Alternative Structures for “Social Businesses”

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Increasing numbers of entrepreneurs are interested in starting “triple-bottom line” businesses.

In other words, while they want to make a reasonable return on their investment, they are also interested in ensuring that their businesses return benefits to their communities and the environment. Nobel Peace Prize winner Mohammed Yunus has termed these kinds of enterprises “social businesses” in his recent book Creating a World without Poverty – Social Business and the Future of Capitalism.

While many social businesses are structured as LLCs, C Corporations, and S Corporations, there are alternatives to these basic structures that were explicitly designed for social businesses and may allow entrepreneurs to better protect the social missions of their businesses.

The purpose of this article is not to discuss the risks and benefits of such alternative structures in depth, but to provide a starting and discussion point for those businesses that are interested in alternative structuring. To that end, I identify and generally discuss three types of entities to consider when structuring a social business: the L3C, the B Corporation, and Cooperatives.

The L3C

The L3C is short for “Low Profit Limited Liability Company.” The first L3C statute was enacted in Vermont in 2008 and was developed in response to a very specific concern related to the Internal Revenue Code’s provisions governing foundations—i.e., the making of Program Related Investments (PRIs). Their history is as follows:

Foundations are required to distribute 5% of the value of their net assets for charitable purposes each year. To meet this requirement, foundations primarily make grants to charitable organizations (organizations exempt from taxation under Section 501(c)(3) of the Internal Revenue Code). However, foundations are also permitted under the IRC to invest the required 5% of net assets in for-profit entities that meet a three-pronged test: 1

  1. The entity must be formed primarily for charitable or educational purposes;
  2. No significant purpose of the entity is the production of income or the appreciation of property; and
  3. No purpose of the entity is to conduct legislative or political activities.

Internal Revenue Code (I.R.C.) § 4944(c) and Treas. Reg. § 53.4944–3. The 5% investment (called a Program-Related Investment or PRI) may produce significant income or capital appreciation so long as the production of income or the appreciation of property was not a significant purpose.

The option of making a PRI is very attractive for foundations in that, unlike grants, PRIs can produce significant returns. Nonetheless, PRIs remain relatively uncommon because foundations are unwilling to risk the uncertainty of having the IRS determine that a PRI it makes does not in fact meet the statutory requirements. Foundations that decide to make PRIs often feel compelled to seek costly Private Letter Rulings to prevent this risk. According to the Foundation Center, of the many thousands of grant-making foundations in the United States, only a few hundred make PRIs.

In response to this unfortunate reality, a group of advocates for socially responsible business called Americans for Community Development wrote model legislation to create a new entity designed to meet the requirements for a PRI. As noted above, Vermont was the first state to adopt this legislation; however, such legislation has now been adopted in several more states.