Low-Profit But How Much Potential? (Part 1)

Posted by Adam Huttler, May 26, 2011 3 comments

Adam Huttler

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.

3 responses for Low-Profit But How Much Potential? (Part 1)

Comments

May 26, 2011 at 9:11 pm

Adam first off I dig Fractured Atlas and would love to connect with you offline about your first hand experience...

Secondly I am not a fan of the title "Low Profit" AT ALL.... I have put my latest venture in the L3c format and Always say HIGH IMPACT low profit when I explain the entity.

I agree that it is a very special vehicle for specific organizations. I am encouraging dynamic founders with great ideas to review the L3C option so that they may steer and ultimately control the destiny of programs they create.

Imagine the founder of Fractured Atlas creating that project or reorganizing that project in the L3C format when is came available in 2008. I believe the founder would have such a better handle on Fractured Atlas and would be more efficient, be able to curtail many meetings, and make clear decisions etc.

What would Fractured Atlas look like if it were and L3C from the beginning?

Is there an argument that the work you are doing could both return a "low profit" and also follow the mission of Fractured Atlas? The L3c can also dramatically benefit those who worked the hardest to create this entity? Most founder's of projects I know get sacked eventually and have to start all over. I did.

Imagine if all the employees of Fractured Atlas owned 1-3% of the company... Would they not be motivated to make more profitable decisions? Waste less paper? Be more efficient?

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May 27, 2011 at 12:08 pm

Adam,

You may want to consider attending the first annual ACD conference, The L3C A-Z June 6-7, 2011 in Evanston, Illinois. See http://www.americansforcommunitydevelopment.org/conferences.php for more information. Great place to network with people who are L3Cs, practitioners, and the people who have created it and working on getting the federal legislation passed. Lots of great panels. Great place to get more information on the L3C to blog on.

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May 27, 2011 at 9:34 am

Hi Paul,

Thanks for the kind words.

I'm the founder of Fractured Atlas, so your thought experiment isn't such a stretch for me! ;-)

There's one huge reason why Fractured Atlas could never function entirely as an L3C, which is that our biggest program - fiscal sponsorship for 2,500 or so artists and arts organizations - legally depends on having 501(c)(3) status.

Another challenge is that, in recent years, we've successfully raised rather substantial amounts of money for some ambitious new work (e.g., ATHENA) that could never have come into being without philanthropic subsidy. Sure, PRI would have been an alternative, but we wouldn't have the pricing flexibility that we have if we had to pay back investors, even at low or no interest.

Having said that, there are a lot of aspects of our work that *could* work really well under an L3C model, and it's something I've thought about from time-to-time. Employee ownership is among the most attractive aspects, so I'm happy you mentioned that.

Thanks,
Adam

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