MICROCAPITAL STORY: Legislation Introduced in North Carolina and Vermont for the Proposed "Low-Profit Limited Liability Company" (L3C) Could Mean New Funding Options for Development Organizations Including Microfinance Institutions (MFIs)

The Low-Profit Limited Liability Company (L³C) is a proposed new business vehicle in the United States which Americans for Community Development (ACD), a Washington DC-based coalition of organizations promoting the model, claim s “combines the best features of a for-profit Limited Liability Company (LLC) with the socially beneficial aspects of a nonprofit.”

Introduced in the North Carolina State Senate through “The Endangered Manufacturing and Jobs Act” in February of last year, the legislation was adopted on July 31st and now awaits approval by the House. Parallel legislation was introduced in the Vermont State House of Representatives in January of 2007 and is awaiting approval before being transferred to the Senate. Legislation is also pending in Georgia, Michigan, and Montana. Once legislation is approved in one state, the L³C may conduct business “in all 50 states, the District of Columbia, and all US territories (page 22)” as long it is legally based within the state which approves the L³C.

Program-related investments (PRIs), an already existing provision in the Internal Revenue Service (IRS) tax code, provide the legal basis for the L³C. Under the PRI provision, all charities and nonprofits operating in the United States may make investments which our consistent with the organization’s mission, are socially beneficial, and whose primary purpose is not the realization of profits. Moreover, all nonprofit organizations are required to mobilize five percent of their funds annually towards their mission. These payouts normally come in the form of grants, but PRIs count towards the five percent as well (page 5). Examples of PRIs, as stated by the IRS, include low-interest loans to disadvantaged small business owners who are unable to locate commercial funds at reasonable interest rates, direct investments in businesses, nonprofits, and properties in economically distressed areas, and low-interest loans to needy students.

PRIs are not currently in wide-spread use by nonprofits due to uncertainty about which investments qualify for the special status and because of the both costly (USD 8,700, page 3) and lengthy (months or years) requirements of the process for acquiring the Private Letter Ruling (PLR) from the IRS which guarantees the PRI status. In contrast, the proposed L³C’s requirements “would match exactly the conditions placed on PRIs in IRS tax law” thereby eliminating the need for a PLR, according to a paper by Maximilian Martin of the Union Bank of Switzerland (UBS) and Arthur Wood of Ashoka.

Additionally, the fiduciary responsibilities of potential for-profit partners often preclude them from joining a nonprofit in a for-profit venture. Thus, market-driven capital, as opposed to grants, is traditionally difficult for nonprofits to access. Upon legal establishment of the L³C designation, it is believed that the entire PRI process will be streamlined and commercial investors will begin to recognize the L³C’s potential profitability.

Possibly the most important advantage to working through the L³C structure is its multi-tranche design which is visualized and explained through a presentation posted on ACD’s web site. This multi-layered structure provides for various investors with different goals—whom may legally include for-profit corporations, governments, individuals, or private foundations—and allows the lower tranches to accept a disproportionately high level of risk while the higher tranches reap the benefits of higher returns.

Generally, a typical L³C would include an “equity tranche” with a zero percent return for investors, a “mezzanine tranche” with below market rate returns (usually falling within the range of one to five percent), and a “senior tranche” which provides the highest market driven returns. The operators of the L³C itself would usually participate in the equity tranche and would invest a higher proportion of the total funds than their actual stake in the ownership in order to attract additional investments from for-profit investors. Accordingly, these operations-affiliated investors would only accept profits after the senior and mezzanine levels have received there shares.

Microfinance institutions (MFIs), which pursue social goals but are much more effective when coupled with access to the capital markets, have traditionally existed in a largely unsupported legal niche due to the nature of their operations and objectives. Most MFIs evaluate their performance in terms of “massification”—the facility to reach as many marginalized borrowers as possible. Because the ability to massify is directly linked to an institution’s ease of access to required funding, those MFIs which are classified as nonprofits are experiencing a significant hindrance to satisfying market demand for microfinance services. MFIs in the United States may find the L³C to be a much more suitable legal structure for their needs.

From a different perspective, many MFIs, like most nonprofits, suffer from a lack of transparency and standardized financial reporting. The L³C designation would also aid this area of concern for investors who need dependable information in order to accurately judge the institution’s financial health.

Robert M. Lang, Jr., the CEO of the Cross River, NY-based Mary Elizabeth & Gordon B. Mannweiler Foundation, pioneered the L³C entity and wrote an article on the topic for Worth Magazine in April 2006 entitled “Charitable Returns”. Mr. Lang is also the CEO of Fabrique Cosmetique.

The Community Interest Company (CIC), a designation for organizations that want to conduct a business for the benefit of the community, was established in the United Kingdom in 2006 and serves much the same purpose as would the proposed L³C in the United States. An “Overview of a Community Interest Company” can be found here.

Most of the information for this article can be found throughout ACD’s web site.

By Anthony Busch, Research Assistant

Additional Resources:

Americans for Community Development: Home, About, L³C, L³C Legislation, Brochure, “The L³C: The For Profit with the Nonprofit Soul”, “F4F – Finance for Foundations”, by Maximilian Martin and Arthur Wood, June 25, 2007

Community Interest Companies: Home, “Overview of a Community Interest Company”

Internal Revenue Service: Home, Program-related investments, Private Letter Rulings and Determination Letters

North Carolina General Assembly: Home, Endangered Manufacturing and Jobs Act

Worth Magazine: Home, “Charitable Returns”, by Robert M. Lang, Jr., April 1, 2006