L3C status would aid investment in social ventures

Monday, April 18, 2011 6:00 am
by Denise Perreault

Backed by Social Venture Partners of Rhode Island, legislation is pending in the General Assembly that would establish a new corporate structure – a low-profit, limited-liability company or L3C – designed to attract a broader range of investment funds for social ventures.

Kelly Ramirez, executive director of Social Venture Partners, explained that the new designation would be a hybrid of for-profit and nonprofit corporate structures and create new fund-gathering options for social ventures. Currently, social ventures in general are enterprises that are for-profit businesses, but with nonprofit missions.

“It will allow private foundations to make program-related investments (PRIs) under a new low-profit corporate structure, and it would give social ventures access to both private foundation funding and venture capital,” Ramirez said.

As things now stand, a private foundation such as the Bill and Melissa Gates Foundation by law must distribute at least 5 percent of its funds annually in the form of grants or program-related investments. The IRS closely monitors the PRIs made by private foundations.

The newly created L3Cs would be able to receive both private-foundation funds and equity investments from institutional or private investors, explained Tobias Lederberg, an attorney with the Providence firm of Lederberg & Blackman LLP, who drafted the legislation.

“The idea is to attract funding from private foundations that in turn can be used as seed money and leveraged to attract additional funds from outside investors,” Lederberg said. “This won't work for every single business,” he stressed, but only those with a charitable, educational or traditional nonprofit mission.

Currently, a nonprofit cannot sell equity to private investors because it does not have equity as part of its corporate structure, he noted. But under an L3C setup, equity is created in the form of membership interests of the limited-liability company. Donations to L3Cs would not be tax-deductible for an individual; rather, the donor now becomes an investor and instead of receiving a tax deduction in exchange for a donation, the donor receives equity in the L3C, which has the potential for future appreciation in value, he explained.

According to Lederberg, eight states as of mid-April have adopted laws creating L3Cs, including Vermont (the first) in 2008 and Maine; another 12 or so states, he said, including Rhode Island, have legislation pending and another five states are in the early “discussion stages” of creating the new law.

The number of states supporting the concept is important, he explained, because a change in federal tax code is needed to fully take advantage of an L3C's benefits.

If Rhode Island enacts the new law, a private foundation still would likely require an L3C to obtain IRS verification that the L3C also qualifies as a PRI vehicle. A change in federal tax law could eliminate or at least ease this requirement by acknowledging that a PRI exists where an L3C has been properly formed.

In Vermont, as of April 11, there were 150 L3Cs registered, three years after the 2008 enactment, Lederberg said. In Michigan, the second state to enact L3Cs in February 2009, there were 80 as of the same date. The number of L3Cs created thus far in these states shows that the L3C law is being used, he noted, and he predicted the number will reach the thousands per state if the federal tax code is changed to recognize the states' L3C legislation.

Lederberg said he and Social Ventures Partners representatives have held “preliminary discussions” with Sens. Jack Reed and Sheldon Whitehouse.

In the General Assembly, the measure has been sponsored by Sen. Paul V. Jabour and Rep. Chris Blazewski, both Providence Democrats, and, according to Ramirez, hearings already have been held by House and Senate committees.

“This would allow a business entity to work in conjunction with charitable or educational purposes,” Jabour told Providence Business News. He suggested an L3C incorporation would allow, for instance, a small, nonprofit entity to move beyond the limits of nonprofit status, yet without becoming a full-fledged for-profit operation.

Ramirez said it is important that Rhode Island adopt the L3C designation because the state is “becoming a leader in social ventures” and enactment of the law would help cement the state's status in this field, she said. Ramirez sees the L3C corporate structure as an option for new, startup ventures rather than conversion of existing nonprofit or for-profit companies.

With the motto “help make Rhode Island the Silicon Valley of social ventures,” Social Venture Partners is an organization that provides social, intellectual and financial capital to catalyze social development in Rhode Island. The organization supports “mission-driven initiatives that apply market-based strategies and entrepreneurship to maximize social impact.”

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