Why Become a Low-Profit Limited Liability Company?

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Answered by: James, An Expert in the Entrepreneurs - General Category
As more entrepreneurs try to build businesses that allow them to fight for social causes as well as make them money personally, it is becoming increasingly apparent that traditional business entities (corporation, non-profit, etc.) are insufficient to meet this growing market's needs. As a result, more states are adopting a new form of organization: the low-profit limited liability company or the L3C. However, many new business owners are unaware of what an L3C is or what benefits it brings.

The low-profit limited liability company is a hybrid of a conventional Limited Liability Company (LLC) and a non-profit. Like an LLC, an L3C is a for-profit entity. Individuals and businesses can own and control and L3C and get a share of an L3C's yearly profits. Owners also get tax benefits as the the L3Cs are "flow-through" entities, meaning that taxes are only assessed at the ownership level as opposed to corporations where income is taxed when it is earned by the business and when it is distributed to the owners. Finally, L3C owners are protected from taking personal responsibility for the business's debts through the organization's "liability shield."

An L3C is also similar to a traditional non-profit, in that its goal is to further a charitable or educational purpose. As a result L3Cs are able to approach charities and foundations for capital, a potential market that is generally off-limits to traditional for profit businesses. Tax-exempt organizations are limited in how they can spend their money as a result of their special tax status, and generally are not allowed to make investments in traditional businesses. However, an L3C's charitable purpose allows tax-exempt foundations the opportunity to invest through what is called Program-Related Investments or PRIs. PRI's are low-interest loans and direct investments by tax-exempts entities to organizations that further the investing foundation's charitable purpose. The represents a unique opportunity for L3Cs to obtain startup capital, provided they could find interested foundations with similar goals.

While there are obvious benefits to the L3C form, there are drawbacks as well. An L3C's purpose must be charitable which makes the long-term profit possibilities for these companies limited by design. This makes it hard for social entrepreneurs to find investors outside of non-profits and limits the entrepreneurs' possible return. Also, while the IRS has recognized individual L3Cs as acceptable options for investment by tax-exempt entities, it has not formally extended that classification to all L3Cs. This means that the chief financial benefit of the business organization, the ability to obtain capital from tax-exempt organizations, is not assured. Possibly as a result of this lack of recognition, foundations and charities in general have been hesitant to invest in L3Cs.

The number of companies that should consider L3C classification are limited. Only those businesses with a strong charitable purpose and limited earning potential should pursue this option. These types of companies would appeal to possible tax-exempt investors while not being burdened by the L3C's limitations. Those companies who expect to make significant future profits should avoid the L3C alternative, as the advantages would be minimal in comparison to the disadvantages and uncertainty of this business organizational option.

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