September 13th, 2010

The Low Profit Limited Liability Company (L3C): A new model for Cleantech?

BOSTON -

The L3C or Low Profit Limited Liability Company is a relatively new form of the LLC (Limited Liability Company), that, for now, is only known about and talked about by its advocates, but is quickly spreading across the nation and becoming a revolutionary new way of doing business.

The L3C differs from the LLC in that the primary purpose of the L3C cannot be to make a profit, but rather the purpose of the business must be to achieve a social benefit, with profit as a secondary or ancillary purpose.  The name itself, Low Profit Limited Liability Company, is a bit of a misnomer.  The business is not restricted in how much profit it can make at all.  ‘Show me the Money’ just can’t be the number one goal.

“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.” Wikipedia.com

On a practical level, the L3C does a few things for business owners.  It provides all the benefits of an LLC structure, including flexibility in ownership, management, decision making power, and profit distributions.  It is still a pass through entity for tax purposes and has very little ongoing administrative and corporate governance burdens.  For the socially minded business, in my previous post  Clean Tech Law: Pros and Cons of the B-Corp for Serious Triple-Bottom-Line Business, I addressed how B-Corp certification provides credibility to a business as well as shields the management from shareholder lawsuits for making the sustainable or social decision as opposed to the most economic one.  The L3C provides both that credibility and liability protection for the owners and management, while leaving enforcement to the state and not subjecting the business to periodic audits by a third party.  Plus, great branding and marketing opportunities.

Additionally, and here is the best part…………..the L3C bridges that gap between non-profits and for profits.  Due to the restrictions on an L3C and the requirements for establishing one (see above), the L3C complies with the IRS rules for “Program Related Investments” (PRIs) and opens up possibilities for this additional source of financing.   PRIs are investments made by Private Foundations to for-profit ventures that are in furtherance of a charitable, educational, or religious activity.  They are generally high risk/low reward investments.  Many Private Foundations shy away from making significant PRIs because of the difficulty in verifying that the for-profit is using the funds in furtherance of an eligible activity.  Hmmmm written into the corporate charter and mandated by state law…………..problem solved!*

So here is an entity that solves a lot of problems existing as a result of there being no middle ground between the non-profit and for-profit entities.  Many non-profits spend more time asking for money than they do executing on their mission, due to the restrictions on revenue streams.  For-profits, due to shareholder interests and tax deduction restrictions, have been struggling with maintaining a social mission.  This is an entity that allows for investment and ownership, just as in a for-profit, but can also exist for charitable, educational, or religious purposes.  The L3C is that perfect gray area, middle child.

So why would a clean tech company find this model appealing?  Well it depends on what you are doing and what your mission is.  Social Entrepreneurship is on the rise and clean tech is a great industry for it.  Research and Development costs are high but the ultimate goal is often altruistic.  If your goal is to produce low cost alternative energy production methods, increase consumer access and making them affordable solutions for developing countries, well then this may work for you.  Are you looking to build green communities? Are you the one laptop per child project? E-waste rehabilitation? Water purification?  The list can continue forever.  Most technologies in this space have significant social benefits; it is all a matter of your mindset and ultimate goals.

For those businesses that do want to have a impact on the world 1st and make money 2nd, this structure gives you credibility, liability insulation, branding, access to PRIs as funding, and access to many government R&D grants that require you to be a for-profit entity.

As of now, the L3C is available in Vermont, Michigan, Illinois, Wyoming, Utah, The Crow Indian Nation, and the Oglala Sioux Tribe.  North Carolina, Maine, Louisiana and New York have passed legislation and will start registering L3C’s shortly.  Legislation for the L3C is under consideration in Colorado, Georgia, Oregon, North Dakota, Tennessee, and Montana.  Fingers Crossed!  I am hoping that Massachusetts will jump on board soon.  The L3C is spreading rapidly and entrepreneurs across industries are starting to explore the doors that it can open.

*The Down Side:  Of course, nothing is ever perfect.  For starters, the L3C limits you to an LLC structure and the equivalent for a C-corp is not around just yet.  There is no operating history for this entity, so the legal and tax repercussions are undetermined.  Most L3C statues allow the state to revoke your L3C status and convert you to an LLC if you don’t live up to your “primary purpose” or start focusing more on money than on mission, but how does the state know that? How does the state determine it? What exactly is involved with the conversion and is there shareholder (member) liability there?  This goes as well for the tax side of things.  While the IRS has issued a few non-binding opinion letters, nothing definitive has been said concerning whether investment in an L3C will qualify as a PRI.   Many attorneys don’t want to touch the structure because there are too many unknowns for their clients. I am one of those crazy early adopters that embrace taking calculated business risks and trying out the new toys. J  There are a growing number of us out there that see the potential and excited about these new opportunities for clients.

So bottom line, if you are socially minded, this could be a great entity for you, but tread carefully.

Another new development to watch out for is B-corp legislation, like that being considered in California.  Is there overlap and are we setting ourselves up for a B-corp versus L3C showdown?! Guess you will have to wait until next month to find out.  I know that you are just Dying!

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Jessica Manganello

About Jessica Manganello

Jessisca R. Manganello is an attorney with and founder of New Leaf Legal, LLC . She works with sustainable and emerging businesses in the Boston area on their corporate and intellectual property needs. Passions include everything green, concept cars, food, movies, heavy metal music, body art, and kitty cats. To learn more check out New Leaf Legal and follow her @mangojess .