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Presented by: MICHAEL D. MARTIN Martin, Stilwell & Jones, LLP

CREATIVE APPLICATIONS FOR CHARITABLE ENTITIES, INCLUDING FOR-PROFIT LLC’S AND CORPORATIONS WITH A NON-PROFIT PURPOSE. Presented by: MICHAEL D. MARTIN Martin, Stilwell & Jones, LLP 1400 Woodloch Forest Drive, Suite 590 The Woodlands, Texas 77380 281-419-6200 281-419-0250 (fax)

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Presented by: MICHAEL D. MARTIN Martin, Stilwell & Jones, LLP

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  1. CREATIVE APPLICATIONS FOR CHARITABLE ENTITIES, INCLUDING FOR-PROFIT LLC’S AND CORPORATIONS WITH A NON-PROFIT PURPOSE Presented by: MICHAEL D. MARTIN Martin, Stilwell & Jones, LLP 1400 Woodloch Forest Drive, Suite 590 The Woodlands, Texas 77380 281-419-6200 281-419-0250 (fax) Email:michael@msjlawfirm.com

  2. Charitable Giving • Tax Laws Encourage Charitable Giving. Options for sophisticated giving include: • Private Foundations. • Public Charities. • Private Operating Foundations. But sometimes “control” and “Hands on Philanthropy” aren’t enough.

  3. When Tax Benefits & Control simply aren’t enough. . . Expanding into Social Enterprise. • The L3C or Low-profit Limited Liability Company; and • The B Corporation.

  4. Social Enterprise: Defining the Terms • Social Enterprise. A businesslike activity designed to “do good” and not simply generate a profit, i.e., a socially motivated revenue generating activity. • Social Entrepreneur. One who forms and leads a Social Enterprise, i.e., society’s change agent; a pioneer of innovation that benefits humanity. • Program Related Investments.Foundation investments-debt or equity-into socially beneficial activities.

  5. Social Enterprise: Making the Case Private Foundation Endowments Increased in 2009 to $583 Bil. USD

  6. Social Enterprise: Making the Case ~ Foundation Resources; Part of the Private Sector Resource Base Private sector resources come in two types: • For-Profit Sector Resources. Market Driven - making money & building wealth - normally require rate of return of +5%. • Nonprofit Sector Resources.Market incentives are inadequate or non-existent - rate of return of 0 to -100%. • The Challenge. How to access the vast pools of market driven wealth to invest in ventures that fall into the gap between the 0 and +5?

  7. Social Enterprise: Making the Case ~ Foundation Resources can fund Low Profit Ventures There are many worthy causes: • Self-sufficient Under 5%. That can be self-sufficient in the 0 to + 5% zone. • Return won’t attract Market Capital. They offer a return on investment but the return is insufficient to attract most market driven investors. • Fall into Low-Profit Zone. They fall into the gap between the for profit and nonprofit worlds – what we call the “Low-Profit Zone.” • The L3C. The L3C lives in the Low-Profit Zone.

  8. Social Enterprise Investing-A Foundation’s Endowment as a Resource? Making the Case Foundation Endowments Likely to Increase Dramatically in the next Few Years. Why? Answer: the “Perfect Storm!” • The Federal Estate Tax Scheme. At 39.6% and going higher! • The Estate and GST Tax Scheme. Likely to return to the pre-Bush tax cut rates. • The Charitable Deduction Scheme.Encourages charitable giving with significant economic benefits. Query-Where will Wealthy Clients’ money likely go, if they know its protected, they can control it and get significant tax benefits, not to mention making a contribution to the community?

  9. Social Enterprise Investing and Social Entrepreneurship-Making the Case (Cont’d) The Current Income Tax Scheme. Rates are 39.6% and may go higher, due to: • The Deficit. The current deficit & continuing bailouts; • Home Foreclosures and Jobs. House foreclosures and Joblessness is on the rise; and • Current & Pending Government Reforms. The cost of Health Care, Immigration and other government reforms.

  10. Social Enterprise Investing So What can Private Foundations do? They can make~ • Minimum Required Distributions; and • Program Related Investments.

  11. Social Enterprise Investing-What can Private Foundations do? What are Minimum Required Distributions and Program Related Investments. • Minimum Required Distributions.Private Foundations must distribute in the current year, five (5%) percent of their average asset balance for the prior year, for its exempt purposes, typically in the form of grants to various public charities. IRC § 4942. (NOTE: Grants are effectively gifts. There is no return on investments. Private Foundations can do more, however this would begin to erode their endowment base and investment income). These distributions are called “qualifying distributions”, id. • Program Related Investments or “PRIs.”Investments by Private Foundations, in the form of debt or equity that support socially beneficial activities. IRC § 4942. These were authorized by the Tax Reform Act of 1968 and are an exception to the “jeopardy investment” rules (i.e., a Private Foundation can not make investments that jeopardize their exempt purposes). PRIs are also qualifying distributions. IRC § 4942(g).

  12. Social Enterprise Investing-What have Private Foundations done ~ The numbers • Assets. $565,000,000,000.00– The amount estimated in held in Private Foundations in 2008, id. This amount is expected to dramatically increase over the near term. • Distributions. The Private Foundation Center reported Private Foundations collectively made qualifying totaling $43,000,000,000.00 in 2008. The Private Foundation Center; Aggregate Data by Private Foundation type, 2006 [released 2008], at http://privatefoundationcenter.org. • Program Related Investments. Of the foregoing amount, less than one (1%) percent consisted of Program Related Investments, despite the fact that PRIs are strong tools of advancing Social Enterprise. id.

  13. Social Enterprise Investing Query-Why haven’t Private Foundations stepped up? There is a Built in Conflict and Tension between For-Profit and Non-Profit entities: • For-Profit. Must Maximize Profit to Investors; whereas • Non-Profit. Can only do Program-related Investing (where income not its “significant purpose”). • PRIs. They complicated, risky and burdensome.

  14. Social Enterprise Investing-So What Gives with Private Foundations? Query-Why haven’t Private Foundations stepped up? A more detailed answer. • PRIs are Complicated. They must meet certain minimum requirements. • Made solely for exempt purposes. Treas. Reg. § 53.4944-3(a)(1)(i). • Production of income or appreciation of property not a significant factor. Treas. Reg. § 53.4944-3(a)(1)(ii). • No politics or lobbying. Treas. Reg. § 53.4944-3(a)(1)(iii). • PRIs are Burdensome. Private Foundation managers have a fiduciary duty to do adequate due diligence and provide ongoing oversight once a PRI is made. Many do not have adequate resources. • PRIs are Risky. While there is no regulatory requirement a Private Foundation get a “due diligence” legal opinion or Private Letter Ruling, the consequences of the Service declaring a PRI is not a qualifying distribution can be economically devastating and potentially carry a “death sentence.”

  15. Social Enterprise Investing; the Roadblocks to using a Foundation’s Endowment Limitations on Accessing a Private Foundation’s Resources. • Limited or Narrow Purpose.Only for Exempt Purposes. • Required Minimum Distributions.5% of its assets, as grants. • No Private Benefit.Except reasonable salaries. • Significant Restrictions. Restrictions on Holdings and Investments. • Excise Taxes.Onerous penalties in Chapter 42, if they get it wrong. • Strong Self Dealing Restraints.Is subject to strict Self Dealing Rules. • Strong Government Oversight.Close IRS oversight.

  16. The “Private Foundation Excise Tax Rules”~ Enacted in 1969 to Stop Abuses-The Regulatory Roadblocks; • Contained in Chapter 42 of the Code.IRC §§4940-4945; • Designed to Prevent Self Dealing. By penalizing & taxing private use of foundation funds; • Two types of rules. • Rules to mandate accomplishment of exempt purposes; • Rules against benefiting related parties; • Penalties and Excise Taxes are Severe. Can be levied against both the foundation and the managers and can include the “death penalty.”

  17. The “Private Foundation Excise Tax Rules”; a Closer Look at these Rules • Mandate Required Minimum Distributions. 5% of assets. IRC §4942. Failure to distribute generates penalty taxes on undistributed amounts. IRC§§4942(a)&(b); • Prohibit Jeopardy Investments. Investments that prevent carrying out the foundation’s exempt purpose. §§4944(a)&(b); • Prohibit Self Dealing. Both direct and indirect, between the foundation and related parties. IRC §4942; • Prohibit Excess Business Holdings. Investments in entities in which disqualified persons are also investors. IRC §4943; • Tax Unrelated Business Taxable Income.Income from an unrelated (to exempt purposes) trade or business.IRC §512.

  18. Social Enterprise Investing: More Roadblocks The Inherent Conflict of Interest: • Mission-related investing. Officers and Directors of for-profit must maximize shareholder value; V. • Program-related Investing. PRI recipients must not produce income or property appreciation as “significant purpose.”

  19. Social Enterprise Investing ~ Can PRIs mix with For-profit Ventures? The short answer: Yes,but!!!The LLC as Entity of Choice.But not without problems: • Legal Opinion or IRS Approval May be Required. PLRs or Lengthy legal opinions are expensive, time consuming and cause delays; • LLCs are For-profit Entities. No incentive for low-profit, social enterprise ventures; and • The LLC Corporate Structure. Itrequires significant restructuring to make “user friendly” for PRIs.

  20. Social Enterprise Investing and the Low-profit Limited Liability Company The Low-profit Limited Liability Company or L3C; A response to the “for-profit/non-profit” dilemma. • The LLC.Organized for profit and to attract risk capital; conflicts with. . . • The Private Foundation. Organized for charitable purposes, where tax exempt benefits are at the core of social enterprise, there are little means to raise capital and a strong profit motive would jeopardize its exempt status. • The L3C Bridges the Gap.It’s a hybrid, for-profit version of the State law the LLC, that is: (i)Approved by State Statutes. 9 Jurisdictions so far. Vermont was the first and others are considering; (ii) User-friendly for PRIs. State law purpose tracts the PRI rules. It can have no other purpose; and (iii) L3C Corporate Structure Simplified.State statutes define the contents.

  21. The Low-Profit Limited Liability Company or L3C~What is it? The L3C~ Is a For-profit LLC.But a special kind. Is State-law Defined. Authorized by state LLC rules. Provides Asset Protection.The non-corporate form of doing business limits owners’ liability. Is Taxed as a Partnership.Affords flow-through tax treatment to members. Provides Governance Flexibility. Both for-profit and non-profit personnel participate in management.

  22. Forming an L3C~The Requirements Establish the Jurisdiction, then- • Select Members Carefully. One or more for-profit “members” and one or more non-profit “members.” • Correctly Develop the Purpose Clause.(i) Charitable or educational purposes; (ii) Would have not formed, except to accomplish those purposes; (iii) No significant purpose to produce income or property appreciation (but may produce significant income or property appreciation); and (iv) No political or legislative purpose. • Otherwise Governed by State’s LLC Rules. Just like any other LLC. Benefits: • Bridges the Gap between Non-profits and For-profits. • Signals Foundation Managers. L3C can hold PRIs. • Alerts State and Federal Regulators.The “L3C brand” signals regulators it contains PRIs, making oversight easier.

  23. Forming an L3C~The Benefits; In General An L3C- • Bridges the Gap between Non-profits and For-profits. • Signals Foundation Managers. L3C can hold PRIs. • Alerts State and Federal Regulators.The “L3C brand” signals regulators it contains PRIs, making oversight easier.

  24. The L3C and Federal Legislation~How Will it Help? The IRS has not yet ruled on the L3C, however any ruling would only be a “facts and circumstances” ruling on whether a foundation’s investment was a PRI. Federal legislation would: Create a Qualification Process. Create Safe Harbors. Update the Code and Regulations to require disclosure and annual reporting.

  25. The L3C~When is it Indicated? • As a Startup. • Two Member LLC ~ Investment Scenario. • As a Foundation Sub ~ Loan Scenario. • Expand a Foundation’s PRI. • Leverage a Foundation’s Financial Resources. • Better Business Oversight.

  26. The L3C~How it’s Done Formation & Organization.Select jurisdiction of choice and follow the rules (NOTE: Local counsel may be necessary). Governance. L3C Managers will include non-profit representatives (for continuing oversight and to assure that a PRI is used for exempt purposes) and for-profit members (or representatives). Tax Implications & Compliance. The L3C is taxed as partnership Exit Strategy. A Private Foundation must always have the unilateral right to withdraw, as a Member, and get its PRI back.

  27. The L3C~Sounds Great! Have any Really Been Implemented? Examples.......... Literally hundreds of L3Cs have been formed since April of 2008 (when Vermont passed the first state law).See outline, Part III, Section H, paragraph 6 for L3Cs in formation or currently operating and two success stories, below. • Moo Milk CO (Westbrook, ME). http://moomilkco.com

  28. The L3C~Sounds Great! Have any Been Really Implemented? More Examples.......... • The Endless Sky Project (Deer Lodge, MT). • In our Firm. Two projects; one under discussion and one on the “drawing board.”

  29. The B Corporation ~ Another Social Venture Hybrid For-profit Corporation with a Social Mission. Designed to Receive PRI Funds. Not Presently State or IRS Sanctioned.But, the process has started. Maryland passed B corporation on May 1, 2010.* *(See Fifty State Series: L3C & B Corporation Legislation Table, tracking legislative developments at http://ssrn.com/absract=1561783) The B Corporation Designation. A brand name developed by a non-profit called B-Labs. This group, for a fee, does extensive due diligence on corporate structure, purpose, activities and personnel and issues a “Certificate” which, for a fee, is renewable.

  30. Thank you! Questions? I hope that this presentation on L3Cs and their potential use with Foundations has been helpful. If you would like more information, please do not hesitate to call me! Michael Martin, Martin, Stilwell & Jones LLP

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