If I said that the State of Michigan passed legislature last year that creates a new Low-Profit Limited Liability Company, many Michigan entrepreneurs might respond that they’ve already been operating one of these for years.

Nevertheless, Michigan’s newest entity, the Low-Profit Limited Liability Company, or L3C, is not designed for the struggling startup but, rather, to ease the tax and regulatory burden of charitable foundations wanting to participate in community and economic development projects.

So, what exactly is an L3C and why do we need one?  The Council of Michigan Foundations sums it up perfectly:

The L3C’s unique structure allows foundations to invest by using an alternative to grants called program-related investments (PRIs) – a loan, loan guarantee, equity purchase or other investment that will further the foundation’s philanthropic purposes.

Before the new law, many foundations shied away from investing in for-profit ventures through PRIs because of burdensome and costly IRS requirements to verify and qualify those types of investments. PRIs are legally complex and expensive for foundations to administer. To date, only about 5% of all foundations have used PRIs nationally, according to the Foundation Center.

But now L3Cs eliminate most of those requirements.

An L3C can have different classes of investors – such as individuals, government agencies, nonprofits and for-profits – with foundations taking the most risk. The L3C’s investment structure is designed to bring new pools of funds, such as pension and endowment investments, to bear on problems normally treatable only by nonprofit dollars.

Because it is now a defined entity under Michigan law, an L3C also virtually eliminates legal fees and organizational costs associated with PRIs.

To qualify as a low-profit limited liability company under the Act, an entity must meet the following requirements:

• It must significantly further the accomplishment of one or more charitable or educational purposes, described in the Internal Revenue Code as to non-profits, and would not have been formed except to accomplish those charitable or educational purposes.
• The production of income or appreciation of property cannot be a significant purpose of the limited liability company.  (This doesn’t mean it can’t produce significant income or capital appreciation, only that this is not the “significant purpose” of the venture.)
• The purposes of the limited liability company cannot include accomplishing one or more political or legislative purposes described in the Internal Revenue Code, also as applied to non-profits.

The low-profit limited liability company must also contain those words, or the abbreviation L.3.C or L3C or l.3.c (with or without periods or other punctuation), in its name.

The hope, of course, is that the L3C will bridge the gap between the profit and non-profit sectors and increase the amount of capital invested in economic and community development and other social enterprises.  Still, there’s some concern that more detail is needed in the Act and that the creation of the L3C disregards reasonable governance requirements that would otherwise be required for operating a true non-profits.

–Matt