The L3C: The For-Profit with the Nonprofit Soul
When Mohammed Yunus spoke at the 2006 Nobel Peace Prize ceremonies honoring his work, he shared a vision of how capitalism could solve “social and economic problems within the scope of the free market.” He extolled the virtues of social businesses and how they could address “almost all social and economic problems of the world.” He suggested that “the challenge is to innovate business models and apply them to produce desired social results cost-effectively and efficiently.”
When Robert Lang (one of the authors of this article) first conceived of the L3C, the initial vision was smaller. As CEO of the Mary Elizabeth and Gordon B. Mannweiler Foundation, all he wanted was a simpler, faster, less expensive and more transparent way for foundations to use the Program Related Investment (PRI) tool. As it developed, it became obvious that the L3C opened the door to a totally different way of achieving socially beneficial goals. This enlightenment came with the help of some early supporters like Tom Blaney, a partner at O’Connor Davies Munns & Dobbins. Others who shared similar visions included Arthur Wood, a former United Kingdom banker and director of social financial services at Ashoka and John Tyler, secretary and general counsel of the Ewing Marion Kauffman Foundation in Kansas City. Retaining Marcus Owens, a former director of the Exempt Division of the IRS and partner in Caplin & Drysdale, allowed the concept to be shaped into a viable law with potential for passage in every state. Additional support came from Steve Gunderson, the CEO of the Council on Foundations (COF) and many more.
The common thread among all those who supported the L3C concept was a desire to find ways to use the vast pool of market-rate investment capital controlled by philanthropies and nonprofit charities to achieve socially beneficial goals. They wanted to encourage patient, low-interest investments in ventures that would create jobs, reverse economic declines, provide access to affordable and needed services and meet environmental sustainability standards. The scale of funds they wanted to move toward such investments exponentially exceeded the little bucket of money given out to the nonprofit sector as grants and charitable donations. The original goal was still there because the PRI investment of a foundation into an L3C could be the leveraging tool that would make that possible. But writing papers, giving speeches and creating awareness is not the same thing as making something happen.
Fortuitously, Jim Jacumin, a state senator from North Carolina, read an article Lang wrote for Worth magazine on the L3C and called. His question was simple: “Can we use the L3C to save the furniture industry in North Carolina?” The answer was “yes,” but he would have to put a bill before the North Carolina Legislature to make the L3C legal. He agreed, and Owens made the process very simple by figuring out how to graft an L3C on to an LLC as a variant form and wrote the very first law for North Carolina. Unfortunately, the bill got bogged down in North Carolina politics and still is. Using the lessons learned there, Lang developed a strategy that has since led the bill to being passed in multiple states.
That early-stage core team created Americans for Community Development (www.americansforcommunitydevelopment.org) as a coalition set up to support the efforts. With the passage of the first L3C law in Vermont in April 2008, L3C Advisors L3C, the world’s first and oldest L3C, was created with Lang as CEO. It has been the resources of that firm that have supported Americans for Community Development and the L3C efforts since then.
Through the L3C model, social enterprise proponents can benefit from a brand that does more than signify good intentions. By law, the “DNA” of the L3C brand ensures that profit is second to its social mission. To attract market-rate capital, L3Cs are free to aggressively pursue earning opportunities that will result in profits for their market-rate members while helping them achieve social aims. A properly organized L3C integrates mission and income and is self-sustaining. As a for-profit, it is also a taxpayer. The members of the L3C, in most cases, will like any LLC be likely to elect pass-through status, which means all profits go directly to the members according to allocations established in the operating agreement.
The L3C business model is exceptionally well suited to play a role in advancing emerging innovations in community development. It is formally recognized by five states and two Tribal Nations and is being used by ventures operating throughout the United States and overseas. The L3C is also rapidly gaining attention from social investment funds, philanthropies, public agencies, economic development organizations and groups involved in economic recovery, food security, agriculture, environmental restoration, alternative energy technologies, the arts, communications, education, health care, infrastructure construction, etc. Businesses operating as L3Cs today include a rural solar energy production farm, a community coffeehouse, a chess camp, a religion-oriented travel service, a cheesecake bakery run by a former Super Bowl star to earn money for prostate cancer screenings, and an entertainment enterprise that provides support for groups presenting at the Edinburgh Fringe Festival. A few have formed to create affordable housing. Plans include L3Cs engaged in the revitalization of the industrial companies of the Rust Belt, furniture manufacturing and processing food for the Montana Food Bank Network. A significant subset has been the exploration of the L3C model as a way to support the survival of newspapers. This effort has gained widespread support, and we may well see several L3C newspapers appear in 2010.
Once registered, an L3C can operate wherever LLCs are recognized because every state must honor every other state's LLCs. The same rule that applies to a Delaware corporation’s authority to operate in Idaho applies to a Vermont L3C’s ability to operate in Nevada.
The L3C has to have a clear description of a social mission in its operating agreement and has to be prepared to demonstrate how it balances that mission with its profit-making concerns. Having this information at hand allows L3C s to provide a case statement to assure foundations that their investment will meet IRS standards for a PRI. Basically, to qualify as a PRI, the investment—which can include loans, guarantees, equity, leases, etc.—must meet the mission objectives of the investing foundation, not be for lobbying purposes and have a risk/reward profile that would normally make the investment violate the standards of fiduciary responsibility. The foundation is not limited in a PRI to any percentage of ownership. It can own 100 percent of an L3C.
The PRI can replace a grant, yet the foundation retains title to the PRI investment. PRIs have been legal for 50 years; however, less than 5 percent of all U.S. foundations have made PRIs. Even fewer have chosen to use PRIs as venture capital to advance programs. Those that have often were large organizations willing to invest in the legal and accounting fees needed to secure predistribution IRS approval.
The L3C as an LLC allows its members to make investments, have responsibilities, receive income and have voting power in disproportionate relationships to one another. The LLC is effectively a partnership with corporate protection. That means that the operating agreement or contract among the members can, within the framework of the law, essentially embody whatever the members agree upon. This makes the L3C well suited to membership by a disparate group of organizations. The membership could include corporations, nonprofits, government organizations and individuals. A nonprofit could be given total day-to-day control and never invest a dime.
Finally, the L3C designation as a brand will come to be recognized by the world at large for what it is. The transparency and efficiency will elevate L3C organizations from obscurity to high public awareness. Once that is achieved, it will be far easier to get public investment in the L3C, which is the eventual goal. We need to greatly reduce the burden on the very limited resources of the nonprofit community and allow businesses to perform many of the services in our society that can be performed under a for-profit umbrella. An L3C will not be exempt from property tax, so its existence makes positive financial contributions to the community.
Recent economic conditions highlight the need for new sources of capital to be brought to bear on social problems. COF has recognized the utility of the L3C as a vehicle to advance new and innovative applications of philanthropy controlled investments. In the spring of 2009, COF made passage of a federal law to simplify the qualification of PRIs a plank in its legislative agenda. This law, the PRI Promotion Act of 2009, will make it easier for L3Cs to receive PRI investments and for newspapers to become L3Cs. The consequences could be tremendous for community development as it would prompt foundations to consider investing in relatively risky ventures that could lead to new technologies, new service models, new job opportunities and new opportunities for communities struggling to sustain tax bases and maintain economic vitality.
The appeal of PRIs and their potential as an investment pool to support L3C business developments is clearly growing. In many respects this is because reports on PRI experiences have been positive and persistent. Unlike other investments made over the past decade, they have retained their equity base and earned income at about 3 percent to 4 percent a year. The opportunities that creative applications of these funds as venture capital could pose for innovative projects are only now beginning to be discovered.
Bridges is a regular review of regional community and economic development issues. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.
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