Frequently Asked Questions about L3Cs
1. What is the L3C?
The L3C is a low-profit limited liability company -- a variant form of the popular Limited Liability Company (LLC). The LLC combines the best features of a partnership (flexibility, ease of organization, and simplified taxation) with the best features of a corporation (liability protection and easier transferability of ownership.)
The L3C is the brand name for a hybrid structure that links business methods with charitable purposes in a for-profit entity organized to engage in socially beneficial activities. Because L3Cs build on the LLC foundation, they offer a legal and commercial comfort level that stems from the successful experience investors, suppliers, and consumers have had with LLCs over the last generation.
2. Are any L3Cs already in operation?
Yes. The first bill to make the L3C into law passed the Vermont Legislature on April 15, 2008 and was signed by the Governor of Vermont on April 30, 2008. Effective beginning May 1, 2008, foundations and other investors nationwide may now form their own L3C.
While the action by permits investors nationwide to register an L3C under rules, other states are considering L3C legislation. In North Carolina, L3C legislation has passed the Senate and is awaiting action in the House.
3. How can I form an L3C?
To register your corporation as an L3C, please visit the Vermont Secretary of State's Office for more information.
4. How does an L3C differ from a nonprofit charitable organization and how does it differ from a for-profit business?
An L3C is run like a regular business and is profitable. Unlike a for-profit business, however, the primary aim of the L3C is not to make a profit, but to achieve socially beneficial purposes. Profit is a secondary goal. The L3C thus occupies a unique niche between the for-profit and charitable sectors.
5. Can you provide examples of the sort of enterprise that might be organized as an L3C?
L3Cs would typically involve businesses that serve socially beneficial purposes and have some economic viability -- but have difficulty attracting capital because of the high risk, low return, (or both) integral to their operation. A few examples:
1) A hotel in a deteriorating business district would have some ability to generate revenue, but not enough to attract sufficient capital to begin operations.
2) Historic buildings could perhaps be saved and turned into office and retail property, but the costs of renovation may be so steep that the projected rents cannot support market-rate debt incurred to finance those renovations.
3) A factory that has employed much of a town’s work force may need to replace obsolete equipment at great cost, leading its owners to explore relocation of manufacturing operations to a lower-cost foreign jurisdiction.
In all of these situations, an L3C could undertake the low-return, high-risk business activity involved in these situations, with a view to combating economic deterioration, destruction of historic property, or job loss.
6. How will L3Cs attract the capital they need?
Attracting capital is the key to this innovative business vehicle. Under the federal tax laws, private foundations must distribute five percent of their capital each year for charitable purposes. Usually, foundations do this by making grants. However, foundations are permitted to make program-related investments (PRI) instead, and to count funds so invested in determining compliance with the five-percent requirement.
The L3C vehicle is designed to attract PRI investments. In our model L3C operating agreement, the foundation investor would have the last claim on the assets of the enterprise upon dissolution while accepting a rate of return well below the market rate. By absorbing excess risk and accepting less than market rate returns, the foundation investment provides a base of capital that makes the subsequent senior tiers of capital less risky and more profitable.
The most senior tier would generate market rates of return. With the PRI capital in place, the model L3C can offer market rates of return at acceptable levels of risk to investors such as pension funds, community banks, etc.
The third tier in the capital structure of an L3C is a potential intermediate tier, between the high-risk, low-return PRI and the market risk-and-return senior tier. The investors participating in this mezzanine tier includes those investors willing to accept some of its return in the form of enhanced social welfare. This group of investors would be junior to the market-rate tier of capital, but senior to the private foundation PRI-generated capital.
7. How would an L3C be taxed?
In the same way as an LLC is taxed. No federal income tax is imposed on the entity itself. Instead, items of income and expense are allocated among the members of the L3C and reported on their returns as the income is earned. It is important to note that, although the L3C serves charitable ends, it is not exempt from taxation. Though L3Cs by their nature begin as enterprises that are expected to generate low overall profits, if those businesses generate profits, those profits would be subject to taxation at the rates of tax that apply to their investors.
8. Are investments in an L3C
tax deductible?
No. The L3C
is a for-profit entity and investments in an L3C are not
deductible. While the L3C is
designed to facilitate Program Related Investments by foundations, these
investments are governed by the rules governing PRIs rather than the rules
governing charitable contributions.