The Katz Law Firm announced this week a program to provide legal services to socially conscious business ventures in southeast Michigan. The Birmingham law firm will waive its fees for counseling and advising investors and entrepreneurs involved in an enterprise using a low profit limited liability company (“L3C”) for their start-up venture.
The program is designed to provide much needed legal counsel to those companies playing a vital role in the communities they serve. The firm will counsel these clients to assist their compliance with state laws, maximize tax efficiencies where necessary, and help them develop an ownership structure compatible with the company’s mission in accordance with Michigan’s Limited Liability Company Act, which governs L3C enterprises. All legal fees for services involved in counseling and planning will be at no cost to the startup.
“Everyone needs a hand when starting a business venture,” says Donald Katz, the firm’s managing member. “By assisting worthy causes with legal and tax issues related to their startup, we also benefit our community and contribute to supporting business development in southeast Michigan.” Katz says that investors and startup entrepreneurs willing to tie social responsibility with business success are deserving of his firm’s support and expertise.
What is an L3C?
L3Cs are Different from Traditional Startups and Nonprofits
L3Cs are a relatively new form of taxable business entity, fast becoming an alternative investment vehicle for the socially conscious investor and entrepreneur because they bridge the gap between for-profit and non-profit entities, particularly when attempting to raise startup capital. The L3C is not a 501(c)(3) organization, nor a nonprofit; however, its organizational documents contain language requiring the company to significantly further the accomplishments of charitable or educational purposes as detailed in section 170 of the Internal Revenue Code. This simple but important distinction sets the L3C organizational structure apart from the traditional startup venture and can also make traditional raising of capital a challenge. However, given the right strategy and positioning, this seemingly negative attribute can be a positive for the right audience.
Start-up Capital and Financing Benefits of L3Cs
L3Cs have different options for accessing startup capital, whether from angel investors or non-traditional sources of financing, such as foundations or philanthropists. By aligning the company’s missions and goals with those similar to foundations, charities or other philanthropic groups, financial options not previously available to traditional startup companies become available. Because investment analyses will extend beyond return on invested capital (ROIC) or the other metrics that leave out the accounting related to enhancing the greater good, the world of investors and financing sources opens up, dramatically. L3Cs change the nature of startup investment by enhancing the character of the expected return.
Sample L3C Scenario
For illustration purposes only, an L3C works like this: entrepreneurial Company X has an idea, which it has developed into a patent pending product. This product serves a particular group of disadvantaged citizens. The entrepreneur has exhausted all possible venture capital and private equity sources. Perhaps, these sources have declined investing because the pending patent’s likelihood of success creates more uncertainty than the investor is willing to risk; the commercialization value is questionable; or Company X’s potential market may be unusually subject to competitive pressures from less expensive products, whereas its profit margin cannot deliver a sufficiently competitive return to secure capital from traditional for-profit sources.
With a passion and entrepreneurial spirit rooted in the desire to serve disadvantaged citizens, Company X subsequently converts to a L3C, whereas it states as a primary mission to serve the disadvantaged citizens of its community for which the product serves. Foundation Y also has the primary purpose of serving the same disadvantaged citizens, and in accordance with the Internal Revenue Code, it needs to distribute five percent of its assets to charities with similar missions or invest in companies that qualify as “program related investments,” under which Company X clearly qualifies.
Foundation Y invests $250,000 in Company X. The investment consists partly of a below market loan and partly of equity. Company X develops its patented product and serves the disadvantaged citizens who it intended to help. Profits abound, just not in the traditional manner for investments, and the company contributes to the economic vitality of the community as well.
