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Understanding business formation: What is an L3C?

One of the most important decisions that a prospective business owner will have to make before opening their doors is selecting a legal structure for their business. In other words, a choice will need to be made as to whether the enterprise should organize as a corporation, limited liability company, partnership, sole proprietorship, or other entity.

There are, of course, many factors that a prospective business owner will need to consider when making this determination, including income taxes, investment needs and, most significantly, potential risks and liability.

In addition, a prospective business owner will want to consider that Michigan is one of only a few states to permit the formation of a relatively new entity known as a low-profit limited liability company — or L3C.

What is an L3C?

At its core, an L3C is sort of hybrid of a non-profit and a for-profit organization, meaning its charitable mission is the primary objective and its profit-earning mission secondary. The purpose in amending state law to permit these types of entities was to encourage investments in “socially beneficial for-profit businesses.”

Are there any requirements relating to an L3C’s charitable mission?

At its core, an L3C must satisfy the following three elements concerning its charitable mission:

  • It must significantly further the accomplishment of one or more altruistic purposes
  • It must not have production of income or appreciation of property as a significant purpose
  • It must not seek to further a political purpose or legislative agenda

What are the advantages of forming as an L3C?

The single biggest advantage of forming as an L3C is that it is extended the same legal treatment as a limited liability company. This means that L3C members are not personally liable for any debts incurred by the organization (absent any personal guarantees), such that the only thing ever really at stake is their investment/contribution to the business.

Furthermore, there is no double taxation, meaning each L3C member will be taxed based on their shares of the profits and the L3C itself will escape taxation.

Are there any disadvantages of forming as an L3C?

Experts indicate that the relatively new status of L3Cs means there is some degree of uncertainty as to how the rules and regulations governing them will be applied/interpret by the state courts.

Given this reality and the complexities surrounding business formation in general, prospective business owners should consider speaking with a skilled legal professional who can outline the law, answer questions and guide them through the formation process.