L3c: Everything You Need to Know
L3C combine aspects of a nonprofit and for profit organizations. It is a relatively new innovation in the United States.4 min read
Updated June 26, 2020:
L3C combine aspects of a nonprofit and for-profit organizations. It is a relatively new innovation in the United States. Its purpose is to attract capital to commercial ventures that promote some sort of social good. The L3C’s primary purpose is a charitable mission while generating profits is a secondary goal.
What is an L3C?
L3C is a legal structure. It is a hybrid of a 501(c)(3) and an LLC. It was created as a path to encourage and increase social entrepreneurship and self-sustaining charitable missions. Some examples include medical research projects and vehicle safety schools.
L3Cs do distribute its profit to its owners. L3Cs can accept investments like an LLC but also donations for specific purposes like a 501(c)(3). The Gates Foundation has been a leader in investing in L3C organizations. Currently, most foundations do not donate to L3C due to the uncertainty surrounding their status. Additionally, donations are not tax deductible.
- Operate similarly to an LLC
- Need to keep track of their investors, obligations and do not receive any favorable treatment from the IRS because most do not qualify as tax-exempt
- Can be tax-exempt only if all members are tax-exempt organizations. Otherwise, the L3C will pay taxes on any income
- On the state level, only a few states recognize the L3C structure
- Most states treat L3Cs like LLCs for tax purposes
Why was L3C Created?
L3Cs were created as a way for businesses to continue operating if they produce a social good but are not commercially viable. For example, a community newspaper may not be able to continue operating, however it does produce a social good by keeping in the community informed of news and events.
The L3C allows people to fund the newspaper in order to keep it running for the social good rather than any return on investment. This can be done through a community-based foundation and may incentivize investors to invest in the newspaper.
Precedence, Similarities, and Differences of L3C in Another Country
The L3C concept was first developed in foreign countries. In Great Britain, there are “community interest companies” that are established for the public good. Returns on investment are capped. Any additional profits are reinvested into the company. Companies must apply and be officially recognized before receiving this classification.
What are the pros and cons of obtaining L3C
Some of the benefits of the L3C categorizations are more avenues for social entrepreneurship, easier organization, private foundations can invest without receiving approval, charities can create subsidiary L3Cs in order to pursue profitable ventures, and support for artists.
Some of the drawbacks are that foundations and investors can lose their capital without any tax benefits, limited oversight of how L3Cs use investment funds, and the uncertainty surrounding L3C status with many foundations and investors unsure about how they fit into their investment plans.
What precedence is there for art companies and creative individuals?
The IRS has always given art schools and art programs tax-exempt status. Examples include dance companies, theater groups, symphonies, musical groups, artist groups, and art activities. L3Cs are a possibility for these art-based organizations to profit from their work while continuing to focus on their core mission of spreading arts appreciation and education.
Who oversees the company’s mission and whether it is fulfilled?
Typically, the L3C is overseen by the state Attorney General’s office. Just like any charity, annual reports should be sent to the Attorney General’s office and posted online. The L3C also has to create an annual report for its investors, detailing operations and how funds are being allocated like an LLC. For L3Cs, there are two sources of oversight - state regulators and its investors.
Do you need a previous track record in social entrepreneurship?
No, you don’t necessarily need a previous track record in social entrepreneurship. More important, you have to find investors who believe in your mission and your ability to execute. Therefore, if you don’t have a track record, you need to develop a detailed plan to show investors and foundations who may want to invest in your L3C.
Why would a nonprofit look into a L3C?
Nonprofits could be looking into L3Cs if setting up a for profit venture can help them achieve their mission. For example, an organization that teaches disadvantaged youth construction skills could open an L3C to buy and repair homes. Once completed, the homes can be sold at a profit. Profits can be used to buy additional homes, fund the nonprofit’s operations, and pay workers.
Another Reason to Become an L3C
Another reason to become an L3C is that it leads to a better governance structure with oversight from donors and investors. Due to this reason, many are advocating that the L3C structure should be open to all types of nonprofit organizations not only charities.
If you need help creating an L3C, you can post your legal needs on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.