Comments on: “L3C” spells “caveat emptor”

By: Low-Profit But How Much Potential? (Part 1) « Art Matters!

Low-Profit But How Much Potential? (Part 1) « Art Matters! — Sat, 04 Jun 2011 20:34:56 +0000

[...] note that I was among the first in our field to note the arrival of the L3C, and I’ve written and debated about it quite a bit since then. Fractured Atlas formed an L3C subsidiary for our insurance program [...]

By: Lele

Lele — Thu, 14 Apr 2011 00:21:11 +0000

Thanks alot – your answer solved all my problems after several days strugginlg

By: Weekend Link Roundup (March 19-20, 2011) | Philanthropy

Weekend Link Roundup (March 19-20, 2011) | Philanthropy — Mon, 21 Mar 2011 02:41:37 +0000

[...] investors may want to think twice before they invest in a limited liability corporation (LC3), writes The [...]

By: Adam Huttler

Adam Huttler — Sat, 19 Mar 2011 16:25:50 +0000

I may have overstated the case. My only point is that investment in an L3C can generally be assumed to be compatible with charitable purposes in a way that investment in an LLC cannot. The language authorizing the formation of L3Cs (at least in Vermont, which is where my experience lies) very closely parallels the language in section 501(c)(3) of the Internal Revenue Code. To that end, I’d think the L3C status of the recipient organization does address (if not exhaustively or definitively) the question of “how the governance and financial structure of the receiving organization ensures that the receiving organization will operate within the PRI requirement.”

I don’t dispute that there are important additional questions related to mission-alignment, etc.

By: Nonprofiteer

Nonprofiteer — Fri, 18 Mar 2011 22:53:10 +0000

Professor, Thanks so much for the expanded explanation of problems with the new form.

By: Daniel S. Kleinberger

Daniel S. Kleinberger — Fri, 18 Mar 2011 16:49:08 +0000

Unfortunately, the assertion that “it’s not unreasonable to think that such investment [in an L3C] could present prima facie evidence of PRI, and perhaps shift the burden of proof from the foundation to the IRS” entirely misses the point about the relationship between a PRI and the foundation. The nature of the PRI recipient could not by itself ever create “prima facie” evidence, because the PRI determination FUNDAMENTALLY and INESCAPABLY requires analysis from the perspective of the foundation. A label on the recipient organization is essentially immaterial to that analysis.

As I’ve tried to explain elsewhere, “[Each time a foundation considers making a PRI, the foundation must make a situation-specific determination that carefully takes into account the foundation’s mission, the purpose of the organization receiving the investment, the relationship of the receiving organization’s purpose to the foundation’s mission, and how the governance and financial structure of the receiving organization ensures that the receiving organization will operate within the PRI requirements.” 35 Del. J. Corp. Law 879, 891 (2010)

By: Nonprofiteer

Nonprofiteer — Thu, 17 Mar 2011 16:59:58 +0000

I agree that the proper term for the relationship between business and charity in the social-entrepreneurial context is “tension” rather than “conflict.” I’m simply less sanguine than you are about the likelihood that foundations will embrace the new form, and more concerned than you are about investors’ likely difficulties in tracking how, and for whose benefit, their invested monies are used. I appreciate your writing, though, and sharing the L3C enthusiast’s perspective.

By: Adam Huttler

Adam Huttler — Thu, 17 Mar 2011 15:27:33 +0000

There is indeed a disconnect between the L3C enthusiasts (of which I am one) and the perspective of the lawyers/regulators. You are correct that, in theory, a regular old LLC can technically do anything an L3C can do, including receive bona fide PRI from a private foundation. (Although one could debate whether operating an LLC in this way would compromise its implicit fiduciary duty to maximize shareholder value.) But you’re ignoring some perceptual issues that are deeply rooted in American philanthropic culture.

Institutional funders are notoriously risk-averse, which is part of why PRI has been so underutilized as a tool for social entrepreneurship. Many also are stuck on the old-fashioned and dangerously simplistic notion that Stuart Levine repeats, namely that there’s an “inherent conflict between ‘charitable’ purposes and ‘business’ purposes.” This reflects a naive and one-dimensional understanding of the ways in which charitable organizations operate and the ways in which their charitable missions can be realized. Yes, clearly there is *tension* between those purposes, but it can just as easily be a healthy, dynamic tension that strengthens the organization’s work as an irreconcilable conflict.

In this cultural context, the L3C is valuable as a powerful signal of charitable intent and long-term commitment to pursuing social ROI; after all, you’ve tied your hands with the entity’s very charter. My hope (and perhaps I’m being naive here) is that foundations will simply be more comfortable investing in an L3C than in a plain vanilla LLC.

Additionally, while the IRS is unlikely to ever establish a bright line rule that investment in an L3C is automatically considered PRI, it’s not unreasonable to think that such investment could present prima facie evidence of PRI, and perhaps shift the burden of proof from the foundation to the IRS.