Achieving Modest Profits and Social Welfare Through an L3C

Michigan recently enacted legislation adopting a new "hybrid" business entity—the "L3C," a low-profit limited liability company. The L3C is designed to promote private investment and philanthropy/social welfare through a single corporate entity.

Individuals and institutions with the means to invest traditionally look either to private enterprise or to charitable giving. If investing for-profit, the investor typically seeks an expected rate of return over 5%; if giving to a non-profit, the donor expects a flat 0% (or negative) rate of return. The Low-Profit Limited Liability Company is able to bring together a variety of entities, such as foundations, trusts, endowments, pension plans, individuals, corporations, other nonprofits and governmental entities to achieve social aims while working pursuant to for-profit status within the 0% to 5% gap. Like the basic LLC, an L3C enjoys the liability protection of a corporation and the organizational flexibility of a partnership. Another advantage is its qualification as a Program Related Investment (PRI) for non-profit entities. Non-profits are permitted to invest in for-profit projects if the project qualifies as a PRI under the tax code. So as not to impair its non-profit status, however, the entity must obtain a costly private letter ruling from the IRS to determine whether its investment qualifies as a PRI; thus, very few non-profits undertake the risk of investing in PRIs. The L3C’s operating agreement, on the other hand, can specifically provide for its qualification as a PRI, thereby protecting its tax exempt status.

Furthermore, an L3C allows access to more investment resources due to the ability of the members to establish layered investing. For example, if a local business determines that it is moving its operations overseas because its current rate of return is 3.5% and it could be more profitable if it invested its resources elsewhere for a rate of return of 7%, the local community loses jobs. A foundation could decide to organize an L3C and attract outside investors to partner with the L3C to purchase the physical plant and operate a business that saves the community those jobs that would have been lost. The Operating Agreement could provide that the foundation has a very low rate of return and its interest is subordinate to all the other investors. The foundation may agree to invest 60% of the capital but receive only 30% of the membership share, and further subordinate its membership to the other investors, allowing the other investors to be paid first, before the foundation. The ability of the foundation to provide capital to the L3C at less than a market rate of return and at a higher risk, lowers the investment risk of other investors while increasing their prospective rate of return.

Layered investing offers flexibility based upon the requirements of the investor. This opens an entire new arena from which nonprofits can engage and partner with an abundance of other entities to achieve important social objectives while permitting profits, within limitations, and attracting investors who may have been previously constrained by fiduciary responsibilities from pursuing philanthropic goals.