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  • 01.26.10

L3Cs: The Hybrid Way to Do Well by Doing Good

As nonprofits brace for the aftershock of state and federal funding cuts (not to mention a shortfall in private donations) there are those who are quietly taking another path out of the rubble. They are the pioneers of a new type of organization, known as an L3C.

L3C

As nonprofits brace for the aftershock of state and federal funding cuts (not to mention a shortfall in private donations) there are those who are quietly taking another path out of the rubble. They are the pioneers of a new type of organization, known as an L3C.

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It’s a hybrid aimed at providing social benefits while keeping an eye on the bottom line. Over 100 have been formed in the six states with laws that allow for their structure. Unlike nonprofits, L3Cs pay taxes, and contributions made to them are not tax deductible.

A (very) brief lesson in how it works

The ability to attract a mix of investment money is the key difference between L3Cs
and LLCs. Venture capitalists and angel investors will always be on the
hunt for breakout businesses because that is what they are set up to
do. But foundations have a more difficult row to hoe when making
Program Related Investments (PRIs). Even though they are required to
spend at least five percent of their assets in a given fiscal year in
order to maintain their tax-exempt status, foundations will often make
grants with no financial return at the expense of PRIs that could earn
a return.

Why? Because the IRS requires them to prove the PRI
relates to their mission and that the risk is higher than the return.
The new designation eliminates the hurdle. L3Cs are specifically formed
to further a socially beneficial mission. Can you say transparent?

Why this, why now?

Think of L3Cs as “a for-profit with a nonprofit soul,” says Bob Lang chief executive of the Mary Elizabeth & Gordon B. Mannweiler Foundation. Lang, a leader in devising the L3C concept, says the business structure–a low-profit limited liability company–was designed to make it easier for businesses with an altruistic eye to attract investments from foundations and additional money from private investors.

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In addition to the economy, “The timing was right,” Lang says. “Government is so big and tottering on broke, while nonprofits are proliferating, but too many are doing the same job.”

Lang doesn’t believe that businesses always get the best allocation of capital by maximizing profits. He argues that a low-profit model is still a good investment likely to attract funding from a variety of sources. L3Cs aren’t quite give-aways but offer something other than cash in return. “As an investor, I’d be willing to risk rather than donate,” Lang says. “Ultimately the work being done is worthy and society gets a return too.”

Who’s milking it for all its worth?

For now, the burgeoning number
of L3Cs is filling needs from preserving family farms to providing
consulting services to others pursuing the designation.

To the 10 organic dairy farms that were dropped by H.P. Hood, joining with the
Maine Farm Bureau and the Maine Organic Farmers and Gardeners
Association (MOFGA) to form Maine’s Own Organic Milk Company (MOOMilkCo)
as an L3C just made sense. The company’s goal is to keep the member
farms in business by offering them a fair price for their milk. Using a
start-up grant from Stonyfield Farms, MOOMilkCo will pay the farms the
difference between the organic contract price and the conventional
price during the interim period. In return, the farmers are part owners
of the company (45%), and are responsible for returns of unsold
product through reductions in the company’s profits.

Though it sounds like a cooperative MOOMilkCo points out that the “attempt to
maximize the profits of the cooperative, sometimes at the expense of
the individual members.” Their L3C will provide a stable and profitable
market for the individual farms, while the company maintains only a
fraction of the profits. “So yes, that means Farm Bureau and MOFGA will
see little, if any, return on their half-percent ownership shares in
the company, but will see some Farm Bureau/MOFGA members stay in
business and profit on their own right. That is, after all, what a
membership-based organization should be doing,” touts the company’s Web
site.

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Lang is currently working on an initiative with the Montana
Food Bank with a similar goal, to assist local farmers by providing a
place to purchase, process, and retail their produce.

L3Cs may also be part of the solution to the beleaguered newspaper industry.
Jennifer Towery, president of Newspaper Guild Local at the Peoria
Journal Star is currently working towards develop a plan to either
purchase and restructure the Peoria Journal Star as a locally based,
independent, L3C newspaper, with a focus on community service and local
news, or start a new newspaper with the same objective.

Towery says an L3C newspaper presents an opportunity, “to hold the principals
of journalism more dearly, not less, far more dearly than corporate
ownership does today.” She believes that while the return on the
investment may be small financially, there will be a return. Comparing
subscribers’ renewal rates to shareholders withdraw their support,
Towery says, “That’s quality control. Frankly, I’d rather work to put
out a quality product to show my community we’re using its investments
well than to try to give Wall Street shareholders a bigger dividend.”

Her vision would set up a firewall between the business and the news and
cap the purchase of shares so no business or individual could own a
majority. “Both subscribers and advertisers already feel ownership and
want to flex it to suggest stories or demand coverage. We explain to
them that neither subscribing nor advertising buys editorial control.
Being an owner in an L3C newspaper doesn’t either,” says Towery.
Instead she plans to educate them on exactly what they’re buying,
“Better trained reporters, better staffed beats, certainly.”

As foundation support already exists for news, Towery is confident they
can find PRI investments. But she’s more interesting appealing to the
community and asking every individual to buy a share. “That would
provide a stable, quality newspaper whose profits and interests are
local,” she emphasizes. And it might add a level of trust the big
papers are quickly losing.

Not everyone’s a believer

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Apparently, even transparency has its limits. Crain’s Detroit Business reported concerns that some early L3Cs “may not have a truly socially beneficial cause or a business model that will attract both nonprofit and for-profit investors,” according to Rob Collier, president of the Grand Haven-based Council of Michigan Foundations. Collier observed that there needs to be a specific definition for “socially beneficial purpose” and what reporting requirements they will have.

Over at Chronicle of Philanthropy, a recent story discussed the fuzzy middle ground created by L3Cs and the potential for greater scrutiny by lawmakers and the public. Though Diana Aviv, chief executive of Independent Sector, a nonprofit association in Washington, made this prediction she doesn’t believe that will mean the end of tax-exempt groups.

Bottom Line

Caryn Capriccioso, MNM, a principal with interSector Partners, (the first L3C to hang out a shingle in Colorado) has seen that hope in action. Her joint consulting venture with Rick Zwetsch was popular immediately, racking up almost 200 hours of pro-bono education services.

Capriccioso acknowledges, “Right out of the gate, there is a level of trust and understanding because this business model just resonates with certain people.” Called innovators and creative thinkers because they chose this business structure, Capriccioso says the L3C is just a step toward what she hopes will be a paradigm shift.

Legislation must be passed in the remaining states to make the structure legally recognized nation-wide. That’s already in the works according to Lang. But more important are the implications for nonprofits. “In the for-profit world, only the best survive. Why can’t nonprofits be on the same metric?” he muses noting this may be an opportunity to allow “true charities” such as churches, to rise above the proliferation of smaller local service organizations.

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Capriccioso believes L3Cs will ease the burden for all nonprofits. “Small and medium-sized businesses and large corporations will have an increasing part to play in addressing social issues while simultaneously focusing on creating shareholder value. It is possible to focus on a bigger mission and still maintain a solid fiscal bottom line.”

About the author

Lydia Dishman is a reporter writing about the intersection of tech, leadership, and innovation. She is a regular contributor to Fast Company and has written for CBS Moneywatch, Fortune, The Guardian, Popular Science, and the New York Times, among others.

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