment of private capital to further a social purpose. Because of its tranching structure; an L3C could be partially funded by money intended for prudent investment only such as state pension funds. This opens the door to trillions of dollars not currently available for socially beneficial investment. Applications
* Possible nonprofit structure for museums, concert halls, symphonies, recreational facilities and the hundreds of thousands of nonprofits that perform service for the government under contract, with the government as their primary source of revenue. As long as there is a definable revenue stream; the L3C is a potential vehicle.
* The L3C is also a possible business structure for newspapers. While the IRS has not accepted newspapers as nonprofits, the federal legislation mentions L3C especially and it lists newspapers specifically. The idea of the Newspaper L3C is to bring back those journalistic contributions like neighborhood reporting, music reviews, book sections and even ads and make them part of the community services. An L3C is sustainable because it can tap into foundation money, and because an L3C business must meet a social purpose, it realigns newspaper with their mission of community service. "The participation of the foundation, which is seeking high social return but low monetary return serves as a catalyst for high investor return," said Marc J. Lane, a Chicago-based attorney who authored the Illinois L3C legislation.
* L3C's investors can also offer low-interest loans to needy students, finance low-income housing projects, provide credit to disadvantaged business owners, combat community deterioration, and help alleviate other social strains.
* An L3C allows its investors to buy, say, an abandoned factory, rehab it as a LEED (Leadership on Energy and Environment Design) green building, and lease it at below-market rates to an ambitious, but cash-strapped manufacturer. The entrepreneur could become a successful employer and a catalyst for sustainable urban development. Legislation
* Vermont. The pioneer legislation approving the L3C as a legally-recognized form of business entity (House Bill 0775) was approved by the full Vermont House of Representatives on February 27, 2008 and by the Vermont Senate on April 11, 2008. It was signed into law by Governor of Vermont James H. Douglas on April 30, 2008. As of August 10, 2009 Vermont lists about 60 L3Cs in the state database, including a chess camp, theater, alternative energy companies, publishers, food companies and numerous consulting firms.
* Michigan. Introduced by Traverse City Republican State Senator Jason Allen on July 24, 2008, Senate Bill 1445 was signed into law on January 16, 2009 as an amendment to the Michigan Limited Liability Company Act by Governor of Michigan Jennifer Granholm. The bill was supported by the Council of Michigan Foundations, and the Michigan Department of Labor and Economic Growth.
* Utah. February 2009 - State Senator Lyle Hillyard (Utah politician) from District 25 introduced the Low-profit Limited Liability Company Act S.B. 148 on February 2, 2009. The Act is sponsored in the House by State Representative Kraig Powell of District 54.On March 23, 2009, Utah Governor Jon M. Huntsman Jr. signed the Low-Profit Limited Liability Company Act S.B. 148 into law.
* Wyoming. January 2009 - Wyoming State Representative, Dan Zwonitzer, introduced the L3C bill HB0182. On February 26, 2009 Wyoming Governor Dave Freudenthal signed the L3C Legislation into law.
* Illinois. August 2009 - Gov. Pat Quinn signed Illinois' L3C bill on August 4, 2009. The law took effect on January 1, 2010. The law aims to make it easier for social enterprises to attract capital, said Sen. Heather Steans (D-Chicago), who sponsored the bill. "Foundations have a growing interest to not only make grants that achieve a social purpose but also use investments to do that," Steans said. Chicago attorney and financial adviser Marc Lane of Marc J. Lane Wealth Group, who helped spearhead the Illinois legislation, said the L3C law could create new jobs by supporting social enterprises that otherwise couldn't exist. It's particularly timely given the credit crunch, he said. Proposed Legislation
Legislation allowing the formation of L3Cs is currently being considered in North Carolina, Georgia, Oregon, North Dakota, Tennessee, and Montana. Marc J. Lane, a Chicago lawyer, who helped push for the L3C legislation in Illinois, and is the midst of helping start as many as 50 L3C around the country said this compelling concept has so much energy behind this movement.