Has the L3C's time come?
New low-profit limited liability corporation is a nonprofit/for-profit hybrid
Stuart Arnett fields a lot of questions about the “L3C” at the end of his company’s name. Most people he encounters have never heard of the L3C. Some, he jokes, might even think it’s a typo.
But Arnett doesn’t mind. He’s quick to explain the L3C, happy to be an ambassador for a relatively new corporate entity that he thinks could be a real game-changer for social entrepreneurs and foundations alike.
In fact, Arnett had never heard of the L3C himself until earlier this year, when he stumbled upon the concept in a Wall Street Journal article about new legal structures for socially minded entrepreneurs.
He was immediately struck by the idea of an L3C — which is common shorthand for “low-profit limited liability corporation.”
The model is a hybrid between a nonprofit and a for-profit corporation and is touted by its proponents as a novel way to bring together public and private funding to further a social purpose. And, he wondered, what better time than now for such a model?
“More people want to do socially responsible investing. It’s not kooky anymore,” said Arnett, who served for more than seven years as head of the New Hampshire Division of Economic Development. “It was kooky 15 years ago, and now it’s kind of mainstream.”
Arnett says that the more he read about the L3C, the more convinced he became that it was the best incorporation vehicle for a new venture he was starting up — a partnership with several people with whom he had worked while he was planning and development director for the city of Claremont.
The members of the group — whose work in the 1990s included the redevelopment of the Claremont mills — were starting up a new firm that aimed to help municipalities across New Hampshire in second- and third-tier markets to redevelop community-owned properties. Their primary goal would be to spur economic development in underperforming areas.
“We kind of wanted to do the for-profit because we wanted to build something that had a bit more flexibility. And having worked with so many nonprofits, they’re all so cash-strapped. We just didn’t want to be in there as one more hungry mouth,” said Arnett. “So we said, ‘Let’s see if we can find some other way of raising private money here.’”
Thus was born the Better Future Alliance L3C. With offices in Hanover and Concord, it is one of the few L3Cs operating in New Hampshire.
Although it’s headquartered in the Granite State, it is incorporated in Vermont, which in 2008 became the first state in the country to adopt the L3C.
Since Vermont pioneered the form, the L3C has since been adopted in a handful of other states — including two others in New England, Maine and Rhode Island — and legislation is pending in several others, including in New Hampshire.
For all its proponents, the L3C has as many critics, who have called into question whether it is necessary or achieves all that it claims.
The L3C is a variant of an LLC, and as such is taxed like an LLC and affords its owners the liability protections and flexible ownership structure of an LLC.
But unlike the LLC, an L3C by definition must have a charitable or educational mission as its primary purpose, with profit only as a secondary goal.
Proponents of the L3C say that the L3C’s greatest benefit is its ability to court funding from a range of sources, including private investors and foundations.
“What an L3C does is it allows federally recognized trusts and foundations to make investments into a project, still meet their IRS requirement, and perhaps keep some of their money instead of all of it just going to a grant,” said Arnett.
To understand the L3C, it’s necessary to understand what a program-related investment, or PRI, is. For foundations and trusts to retain their tax-exempt statuses, they are required by law to distribute at least 5 percent of their net assets each year.
Most of the time, they meet this payout requirement by distributing grants. But they can also fulfill the payout through a tool known as the PRI.
According to Americans for Community Development, a professional organization that promotes the L3C, PRIs are “IRS-sanctioned investments made by foundations, often into for-profit business ventures, to support charitable activities, which may involve the potential return of capital within an established period of time.”
PRIs can take the form of equity, loans, or loan guarantees. According to the IRS, three criteria must be met for an investment to qualify as a PRI:
• Its primary purpose must be to accomplish a charitable or educational purpose.
• No significant purpose of it can be for production of income or appreciation of property.
• It can’t be used for legislative or political activities.
The language behind the L3C was deliberately written in such a way that it would mirror the IRS rules regarding PRIs. So — according to L3C proponents — an investment made in an L3C should automatically qualify as a PRI.
But foundations often have trepidations about PRIs. For one, they can be expensive: Foundations will often ask the IRS to issue a private letter ruling in advance of making the investment to ensure it will qualify as a PRI, which is an expensive and time-consuming process.
Secondly, if a foundation makes an investment that is later found not to have qualified as a PRI, it risks large fines and potentially the loss of its tax-exempt status.
“The problem is, if it’s challenged later and the trust loses, the IRS whacks them with an excise tax that’s several times the investment,” said Arnett. “It’s a real disincentive.”
Arnett said the IRS has been asked to rule generally on whether investment in an L3C automatically qualifies as a PRI, but it hasn’t issued any general ruling on the matter, nor is it likely to do so.
In the meantime, “there will be some trusts that say, ‘We’ll wait until we see more evidence,” said Arnett.
That’s unfortunate, said Arnett, because PRIs can be great tools for foundations and entrepreneurs alike. For the foundations, repaid funds can be recycled for another charitable purpose. Tor entrepreneurs, PRIs can be leveraged to attract more private capital.
The state’s largest foundation, the New Hampshire Charitable Foundation, declined to be interviewed for this story. Kristen Oliveri, the foundation’s communications manager, said in an email: “Since L3Cs are not yet an option in New Hampshire, the foundation hasn’t had a substantive conversation about these organizations.”
Although the Better Future Alliance has had meetings with a few foundations, Arnett said it has yet to find any foundational support, though he remains hopeful that it will as more become aware of the L3C.
“The trick is now to help us find that trust or foundation that wants to take a leadership role in making something happen,” he said.
The L3C has had some high-profile critics. In a white paper published in May, the Business Law Section of the American Bar Association expressed its opposition to L3C legislation, and a March 2009 letter, penned by the National Association of State Charity Officials to the U.S. Senate Finance Committee, raised several concerns about the L3C, including the possibility that charitable funds would be diverted from nonprofits “toward a new and untried corporate form that may lack the supervision state charity officials now exercise over true public charities.”
Count among those skeptics John Cunningham, an attorney at McLane Graf Raulerson and Middleton and the architect of New Hampshire’s new LLC law.
While he believes L3C promoters are well intentioned, he said they “may well be doing more harm than good.”
“It’s not that it’s a scam — it’s just that if you’re going to successfully participate as a charitable foundation — for example, let’s say in a depressed area — it takes more than just being an L3C. The L3C is completely irrelevant,” said Cunningham. “But if you adopt an L3C, this might lead you to think you won’t have the same sort of careful monitoring obligations and that you might otherwise have, and in fact qualifying for these favored qualified tax programs is a demanding process that takes substantial care.”
Expect to hear about these concerns and more in the upcoming legislative session in Concord, when one of Arnett’s partners in the alliance — Ray Gagnon, a Democratic state representative from Claremont — plans to introduce L3C legislation in the House.
It will join SB 352, an L3C bill introduced by Sen. Sharon Carson, R-Londonderry, and tabled last session.
As Arnett pointed out, that means the measure will have support from both sides of the aisle and chambers.
That is welcome news for Dave Boynton, director of Seacoast Local and founder of 7th Settlement in Dover, the country’s first community-supported brewery, which aims to open in early 2013.
In a post on the brewery’s blog last year, Boynton had asked readers whether it should incorporate locally as an LLC in New Hampshire or as an L3C in Vermont. (He settled on the former.)
“I’d love to have the model accepted in the Legislature, same with the B Corporation (a benefit corporation, requiring the corporation to create general benefit for society as well as for shareholders) — I think that would be great for larger companies,” Boynton told NHBR. “We’re starting a community-supported brewery, (and) the business models we use with presale and community capital and local investors really would lend toward incorporating as an L3C, but it’s just not available here.”
On the blog post, someone chimed in from The Starving Artist, a nonprofit creative collective in Keene.
“We want to do this in our home state as well,” the post read. “Perhaps we can exchange thought and make some committed voices heard in this arena. I know there are more thinking the same thing. Good luck and I am sure we will meet up down the road.”