Traditionally, there have been two options available to entrepreneurs who are incorporating a new business. The first option, and the oldest, is to form a standard, for-profit company according to one of the several incorporation models. For example, profit-oriented entities can be partnerships, cooperatives, or corporations. Each of these types has laws and regulations governing its operating procedures. Since 1986, businesses in the United States have also had the option of becoming nonprofit organizations, exempting them from certain federal taxes.
The Difference Between For-Profit and Nonprofit Organizations
For-profit businesses often generate money for their operations by raising capital from investors. Since they are oriented towards making a profit through delivering goods or services to a client base, investors expect to receive a return on their investments in the form of a share of the earnings. For example, a company may raise capital from several investors. It would then be expected to use this money to improve its business operations.
By using the funds wisely, the company could win more customers, reduce its operating costs, or improve operating efficiency. Ideally, this would lead to increased profit. The investors would then expect to receive their investment back, in addition to a portion of the extra profit earned by the company. In a growing company, this process could be expected to continue indefinitely, with more capital leading to further improvements, and increased profit for both the company and its stakeholders.
By contrast, a nonprofit organization is not expected to return investors' contributions or share profits with stakeholders. Instead, it uses all of its revenue for its primary purpose which is to further a cause, either in the arts, to improve literacy, or any other qualifying activity. They are typically charities or groups dedicated to improving society in some way.
The Problem With Nonprofits
For entrepreneurs who are interested in making a substantial contribution to society, developing a nonprofit organization can be beneficial because it removes some of the pressure of being financially accountable to the stakeholders and the federal government. However, as they are usually not allowed to raise capital through traditional investments and may not sell shares in the company, such enterprises are often forced to rely on volunteer labor and charitable donations in order to achieve financial stability. This inability to raise money through investment can severely limit the extent to which these organizations are able to bring about change.
What is an L3C?
In order to address the problems faced by nonprofit organizations, some states in the US have adopted a new form of business model called the L3C. It stands for low-profit limited liability company and was created as a way to allow socially-minded businesses to achieve greater financial power, without being responsible to stakeholders in the same way that for-profit entities are. Unlike nonprofits, L3Cs may accept investments and operate in much the same way that for-profit companies do. However, unlike for-profit businesses, they are expected to pursue a social goal, rather than profit, as their primary purpose. By incorporating elements from both traditional for-profit and nonprofit organizations, the L3C could become a powerful tool for American entrepreneurs who wish to make a contribution to society.
Is it the Right Choice for You?
Although, investments made to L3Cs are not tax-deductible, they are classed as program-related investments (PRI). This is an important element because private foundations are required to make grants or PRIs by law, equal to at least 5% of their assets every year. They can fulfill this requirement by investing in L3Cs and also get a small return. In reality, investing in such a business could often be a high-risk, low-return proposition because it does not have profit as its primary goal. For those willing to take a risk in order to make a real, positive impact on society, the L3C could be the right choice for entrepreneurs and investors alike.