Regulation of L³cs for Social Entrepreneurship: a Prerequisite to Increased Utilization

• Publication year: 2021

92 Nebraska L. Rev. 259. Regulation of L³Cs for Social Entrepreneurship: A Prerequisite to Increased Utilization

Regulation of L³Cs for Social Entrepreneurship: A Prerequisite to Increased Utilization

John A. Pearce II (fn*) and Jamie Patrick Hopkins(fn**)

TABLE OF CONTENTS

I. L³Cs Serve Needs of Social Entrepreneurs ............. 260

II. Social Ventures and L³Cs ............................. 264
A. The Development of the LLC ...................... 265
B. Legislative History and Passage of the L3C ........ 266
C. Current Legal Landscape of L³Cs .................. 268

III. Sources of L³C Funding ............................... 269
A. Program-Related Investments ..................... 269
B. Proposed Federal PRI Legislation .................. 273
C. Proposed IRS Guidelines For PRIs ................. 275
D. Flexibility of Tranche Investing .................... 276

IV. LLC Fiduciary Duties: L³C Accountability Issues ...... 279

V. The L³C Brand ........................................ 281

VI. Legal Protection for L³C Investors ..................... 282

VII. Need for Increased Government Regulation and Oversight ............................................. 283

VIII. Double Bottom Line Success-Community Interest Companies ............................................ 284

IX. Strengthening the L³C Form .......................... 287

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I. L³Cs SERVE NEEDS OF SOCIAL ENTREPRENEURS

Between 2008 and 2012, three new business models were legally activated in the United States to facilitate the creation of hybrid firms.(fn1) While social enterprises have been part of the U.S. economy for more than a hundred years,(fn2) organizations in the United States have operated in two very different legal categories: for-profit businesses and nonprofit charitable organizations.(fn3) Although some companies, such as Goodwill Industries, blend charitable work with revenue-generating services, they are rare exceptions.(fn4) The advent of the new legal business models, however, has created strong interest in businesses that can pursue a dominant social mission.(fn5)

One new business model is the low-profit, limited liability company (L³C). The L³C was first introduced in Vermont in 2008 and has since been adopted by several other states.(fn6) The L³C is designed to serve the for-profit and nonprofit needs of social enterprise within one or-

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ganization.(fn7) As such, it has been referred to as a "[f]or-profit with [a] nonprofit soul."(fn8) The L³C operates like a nonprofit by primarily pursuing a social or charitable mission, but it also functions like a for-profit company because it generates revenues and distributes the profits to its equity owners. The L³C model thus enables social entrepreneurs to combine funding that would typically be set aside for either financial investments or charitable donations and allows investors to seek both a financial and social return on their investment. This double bottom line, involving social and financial returns, increases access to funding not ordinarily available to social entrepreneurs.(fn9)

In an effort to efficiently introduce the L³C business model, states have designed L³C laws under existing LLC regulations.(fn10) The flexibility provided by LLC laws allows an L³C to claim a primary social mission and avail itself of unique financing tools such as tranche in-vesting.(fn11) Specifically, the L³C statutes are devised to attract the program related investments (PRIs) of charitable foundations.(fn12)

Foundations give out billions of dollars every year, and PRIs are a valuable financing tool that allows social enterprises access to this money.(fn13) PRI funds can also be used to reduce the risk for other investors, thereby increasing returns as well as the total funding available to social entrepreneurs.(fn14) By design, L³C qualifications mirror the Internal Revenue Service's (IRS) definition of a PRI-qualified entity,

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making this business model an attractive recipient of PRI funds.(fn15) However, neither the IRS nor the federal government has provided formal notification that L³Cs will receive preferential consideration,(fn16) and L³C advocates have thus proposed federal legislation that would enable L³Cs to receive preferential designation as presumptively PRI-qualified organizations.(fn17)

An L³C's access to large-scale funding allows it to develop a business that is both long-term and self-sufficient, unlike charities that are often dependent on annual refunding processes to sustain their operations.(fn18) The L³C model's focus on a double bottom line and tranche investing "gives many social enterprises a low enough cost of capital that they are able to be self sustainable," therefore making it "[a] perfect vehicle for economic development, medical research, operation of social service agencies, museums, concert venues, housing and any other activity with both a charitable purpose and a revenue stream."(fn19)

The creation of the L³C form was accompanied by high expectations that it could benefit some struggling businesses.(fn20) For example, in 2010, the North Carolina Legislature justified the passage of L³C legislation by arguing the hybrid model would help reinvigorate a stagnant state economy.(fn21) By mid-2012, forty-seven companies incor-

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porated as L³Cs in North Carolina, giving L³C supporters hope for even greater business growth in the upcoming years.(fn22)

Despite these successes, adoption of the L³C form has been slower than proponents expected. Some critics argue that L³Cs are nothing more than "specifically branded LLCs" and that the novelty of this new business form leaves its benefits and consequences shrouded in uncertainty.(fn23) With little state or federal governance, many questions remain regarding investor rights, securities trading, fiduciary duties, and profit distributions. Despite these criticisms and uncertainties, several states have passed L³C laws, and an increasing number of business are adopting this model.(fn24)

A similar business initiative has found great success in the United Kingdom (U.K.), where numerous proponents supported legislation designed to create hybrid business models that would promote social entrepreneurship.(fn25) As a result, the U.K. created the Community Interest Company (CIC) in 2006, allowing more than 4,500 companies to register as CICs that offer a double bottom line (or dual benefit) to investors.(fn26) Companies adopting the CIC model have ranged from one-person startups to well-established multimillion dollar compa-nies.(fn27) The CIC model operates in a wide range of economic sectors, including agriculture, fishing, manufacturing, construction, hotels, education, and health services sectors.(fn28)

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While CICs and L³Cs were created with the same double bottom line in mind, CICs face strict government regulations that provide investors with additional protections. These regulations have indirectly contributed to the success of many CICs by increasing investor confidence in the success of these businesses.(fn29) In the United States, the flexibility of LLC statutes may provide L³Cs with unique funding options, but the lack of government regulation leaves investor outcomes uncertain and inhibits L³Cs from being a better-utilized business model for social entrepreneurship.

II. SOCIAL VENTURES AND L³Cs

While the L³Cs business form is still in its introductory stage, there are examples of social entrepreneurs taking advantage of the business model and the L³C brand to attract new investors. In February 2012, Renewable Social Benefit Funds, "an alternative energy company focused exclusively on bringing solar power to hospitals, schools, low-income housing projects and other governmental and tax-exempt entities," announced a collaboration with Panasonic Enterprise Solutions Company and the Conrad N. Hilton Foundation to provide a solar power installation on the Hilton Foundation's corporate campus.(fn30) The Hilton Foundation stated that working with "Renewable Social Benefit Funds' financing will allow [it] to allocate assets to other charitable purposes, a double win for the Foundation."(fn31) This collaboration enables the Hilton Foundation to take advantage of Renewable Social Benefit Funds' L³C business model and "lower [its] carbonfootprint."(fn32)

Another business that has successfully used the L³C's unique financing model is the Paradigm Project, a company dedicated "to creat[ing] sustainable social, economic and environmental value

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within developing world communities."(fn33) The Paradigm Project combines grants, low-interest loans, charitable donations, and traditional market investments to fund its various projects, including the marketing of affordable, energy-efficient stoves in Kenya, Guatemala, and Haiti.(fn34) Through partnerships with nongovernmental organizations (NGOs), charitable organizations, social capital partners, and investors, the Paradigm Project has distributed over 36,000 energy efficient stoves in developing countries across the globe.(fn35)

A. The Development of the LLC

Since 1990, market demands for more diverse and flexible business arrangements resulted in dramatic changes in traditional business forms that exceeded the original flexibility allowed under corporate and partnership law.(fn36) The first LLC statute was passed in Wyoming in 1977; however, widespread adoption of the LLC...