A remarkably clear statement of what’s wrong with L3Cs. . .

for which the Nonprofiteer can take no credit.  Rather, thanks to her friend, Baltimore tax lawyer Stuart Levine, for laying out so clearly the problem with low-profit limited-liability companies, the latest fad in efforts to do well by doing good.  Stuart’s argument appears in response to, among other things, a recent New York Times report that foundations have increased the proportion of their “grants” which are actually program-related investments, that is, grants for which repayment is expected to a greater or lesser degree.

Words from the wise:

Look, there are numerous “good cases” where one can see that infusion of capital that doesn’t really have to be repaid at market rates makes good sense.  (Actually, government loan guarantees of, say, solar power start-ups falls into this category.)  The problem with allowing 501(c)(3)’s to make these sorts of investments is that the process is subject to abuse.

Say that I want to create “Stuart Levine’s Good Works Foundation.”  The Foundation attracts $10M in tax deductible contributions.  The Foundation uses the cash to “invest” in projects operated either by me or my Aunt Minnie.  While Minnie and I invest our own funds in these businesses, our capital position is ahead of the Foundation’s and gets a higher return, so that the first profit out goes to pay us and, if the deal craters, the biggest part of the hit will fall on the foundation.  (Did I mention the $250K a year consulting fee paid to me by the investment entity?)

I don’t for a minute believe that the Bill and Melinda Gates Foundation is engaged in double-dealing of the sort that I described.  I have less faith in the “Stuart Levine’s Good Works Foundation.”   Has everyone forgotten the Pallottine Fathers?  See here:

http://tvnews.vanderbilt.edu/program.pl?ID=254962

Or, as one might say, everything old is new again.

The burden of proof rests on those who believe L3Cs are essential.  They must demonstrate that the entities’ potential for abuse is outweighed by their capacity to meet needs that are otherwise unmet.  But all that’s unmet so far is that burden of proof.

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3 Responses to “A remarkably clear statement of what’s wrong with L3Cs. . .”

  1. Sandra Xenakis Says:

    Like nonprofits have never been abused!

    C’mon, people, the L3C is just another tool in the toolbox. If it works for your situation, use it. If it doesn’t, try something else. It’s kind of misguided to chastise the legal entity for the sins of the owner. We need new business models, since the old ones aren’t working for those of us who want to straddle the line between non-profit and for-profit. From what I’ve seen of the L3C, it does offer an advantage to those mission-based organizations that work primarily with non-profits. That’s a gift, not a burden!

    • Nonprofiteer Says:

      Yes, both nonprofit and for-profit business forms can be misused. The problem with LC3s is they’re neither fish nor fowl, and the allocation of responsibility (to the investors, the clients, the management) is unclear–which means there’s more chance for someone to get screwed. Also, until the IRS announces that L3Cs are automatically consider acceptable program-related investment, the entities aren’t solving any existing problem. So it may be “just another tool” but it’s kind of a 3-headed hammer.

  2. Sandra Xenakis Says:

    That has been the prevailing view among legal types, who are looking ONLY at the issue of capital sourcing. What if you’re not looking for investment financing? I’m much more interested in the “branding” advantage of the L3C as an organization based on mission rather than profits. I know someone in Michigan who incorporated as an L3C and has seen huge advantages in obtaining work from non-profits. His company provides both mission-based services (music education and programming to schools) and traditional for-profit services like recording. A major plus: he doesn’t have to deal with the drawbacks of the 501(c)3, which can include unskilled and uneducated boards, dependence on volunteers, continuous competition for grant funding, funders who want to tinker with your vision, and so forth.

    As for allocation of responsibility among clients, managers, and investors; operating structure; etc.–these can and should be clearly spelled out in the L3C’s operating statement and/or agreements with investors, as they would be in any for-profit entity.

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