Low-Profit But How Much Potential? (Part 1)
The L3C (low-profit limited liability company) construct has been getting a ton of virtual ink lately. As a way of establishing my dubious credentials, I’ll note that I was among the first in our field to note the arrival of the L3C, and I’ve written and debated about it quite a bit since then. Fractured Atlas formed an L3C subsidiary for our insurance program back in 2008.
All of that is just to establish why I’m having trouble thinking of something new and inspiring to say about the L3C. I suppose it also explains why I’m interviewed on the subject frequently enough that I can confidently lump the questioners into two categories: (1) big thinkers – often grad students or consultants - who see tremendous potential in the L3C but have only a vague concept of its real legal and financial contours, and (2) jaded skeptics – often professors or attorneys – who know just enough about the L3C to have serious doubts about its applicability to the arts.
The truth as I’ve seen it is that the L3C does have potential use cases in the cultural sector, but that they’re narrow, totally untested, and unlikely to serve as a panacea for the field’s business model woes.
Remember that the L3C differs from a conventional LLC in only one significant way: that its raison d’être is to accomplish charitable or educational purposes, with the profit-motive being secondary. There are a few implications that theoretically flow from this distinction (note that essentially none of this has yet been tested in court):
(1) L3Cs may attract program-related investment (PRI) from private foundations. Those foundations can already make PRI in regular old LLCs, but the argument is that investing in an L3C strengthens the case that the activities are likely to further the foundation’s own charitable purposes.
(2) L3Cs may be useful as for-profit subsidiaries of non-profit corporations. With an LLC, the profits that flow up to the parent nonprofit are subject to unrelated business income tax. With an L3C subsidiary, it may be easier for the nonprofit to argue that the income is related to its charitable purposes.
(3) The conventional view is that managers of a for-profit business have a fiduciary duty to maximize shareholder value. By establishing in its organizing documents that profit is secondary to social welfare, managers of an L3C may be exempt from this principle.
If you boil all of this down, you start to get a picture of the kinds of activities that are good candidates for an L3C. It’s a capital-intensive undertaking that is likely to have a positive but below-market ROI, and some potential profits will be left on the table. It may also be owned or managed by a nonprofit parent.
There aren’t a lot of arts organizations that fit this mold, although one can imagine a handful of specific use cases. Perhaps a nonprofit theatre has a hit on its hands and wants to take it to Broadway or on tour: an L3C would make a great special-purpose vehicle for the “commercial” production. Or maybe a dance company wants to build a new facility to house both its own rehearsal spaces and a school. In general, though, it’s hard to imagine many arts organizations themselves that fit the L3C model, if for no other reason than they need grants and contributions (as opposed to investments) to survive.