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SHOULD I INVEST IN A LOW-PROFIT LLC (L3C)?

A low-profit limited liability company (L3C) is essentially a limited liability company (LLC) authorized under recent statutes passed in at least seven states.  They are similar to traditional LLCs but, among other things, are statutorily required at all times to significantly further the accomplishment of one or more charitable or educational purposes as defined in the Internal Revenue Code, and the production of income and the appreciation of property must not be a significant purpose of the L3C.

Purpose of L3Cs

L3Cs are intended to increase socially beneficial investment by bringing together various sources of funding (e.g., foundations, governments, and market rate investors).  The requirements and restrictions imposed on L3Cs are intended to attract Program Related Investments (PRIs) by foundations.  The idea is for PRIs, as low return, first lost capital, to replace high return, first lost private capital, which is normally unavailable for socially beneficial projects with below-market returns (e.g., urban redevelopment, publications, and affordable housing development).  With low return, first lost capital in place, the L3C should then be able to seek capital from investors that are interested in the L3C’s socially beneficial mission/projects but require market or near-market returns.  The end result would be the L3C having access to capital at lower rates than would otherwise be available and market-rate investors receiving market-rate returns.

Potential Drawbacks

The IRS has not provided guidance on whether L3Cs automatically qualify for PRIs.  In fact, the IRS has warned that it may be premature to use the L3C as a vehicle for PRIs because the tax consequences are unclear. In contrast, foundations appear to be comfortable using for-profit entities as vehicles for PRIs (less than 30 PRI-related private letter rulings have been issued despite more than $1B in PRIs over the  past 10 years).  As a result, foundations have been slow to warm to L3Cs.  At this time, L3Cs do not appear to be in any better of a position to receive PRI funding than other for-profit entities, and the designation could actually place them at a disadvantage if foundations construe the “low profit” nature of L3Cs as a sign of weakness in their business model.  Additionally, for-profit investors must be careful to avoid any relationship or transaction with investing foundations that could run afoul of rules which provide that a section 501(c)(3) organization must not be organized or operated for the benefit of private interests and no part of its net earnings may inure to the benefit of any private shareholder or individual. Also, there is uncertainty as to whether the market returns provided to investors elevate profit to a “significant purpose” of an L3C, thereby violating one of the L3C requirements. The bottom line is that L3Cs may have the potential to spur socially beneficial projects, but you should consult competent counsel to work through the legal and tax issues before investing in one.

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