Saturday, January 12, 2013

About the L3C

There is a rough consensus that the not-for-profit theater in the U. S. is in trouble.  At first, the recession that began in 2008 was blamed, but, gradually, many realized that the recession was just the last straw on top of a number of underlying weaknesses.  The illness of the NFP theater has been around for  a long time.   In 1974 a national meeting of  leaders of the commercial and NFP theaters, the American Congress of Theater, identified a number of problems at that time, "including declining attendance and the need to stimulate youth and minority audiences, an economic recession, rising operating and production costs, and unreliable financing."  That list still reflects NFP theater concerns today, twenty-eight years later.  More problems might be added, including the health of new play development, administration bloat, living wages for artists, and a fall-off in management nerve for experimentation.
The remedies for the NFP theater's malaise most being discussed focus on two areas: the NFP business model and marketing NFP theater to government and other grant giving entities.  (The latter is often framed  in terms of developing new metrics for the impact of theater and new ways of discussing the arts—a new "framing" of the terms of debate.) This post focuses on the chief business model being discussed.  Future posts will look at aspects of the metric/framing discussion.
Some pundits of the not-for-profit arts, including NFP theater, are writing about the L3C legal organization as a potential cure for problems with the NFP arts business model.  The L3C is hastily described as a cross between a NFP organization and a commercial organization.  Here, let's slow down and see what the L3C really means.

The letters stand for "low-profit limited liability company," a form of business organization legal in nine states so far.  The L3C is identical to the conventional LLC, the "limited liability company," except for having a commitment to social issues that is equivalent to the purposes that would qualify a NFP group for 501(c)3 standing with the IRS plus a minimal interest in profit.  In states where lawful, the L3C has been passed as an amendment to existing LLC law and so is a special type of LLC.  The LLC blends the qualities of a partnership and a corporation, in that an LLC like a regular partnership does not have the legal, reporting, public accounting, and tax issues of a corporation but, unlike a normal partnership, the owners of an LLC are not responsible privately for the debts and liabilities of the company.  LLCs and L3Cs are fully taxable.

Note that a L3C has owners, generally called "members."  A 501(c)3 organization has no owner but is directed by a board for the public good.  When a 501(c)3 goes bankrupt or otherwise disbands, whatever resources remain are required to be dispersed to another NFP organization whose purposes are close to those of the defunct NFP.  When an L3C disbands, its remaining resources are split among members.

So, why a L3C instead of a LLC?  The primary reason is that L3Cs are eligible for PRIs, "program-related investments."  PRIs allow a grant-making foundation to invest or loan money to another group and have that dispersal count as part of the 5 percent per year of net worth required by the IRS for the foundation to disperse.  A PRI must be made in support of the foundation's incorporating purposes and must have a minimal income for the foundation. 

The belief is that a PRI, by taking some of the risk of investment in or loans to a L3C, will allow more conventional investors to take L3Cs seriously as a potential investment.  Thus, L3Cs allow for "tranche" investment, where different investors in the same organization have different potential risks and return profiles.  The PRI would take a high risk/low return investment or loan and that would allow a lower risk/higher return potential for commercial investors.

Of course, to provide any return requires a profit-making operation.  Adopting the L3C business organization would move an otherwise NFP theater to a special kind of commercial theater.  The commercial theater today is on average a high-profit venture but it is also an extremely high-risk endeavor. Considering just Broadway, about two-thirds of productions close without recouping their investments.  Commercial theater investments are classed by the SEC as "alternative investments," which require investors to have substantial other wealth and be able to lose their theater investment without significant damage to their financial position.  

It's hard to imagine how moving closer to a commercial model will benefit the current NFP theater.

One potential use for the L3C might be in capital investments.  A NFP producing group looking for a new physical theater building might form a L3C to own, finance, build, and operate the building, promising rent from the NFP theater and maybe other tenants.  A PRI could be the seed to attract commercial investments and loans.  If the NFP goes under or fails to pay rent, the L3C would still own the building, reducing its risk.

Looking at history prior to the recession, NFP theaters seemed capable of attracting donations adequate to build and expand theater buildings, without the innovation of a L3C.

Of course, there are other types of socially-focused endeavors for which the L3C could be a potent tool.

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