The L3C: A More Creative Capitalism |. (an excerpt)
The goal of the L3C form is to bring together a mix of investment money from a variety of sources. This process starts with investments from Foundations known as Program Related Investments (PRIs). Foundations are required to spend at least five percent of their assets in a given fiscal year in order to maintain their tax-exempt status. They have two basic options for spending their money: they can make grants, where there is no financial return on the money, or they can make program-related investments (PRIs) investing in for-profit ventures and potentially earn a return.
But to qualify as a PRI, the investment must relate to the Foundation’s mission and the risk/reward ratio must exceed that of a standard market-driven investment (ie, the risk must be higher, and the return lower). Surprisingly, the use of PRIs by Foundations is limited even with the potential to earn a small return. Because of burdensome and costly IRS requirements to verify PRIs, many foundations shy away from investing in for-profit ventures due to the uncertainty of whether they would qualify as PRIs.
Unlike the Limited Liability Corporation (LLC), the L3C is explicitly formed to further a socially beneficial mission. The L3C’s operating agreement specifically outlines its PRI-qualified purpose. This should make it much easier for Foundations to make program related investments in social ventures while ensuring their tax-exempt status remains secure.
Like the LLC, the L3C is able to form flexible partnerships where ownership rights can be tailored to meet the requirements of each partner. This flexibility permits a tranched or layered investment and ownership structure. The Foundation’s L3C membership stake provides for a very low rate of return and can be subordinate to the other investors. Because the Foundation can invest through PRIs at less than the market rate while embracing higher risk levels, this lowers the risk to other investors and increases their potential rate of return. So the remaining L3C memberships can then be marketed at risk/return profiles necessary to attract market driven investors.
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