December 4, 2021

start the future: understanding L3C

a moss-covered stone bridge
photo caption: a stone bridge with several generations of moss living on it. there’s a small arched opening in the bridge wall with metal bars to let the water flow through. you know… this moss has shown incredible growth over time across all the desired metrics. i think we should invest.

I’m continuing the series where I try creating a new organization that serves a public good. I can be intentional about my goals and work with people who align with these intentions. I’ll start by researching different organization types in the united states.

This is an essay about starting a limited liability low-profit corporation. It’s written by someone who has never started one. I am doing the research, but I am not a lawyer (takeout napkins are still not accepted as a law degree in many states). It’s important to me to state this caveat up front. We’ll first revisit my goals from last time.

my organization goals

Here are a few thoughts I have about the type of organization I want to create.

  • I want the organization to be worker-led or employee owned
  • I want the organization to exist within the community it wants to support
  • We’ll use many Teal Organization principles at startup. We’ll be free to adapt our approaches considering a pretty basic “do no harm” principle
  • I want the people or teams to function in cooperation or collaboration
  • The organization will run without a hierarchy. This does not mean flat or directionless! Everyone has distributed decision-making authority within their area of work. We’d discuss larger decisions as a collective and choose a person to make the decision
  • We’ll use the advice process for all decisions. That means anyone can identify a problem and come together with others to solve it. Consensus is not necessary
  • The organization will be explicitly antiracist

L3C – what is it?

The limited liability low-profit corporation is somewhat new to the business world. The business structure started in Vermont, where the state passed an L3C law in 2008. The L3C has roots in the more common LLC, which is how many companies incorporate. The big change, of course, is the third L: low-profit. In a traditional LLC, a company has a default obligation to generate profit for its investors. In an L3C, profit comes second to the serving of some social mission.

The “social mission” here is key. Unlike a non-profit organization, an L3C is a private business. They don’t need to produce an annual impact report like a 501(c)(3) does. They aren’t required to prove to investors that their work is charitable or has a social impact. Donations to an L3C are not tax-deductible. An L3C is subject to the same regulations as a standard for-profit LLC. Where an L3C surpasses an LLC is the source of its investments. Private Foundations must spend 5% of their assets each year to charitable causes. That expense goes by the term Program-Related Investments, or PRIs. These funds sometimes go to non-profits as grants. PRIs can also go to an L3C as an investment. The L3C could then pay back that investment on any terms.

I found a few L3Cs that run the gamut from supporting non-profits to operating a coffeehouse. The Nonprofit Law Blog cites Chris Larson’s take on an ideal L3C. An example he uses is a biotech firm that develops a new product or service that helps people. The profit margin on that product may be low, which could scare off potential investors. But the L3C could seek investments from a foundation needing to make their 5% expense. The foundation could invest their money and expect a meager rate of return for their trouble. The biotech L3C, now invested, could sell their product and scale up production. Future funding could come from more traditional investors who want a better return.

Ellis Carter at Charity Lawyer says that this new structure might not even be necessary. “LLC statutes are very flexible,” Ellis says. The LLC could write its governing documents to say they will pursue charitable goals.

how do you do it?

A funny thing I learned is that the L3C is not yet legal in Washington! Someone who wanted to start an L3C would want to use an LLC in the way Ellis Carter describes above. Washington does offer a Social Purpose Corporation, but that’s a different story. In states that don’t have legislation for establishing an L3C, you can incorporate as an LLC.

what’s good?

The best thing about the L3C structure is what it has in common with an LLC. Most people start corporations to shield its owners from financial liability. If I start an organization and face financial trouble, I would be liable for any losses or damages that exceed the corporation’s worth. If my business incurred debts or someone sued us, in an LLC my personal assets are more protected.

One major benefit of an L3C is that they can accept money from private foundations. Investors would know from the start that they should not expect massive profits from us. It may happen, but that is not our first goal. We may get investments from social-impact mutual funds and the like. People who want to feel good while they make millions. I could attract investors that might not go for a non-profit or a traditional for-profit.

what’s good to avoid

This one’s big. L3Cs are not well-known in the business world. Their ability to accept PRIs varies state by state. Without a national law approving L3Cs, the IRS is handling them one at a time. If they don’t deem my L3C charitable, foundations seeking a charitable investment could backfire. Getting approval first from the IRS can be costly and time-consuming.

So, with all that said, it’s starting to feel like a tax shelter to me. Billions of dollars sit in foundations when the very rich want to write off their earnings. It’s no secret why many billionaires “donate” their money to charities they establish. Operating a foundation you run to give money to an L3C you run is pretty much just starting a new business.

Vu Le at Nonprofit AF calls unethical foundations that meet only their 5% payout minimum. That’s a problem in itself. Legitimizing the L3C may reduce even further how much goes to organizations not expressly designed for profit. Adding to my suspicions here is that L3Cs don’t even need to prove they are making a social impact. They don’t need to determine if the impact they are making is even a net positive.

closing thoughts

I will admit that I started this research because the L3C was a structure I hadn’t heard of before. Shared in the same breath as B-corps, I hoped this might be a model more rooted in social justice. But at the end of my research (I’m not a lawyer), I can’t shake the feeling that it’s a racket.

When I reflect on my organization’s founding values, I don’t see a lot we’ll have in common here. This is a type of organization founded within capitalism by and for capitalists. The public should own all organizations that serve the public good. We should rip out the charity sector root and branch. We should replace charity with programs owned by the public that benefit the public. This feels like a step back towards the system that is killing us all.

Any business structured like a business will benefit whoever holds the money. There are definitely reasons for why people might choose to start an L3C. But this one’s not for me.

other sources I used
https://apexlg.com/what-is-a-low-profit-limited-liability-company-l3c/
https://digitalcommons.law.seattleu.edu/cgi/viewcontent.cgi?article=1051&context=sjel
https://www.journalofaccountancy.com/Issues/2008/Jul/CapitalWithaConscience

my name is josh martinez. i have always loved trying to understand systems, and the systems that built those systems. i spend a lot of time thinking about how to get there from here.

say hello: josh[at]bethefuture[dot]space

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