Anthony Pisapia

B-Corps and L3C’s have been getting alot of attention recently.

I’d like to dispel one myth I’ve heard in regard to both structures, namely that foundations can give you grants if you are a for-profit structured as a B-Corp or an L3C.  There are other ways to structure your business to gain this advantage (and I’ll talk about those in future posts) but these are not it.

First a little background on foundations.  Foundations are required by the IRS to give 5% of their assets to “charitable purposes” each year. Distribution of assets for “non-charitable purposes” do not meet that definition and do not accrue toward the 5%.    Distributions for non-charitable purposes are taxable.  Taxes are something foundations usually avoid (like the plague).

Additionally, the IRS restricts foundations in the following ways:

1. restrictions on self-dealing between private foundations and their substantial contributors and other disqualified persons (easy to define);
2. requirements that the foundation annually distribute income for charitable purposes (not so easy to define if the distribution goes to a for-profit company);
3. limits on their holdings in private businesses (so their ability to take equity is limited);
4. provisions that investments must not jeopardize the carrying out of exempt purposes (there’s that pesky word again, “exempt”); and
5. provisions to assure that expenditures further exempt purposes (they use that word so much, it must mean something).

There is one way around these restrictions: Program Related Investments (PRI). PRI’s are a legal way for foundations to grant or loan to for-profit entities and still meet the “exempt” guideline. Some people (I’m not naming names) seem to be hoping that PRI’s will be extended to their companies.  The problems here are two-fold:

1. few foundations give PRI’s (save the Ford Foundation) and
2. PRI’s are typically defined as “purely charitable”.

To illuminate the “purely charitable” bit, here are the examples the IRS cites for allowable PRI’s:

1. Low-interest or interest-free loans to needy students,
2. High-risk investments in nonprofit low-income housing projects,
3. Low-interest loans to small businesses owned by members of economically disadvantaged groups, where commercial funds at reasonable interest rates are not readily available,
4. Investments in businesses in deteriorated urban areas under a plan to improve the economy of the area by providing employment or training for unemployed residents, and
5. Investments in nonprofit organizations combating community deterioration.

If the definition of allowable PRI’s is that strict going forward, there’s almost no reason for an entrepreneur to pursue them unless they are planning on opening businesses to serve low income individuals in low income neighborhoods.

It is also seems that foundations are playing with fire by making charitable grants or PRI’s to for-profit companies. I don’t know of a case in federal court that has produced a usable definition of “charitable purposes” and “exempt purposes” within a for-profit corporation (I’d love to hear about one).  Perhaps it’s forthcoming.  I wouldn’t want to be the first to test it.  I also wouldn’t want to be the first corporation that tried to file my tax return with a charitable deduction to a for-profit corporation on my books no matter what their structure (i.e. L3C, B-Corp, LLC, S-Corp, C-Corp, etc.).

On the flip side, 501c3’s are, by definition, organized for exempt purposes (hint, hint, hint). To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual.   So the feds seem to want foundations to only grant charitably to nonprofits, or suffer their wrath.

Foundations who wind up granting to a 501c3 for “non-charitable purposes” could claim they were defrauded and the nonprofit could lose its exempt status.  Same with corporations giving donations to such groups.  There’s no such protection in granting to for-profit entities (I wouldn’t want to be the program manager that lost my foundation it’s exempt status).

It is possible that federal tax law will change, though this seems unlikely.  Imagine the headaches it would give the IRS to validate a for-profits charitable intentions.  Either way, I’m not convinced these structures will do anything to expand your pool of investors to foundations, at least on the charitable side.  Maybe foundations will be so bowled over by these designations that they will set aside a portion of their endowment to invest in these companies, but that’s the most anyone should hope for.  Even then, your little startup would probably have to be part of a large pool of investments in order for foundations to participate (remember those limits on private holdings?  Here’s where they come in to play).

This post isn’t for or against the structure’s themselves. This post is meant to shatter dreams.  Foundations in the US won’t be giving grants to for-profits any time soon (at least not anything you could build a company on).  Sorry, look for your capital elsewhere. Or turn to Kaufman realizing that they will turn you toward angels in their network.

If you’re in the UK it’s not much different.  I will say that UnLtd rocks.  I love the idea of a small individual grant foundation with a Venture Captial firm as a sidecar.  Very cool.

Please note, I am not a tax lawyer and this is not legal advice.  It is also not accounting advice.  Take it for what it is, an opinion, and look before you leap. I’m always up for enlightenment so feel free to leave a comment. I’m looking forward to it!.