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Editorial 8 MIN READ

The L3C in mid-2018: the quiet part of a slow decline

Eighteen months after the last time we looked, the map has not grown, the PRI promise never closed, and benefit corporations have taken the oxygen

The Editors
Staff, Incorporator.org
8 min read Updated
Contents 6 sections
  1. The state map as of summer 2018
  2. What the 2016 PRI regulations actually did
  3. The benefit-corporation tide
  4. What a 2018 founder should actually pick
  5. What the last eighteen months confirm
  6. Sources

he low-profit limited liability company, the L3C, has not been repealed out of existence, but it has stopped spreading. Eighteen months after our November 2016 look at the form, no state has enacted L3C legislation, North Carolina's 2014 repeal still stands, and the April 2016 IRS regulations that were supposed to validate the entire concept ended up helping everyone else.

This is a short update, because the story has not changed. The L3C still does what it always did. The market has moved on.

The state map as of summer 2018

The jurisdictions recognizing the L3C designation in mid-2018 are the same ones that recognized it at the end of 2016: Vermont, Michigan, Utah, Wyoming, Illinois, Louisiana, Maine, Rhode Island, North Dakota, and (added later than most people remember) Kansas, plus Puerto Rico and the Crow and Oglala Sioux tribal jurisdictions. Rhode Island's 2012 enactment was the last L3C adoption in a major jurisdiction; no state has passed the form since. Missouri's L3C provisions sit in Chapter 347 of the Revised Statutes and remain on the books, but new filings are uncommon.

North Carolina's repeal is the only reversal that took effect. The General Assembly replaced Chapter 57C of the North Carolina General Statutes with a rewritten Chapter 57D, effective January 1, 2014, and in doing so stripped the L3C definition and naming rule out of state law. Existing L3Cs were grandfathered in name only. The committee rationale, memorialized in the drafting commentary from the North Carolina Bar Association, was that a properly drafted plain LLC can do whatever an L3C can do, without the federal tax baggage the designation implies.

Vermont, which invented the form in Act 106 of the 2007 to 2008 biennium, has not repealed. The Vermont L3C statute still lives at 11 V.S.A. § 3001(27) and requires that the company significantly further one or more charitable or educational purposes within the meaning of IRC § 170(c)(2)(B), that no significant purpose be the production of income or appreciation of property, and that no purpose be political or legislative. Vermont's S.269, passed by the General Assembly this spring, touches the LLC act but only to add Subchapter 12 for blockchain-based LLCs. The L3C subchapter is untouched.

What did change in 2018 is the silence. The advocacy infrastructure that pushed L3C bills in roughly two dozen legislatures between 2009 and 2014 has gone quiet. Americans for Community Development, the coalition that lobbied the form into existence, still runs its website, but its state-by-state tracker has not had a net addition in six years. The pipeline is empty.

What the 2016 PRI regulations actually did

The L3C's original pitch was that state statutes mirroring the program-related investment tests in IRC § 4944(c) would let a foundation skip an individual IRS determination. That theory needed Treasury to agree. Treasury never has.

The closest the agency came was TD 9762, published in the Federal Register on April 25, 2016, which finalized nine additional examples at Treas. Reg. § 53.4944-3(b), numbered Examples 11 through 19. The final regulations replaced proposed regulations from April 2012 and were picked up, more or less unchanged, from the proposed versions. The rule's contribution is broader than the L3C advocates wanted. It says, with the force of a regulation, that PRIs can be made in pursuit of purposes beyond economically disadvantaged individuals and deteriorated urban areas, that they can be made outside the United States, that they can earn a potentially high rate of return, and that they can use instruments besides low-interest loans.

None of that singled out the L3C. Every example in the rule uses generic "Corporation" and "LLC" recipients. The point of the examples is to illustrate the facts-and-circumstances test, not to bless a particular state-law label. The Council on Foundations, reading the regulation in April 2016, noted that the expanded examples reduced the need for a foundation to seek a private letter ruling for a novel structure. The L3C was supposed to be the structural shortcut. The regulation made the shortcut unnecessary for everyone, which is a different outcome than making the shortcut work.

IRS guidance on PRIs at the subregulatory level has not shifted since then. There is no Rev. Rul., no Rev. Proc., and no Notice that treats L3C status as probative of PRI qualification. A foundation investing in an L3C today runs exactly the same legal analysis it would run for an investment in a plain LLC: is the primary purpose charitable, is the income-or-appreciation purpose insignificant, and is there any political purpose. The answers depend on the deal documents. They never depended on the label.

The benefit-corporation tide

The story on the other side is the opposite. As of March 2018, 36 states and the District of Columbia have enacted benefit-corporation legislation, a count B Lab publishes on a rolling basis. Kansas, Kentucky, Texas, and Wisconsin all enacted between late 2017 and early 2018, with Texas's statute taking effect September 1, 2017 and Kansas's on July 1, 2017. Delaware's statute, enacted in 2013, has in practice become the default for venture-backed mission-aligned companies, the same way Delaware's general corporation law is the default for venture-backed anything.

Benefit corporations outnumber L3Cs at both the jurisdictional level and the per-jurisdiction filing level. InterSector Partners, which tracks active L3Cs by state, has the count moving from roughly 1,050 in mid-2014 to somewhere in the mid-1,500s by mid-2018, with growth coming largely from Illinois and Wyoming. The number of benefit corporations, counted by B Lab and by the various state Divisions of Corporations that publish annual reports, is north of that and rising faster. B Lab's separate Certified B Corporation program, which is not a legal form, sits on top with more than 2,500 certifications globally. Mission-aligned founders asking for "a B Corp" almost always mean one of those two things; "L3C" comes up rarely.

The structural reason is straightforward. A benefit corporation is a corporation, so venture investors can price it. A benefit corporation's directors owe a statutory duty to consider a defined set of stakeholder interests, which is enforceable and which most state statutes back with a public benefit report. The L3C is an LLC whose operating agreement does something a plain LLC's operating agreement could also do, with no reporting regime, no certification, and no tax consequence.

What a 2018 founder should actually pick

For a founder forming this quarter, the decision tree is short.

If the plan is to raise institutional capital, form a Delaware benefit corporation or a Delaware C-corp. The L3C is off the table for this lane; venture funds do not invest in LLCs, and the few that invest in benefit corporations prefer Delaware's § 362 statute.

If the plan is a foundation-funded project, form an LLC in the operating state with an operating agreement that tracks Treas. Reg. § 53.4944-3 in substance: a primary charitable purpose drawn from IRC § 170(c)(2)(B), restrictions on distributions that prevent significant income or appreciation as purposes, and an explicit no-politics clause. Have the foundation's counsel review the deal documents. Do not expect the state-law label to do the work the regulation asks the deal to do.

If the plan is a mission-driven business that wants the signaling value of a statutory mission clause without institutional investors, a benefit corporation in a state that offers one (roughly 36 and DC, as of this writing) is the cleaner choice. The L3C remains a legitimate option in Vermont, Michigan, Illinois, and the other L3C states, but it carries two friction costs: foreign qualification as a plain LLC in any non-L3C state where it operates, and the absence of any institutional understanding of what the designation means.

If the plan is to receive a PRI from a specific foundation that has asked for an L3C by name, form one. That is the narrowest surviving use case, and it exists because some funders still treat the label as a filter. The form works. It just does not do what its designers hoped it would do.

What the last eighteen months confirm

The L3C has not collapsed. It still exists, its statutes still work, and the handful of L3Cs being formed each year are generally formed for good reasons. The question the 2016 piece asked ("is the PRI shortcut ever going to close") has an answer: no. The April 2016 regulations were the moment it could have closed, and the moment passed without the IRS agreeing. What closed instead was the need for a state-law shortcut at all, because the regulation expanded every PRI path simultaneously.

The benefit corporation has run the other direction on the same road. Thirty-six states is not saturation, but it is the critical mass that produces default templates in the big law firms and default dropdown options in the big formation services. L3C is neither of those things in 2018.

The honest summary is that the L3C was a solution in search of a ruling it never got. Private foundations and the counsel who advise them read the 2016 regulations, updated their diligence checklists, and went back to making PRIs into whatever entity form made sense on the facts. For most of those deals, the entity form that makes sense is a plain LLC with a carefully drafted operating agreement. The statute book still has room for the L3C. The market, eighteen months after we last checked, does not seem to.

Sources

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