L3Cs and the shock of the new

Recently the socialverse has been buzzing about the new legal structure known as the L3C, or low-profit limited liability company. This hybrid form is particularly designed to facility program-related investments by private foundations--a mechanism that, in a nutshell, enables them to avoid a penalty tax on so-called jeopardy investments. The structure has also garnered more general interest for its potential as a standard form for blended purpose ventures.

However, an IRS office speaking at a recent conference made a simple observation that has justifiably raised some concern within the social enterprise community:

"The point I want to make today is that, at the federal level, no one has really signed off on this yet," he said. "So if you are out there hearing about L3Cs and you have a private foundation that wants to invest in it, and you think the jeopardy investment issue is a slam dunk and you don't need to concern yourself with it, that would be premature."

Anyone considering the L3C form needs to pay attention to this statement. While it is true that a respected tax attorney is advocating in favor of the L3C, his conclusions, however well reasoned, are currently not those of the IRS, nor do they necessarily reflect the way that L3C laws will be interpreted and administered from state to state.

Yes, the IRS may eventually sign off on the L3C, just as Congress may eventually pass the legislation that L3C advocates hope will provide an even more secure legal foundation for the form. But that's a possible future, not the present reality.

I note this not to discourage people from choosing to create L3C's, nor do I think the IRS' caution should be a reason for states to refrain from adopting the form. Anyone who lived through the process whereby LLCs themselves became a standard feature of U.S. organizational law knows that investing in legislative innovation can have substantial payoffs.

However, being part of a movement for legal innovation can be risky, and not all ventures have the same tolerance for risk. Arguments designed to persuade the IRS to recognize the form will not necessarily address issues that a start-up should consider when deciding which organizational form to choose. The best choice for a new venture, whether considering a standard legal entity or an innovative hybrid, is to be fully informed.