My heart inevitably sinks when a client asks the ever popular question “What form of legal entity would be best for my for-profit enterprise?” The entrepreneur’s excitement is contagious but answering is never easy. There are so many variables that determine where a start-up might end up no matter how researched the assumptions and projections might be. And yet, a choice has to be made.
For the growing number of social entrepreneurs, it has become even more nuanced. There are three new legal forms emerging to satisfy the “Impact Investment Revolution” in our midst (the Flexible Purpose Corporation, the Benefit Corporation and the Low-Profit Limited Liability Company or L3C), and Illinois is considering the creation of a fourth, the Benefit L3C. While each is designed to accommodate ventures that pursue social and environmental benefits attractive to impact investors, social entrepreneurs should consider a variety of factors before using the traditional LLC or corporation.
Summarizing the similarities and differences of each of the new legal forms is no straightforward task. Each state that has adopted one or more of the alternative new forms has slightly different requirements and there is no real case law to date analyzing how state specific legislation is to be interpreted since these legal forms are so new.
In general, the Flexible Purpose Corporation permits the founders of a for profit corporation to establish a blend of business and charitable or social objectives that are not profit maximization or asset growth oriented. The board and management of the Flexible Purpose Corporation are then charged to act with those blended objectives in mind and to report to the shareholders on its success or failure in achieving them.
The Benefit Corporation differs slightly in that it is a for profit entity that is required to advance a general public benefit in addition to any other purposes adopted as a business corporation. The Benefit Corporation may also have as a purpose the creation of one or more specific public benefits. The directors have an affirmative duty to consider the effects of their decisions on all of the corporation’s constituencies (shareholders, customers, suppliers, the environment, the community) and an annual benefit report prepared by an independent third party describing efforts to create the public benefit during the preceding year must be filed with the Department of State and distributed to shareholders.
In contrast, an L3C is usually formed to create a presumption of eligibility for program related investments (PRIs) from one or more foundations or to lock in a charitable mission when the founders have a set of investors who will support that mission. See my earlier post “Private Foundations and New Regulations Regarding Program-Related Investments”. The L3C is, by definition, a low-profit limited liability company which significantly furthers the accomplishment of one or more charitable or educational purposes within the meaning of Section 170(c)(2)(B) of the IRS Code of 1986, as amended. No significant purpose of the L3C can be the production of income, the appreciation of property or one or more political or legislative agendum within the meaning of Section 170(c)(2)(D) of the IRS Code of 1986, as amended.
The L3C therefore goes further than the Flexible Purpose Corporation or the Benefit Corporation in that both of those are set up to be money-making enterprises that also have social or charitable mission(s). The L3C can operate a business but producing income or maximizing appreciation of assets cannot be a significant purpose of the venture and if it becomes clear after formation that income or appreciation is the focus, the L3C will immediately cease to exist as a low-profit LLC although it will continue to exist as a limited liability company.
Note that “B Corporations” are not a corporate form but rather a certification mark available to all three of the above forms and even traditional for profit corporations. The certification or brand can be obtained from the nonprofit organization called B Lab and requires achieving a specific score after the B Lab evaluation of a variety of factors including the entity’s treatment of its employees and successful evaluation of socially responsible goals. See http://www.bcorporation.net for more information on B corporations.
With the above in mind, reverting to the age old “Who”, “What”, “Where”, “When” and “Why” analysis is probably the best way to analyze the alternatives. Throwing in a “How” or two will help even more.
Looking at the “who”, entrepreneurs, investors and consumers each have characteristics that may make one choice unavailable or at least inappropriate. For example, if the founding principals consist of one or more non-profit corporations rather than individuals, a Benefit Corporation may be desired although such an entity would be unable to elect pass through “S” status which may prompt a closer examination of the L3C model. If attracting foundation PRIs is a large part of the business plan, that too might suggest that the L3C is the proper vehicle. In contrast, if the initial or anticipated future investors articulate the desire to consistently build profits along with a material positive impact on society or the environment, the L3C requirement for “low-profit” expectations will be violated and the L3C status possibly challenged. The Benefit Corporation would be a better choice for such investors especially where enough time has simply not elapsed for anyone to determine how low the “low profit” requirement really is.
The “what” and the “where” is a close examination of the intended business activities and cross border implications, if any. Some activities are more fundamentally socially or environmentally beneficial than others and some are clearly charitable at their core. At the same time, while you can form a legal entity anywhere that the chosen structure is permitted and file for authority to do business in any state of operation, PRIs, bonds and grant programs are often geographically specific.
“When” is a determination of the planned exit of either the founders or specific staged investors which may suggest starting out as one kind of entity and evolving over time into another kind of entity which is permitted in most states if the requisite shareholder/member consent is obtained. The transition is not intended to be as difficult as a non-profit to for profit transformation (which, in Pennsylvania, require Attorney General and Orphans’ Court participation). “Why” is really another examination of the social/environmental/charitable mission and the expectations of all principals along with the individuals or programs the principals intend to benefit with the new endeavor. And, finally, an old fashioned projection of just “how” much money is needed at different junctures of the anticipated growth cycle is key.
LawForChange at http://www.lawforchange.org features some interesting content on the variety of legal structures available on a state by state basis. There are certainly pros and cons of using each structure and I sincerely wish you well in your efforts to choose which will be best. Forget what I said at the beginning of this post and feel free to call me if I can be of any help.