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To L3C or Not to L3C? That was the Question

February 11th, 2013

Richard Marker

All of us who are funders know the moment. At some point in a conversation, especially at a social event, there is a pregnant pause when the person who just learned we are or work with funders decides to tell us of a project or organization in need of funds. Often the petitioner raises the idea as if no one else had ever thought to propose such a request before. In our case, since we have taught and worked with many philanthropists and foundations in the USA and around the world, and in modest ways are funders ourselves, the question is guaranteed within the first three paragraphs of meeting someone.

So, when at a social event recently, someone I had just met asked me about how I spend my professional time, I wasn’t surprised when his first reaction was to pause, take a breath, stroke his beard, and begin his query. But I was wrong. His question wasn’t about funding his project but, instead, whether or not I believed in the value of L3C’s.

Most of you know, in general at least, what an L3C is. It is one of several examples of attempts to create a for profit legal entity where social purpose is valued as much as bottom line. Legal, in one form or another in a growing number of states, but it is still very early in their history. Serious observers, some positively inclined, others more skeptical, all agree that there are simply too few time-tested examples to know if the idea works or not – and if it does, in what circumstances is it most effective.

The fellow who asked me had a project in the arts to which he was, and remains, committed. He had started a non-profit in order to implement his dream, but he ended up being its primary funder and ended losing a lot of his own money. He was enticed by the L3C model because, at least as he read it, more foundations and investors would be willing to put in substantial money, he would have an ownership stake, and, as he imagined, he would be able to fulfill his dream and make money at the same time.

He had done his homework about for-profit entities in the arts. They do exist. Depending how broadly one defines the field, one might include media such as television, cinema, etc. But none of his examples were start-ups or L3C’s. While that didn’t rule out the viability of his start-up, what struck me was that there was nothing about his description which suggested to me that there was a viable business model. If no one would contribute or grant to it when it was a non-profit, why would they invest in it as a for-profit?

What struck me was that this was all based on buying into the idea that a for-profit would, by definition, be better for him than his failed non-profit. Not one word about what likelihood that anyone would ever be able to see a profit, that the project was sustainable in some way, or that there was any evidence that others endorsed the quality of the project. [I didn’t encourage a long description since I didn’t want to lead him into thinking that I could provide the kind of professional support he might need. For all I know, it is a brilliant, transformative idea.]

This brief incident, though, did underscore a very problematic way of thinking among many who are engaged in trying to solve social problems or start innovative projects. There are substantial players who believe that it is a given that a for-profit model is better than a non-profit, that it will be easier to capitalize, sustain, and grow through one of these vehicles more readily than a traditional non profit one.

I see this when I speak at b-schools, it is the undercurrent of meetings with many social entrepreneurs, and it is a special problem for start-ups trying to create a viable and persuasive business model. Some believe that it would be great to do well by doing good; others believe that only sustainable models are those which serve self-interest.

Is this bias toward the for-profit model justified? In some cases it isn’t unreasonable. It is true that, for projects with certain business models, it is far easier to raise larger sums of capital than it is for non-profits. And there is some evidence that in some areas the for-profit world will find it desirable to co-opt or support ideas even if non-profits are in the same playing field. [E.g., wind and solar power may not be equally profitable everywhere in the world, but they are no longer in the realm of foundation-funded alternatives.]

Social impact bonds are another hot topic the concept has been buoyed by the success of a couple of carefully crafted trials. Yet thoughtful analyses demonstrate that the conditions for their success make it highly unlikely that they would work for every social problem – many of which will continue to need either government funding or non-profit commitment, or both.

The push for privatization leads beyond simple discussion of business models to deep-seated questions of public policy. The success of private for-profit hospitals and health care systems has led some to posit that there is no longer a need for public and non-profit ones. The argument goes: why should we give tax preferences and public monies when others can do the same thing privately and make money doing so? There is enough literature in the public sphere on positions on both sides of this issue that it would be superfluous to repeat them here. Suffice it to say that, at least so far, there continue to be too many gaps in service to justify turning the entire health care system over to for profit entities.

Which brings us to the essence of the question: is the bias toward profit motive solutions justified? The simple answer is “it depends.” But that is too easy. The real answer is that one must be careful to ask the correct bottom line question. In the area of social benefit, the ultimate question is not the nature of the organization but does that organizational structure serve the public good. Non-profits exist, or should, to solve problems – problems of human beings or culture or equity. The funding is not the goal but the enabler. For-profits exist to make money. What they do may or may not make the world a better place. If any of the alternative models truly, in the long run, prove to solve human problems better than existing ones, then of course they should be a consideration. But, I confess, and the anecdote that introduced this post illustrates, that simply affirming the for-profit solution is far from a panacea, or a guarantee of financial support.

5 Comments

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  1. February 12, 2013

    Having run a large 501c3, a small 501c3s, an LLC and an S-Corp, I can say that the L3C model, to the extent that it fulfills its promise to simplify IRS reporting requirements, it’s an attractive idea irrespective of other benefits it may confer. However, as you rightly say, this implicated deep-seated questions of public policy. One of the obstacles I’ve encountered that weighs directly on this question is the opposition or hostility among some in the business community towards non-profits, simply because of how differently they operate from for-profits. I’ve seen and idea, pitched as a non-profit flounder, and pitched as a for-profit attract investors and support. Perhaps non-profits have an image problem that an L3C can solve?

    • Richard Marker #
      March 7, 2013

      Sadly, there is indeed a bias in some circles toward the sector called non-profit. [a terrible nomenclature!]. The bias has both some historic legitimacy and some misunderstandings. It is quite true that the nfp sector has a history of being under-capitalized and often works at a disadvantage in keeping or attracting professionals, providing appropriate benefits, and respecting accomplishment. It is also true that a non profit [by law and practice] is accountable to many more stakeholders than a comparable private company which serves to make them much less agile. As Robin Hood Foundation found out [and many others have come to understand], much of the under-performance of the sector is attributable to underinvestment and not the absence of professional competence or energy.

      It remains an interesting and VERY open question where the sweet spot should be for the historically non profit sector, the for profit sector, and the hybrid models. But what is very clear is that the for profit model by itself, for all of its capital, has not proven up to the task of voluntarily solving the big problems of the world. So any bias toward that as the primary problem solving mode is far from convincing.

  2. March 28, 2013

    Do you have an opinion about how news organizations fit into this discussion? They are definitely serving a public good, but until just a few years ago, they were a business model that also made money. Now, it seems, they are caught in a sort of limbo where people expect them to make money (as well as serving the public’s need to know), but many no longer can.

  3. October 1, 2013

    L3C’s sure seem to have great potential, both in operations and agility. For-profit philanthropy. I imagine different ways B-Corps and L3C’s can organize and incentivize underutilized talents that are now dormant. Harnessing this energy and building the new business models necessary are something I look forward to. Great Article. Thanks

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