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Marc Lane: Are You are .Com or a .Org?


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Noted national author, attorney and entrepreneur/social entrepreneur and L3C guru discusses key issues to keep in mind when deciding whether to be a for-profit or a not-for-profit organization. He also discusses the lasted events in the growing L3C movement for the social sector.

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Marc Lane: Are You are .Com or a .Org?

  1. 1. Are you a [ .com ] or a [ .org ] ? Marc J. Lane June 30, 2011 Copyright © 2011, by Marc J. Lane Advisors, L3C. All rights reserved.
  2. 2. The 1-2-3 Punch <ul><li>Socially responsible and mission-related investing </li></ul><ul><li>Impact investing </li></ul><ul><li>Program-related investing </li></ul>
  3. 3. Socially responsible and mission-related investing <ul><li>Screening </li></ul><ul><li>Shareholder advocacy </li></ul><ul><li>Community investing </li></ul>
  4. 4. Impact investing <ul><li>Seeks to solve a social or environmental problem while generating a financial return to investors </li></ul><ul><li>Complements philanthropy and government efforts </li></ul>
  5. 5. Program-related investing and the L 3 C
  6. 6. <ul><li>Make grants of 5% of &quot;non-charitable-use&quot; assets to charitable causes annually </li></ul><ul><li>  or </li></ul><ul><li>Make &quot;program-related investments&quot; of 5% of &quot;non-charitable-use&quot; assets annually </li></ul>The Foundation's Choice
  7. 7. <ul><li>Venture capital and other high-risk investments that would otherwise subject foundation and its manager to 10% jeopardizing investment excise tax. </li></ul><ul><li>Primary purpose is charitable - - religious, scientific, literary or educational, fostering amateur sports competition, or preventing cruelty to children or animals </li></ul><ul><li>Income production or property appreciation not a significant purpose </li></ul><ul><li>Purpose is not to attempt to influence legislation; or to participate in, oppose or intervene in a political campaign of candidate for public office </li></ul>PRIs
  8. 8. PRIs come in many flavors <ul><li>Interest-free or below-market-rate loans </li></ul><ul><li>Loan participations </li></ul><ul><li>Loan guarantees </li></ul><ul><li>Deposits in community development banks </li></ul><ul><li>Leases </li></ul><ul><li>Equity investments </li></ul>
  9. 9. PRIs in Action <ul><li>Low-interest loans to needy students </li></ul><ul><li>Investments in low-income housing projects </li></ul><ul><li>Low-interest loans to disadvantaged business owners </li></ul><ul><li>Direct investments in businesses which create jobs </li></ul><ul><li>Investments in land conservation or brownfields mitigation </li></ul><ul><li>Investments in arts groups or cultural organizations </li></ul><ul><li>Investments in faith-based programs </li></ul><ul><li>Investments in child care centers </li></ul><ul><li>Investments in community development initiatives </li></ul><ul><li>Investments in social services organizations </li></ul><ul><li>Investments in educational or workforce development training opportunities </li></ul><ul><li>Investments in businesses that develop cutting-edge technology in rapidly changing environmental or health-related fields </li></ul><ul><li>Investments in historic preservation </li></ul>
  10. 10. Additional PRI Examples Proposed by ABA Section of Taxation <ul><li>Development of new drug </li></ul><ul><li>Development of new organic-farming process </li></ul><ul><li>Loan made to media in former Communist bloc countries </li></ul><ul><li>Economic redevelopment of terrorism site or site of national disaster </li></ul><ul><li>Environmental investments in Third World or economically depressed countries </li></ul><ul><li>Foreign economic development </li></ul><ul><li>Investment that lessens the burdens of government </li></ul>
  11. 11. PRIs have been seen as complex and expensive <ul><li>No process to guarantee that an investment complies with PRI tax regulations </li></ul><ul><li>No standards to ensure that an entity is a proper recipient of PRIs </li></ul><ul><li>IRS private letter rulings expensive and time-consuming </li></ul>
  12. 12. A Low-Profit Limited Liability Company (L 3 C) is an LLC <ul><li>Non-corporate form of doing business that limits owners' liability </li></ul><ul><li>Affords them flow-through tax treatment, and </li></ul><ul><li>Offers operating flexibility through participation in management </li></ul>
  13. 13. But a special kind of LLC <ul><li>One or more for-profit &quot;members&quot; and one or more non-profit &quot;members&quot; </li></ul><ul><li>Charitable or educational purposes </li></ul><ul><li>Would not have been formed except to accomplish those purposes </li></ul><ul><li>No significant purpose to produce income or property appreciation </li></ul><ul><li>But may produce significant income or property appreciation </li></ul><ul><li>No political or legislative purpose </li></ul>
  14. 14. The L 3 C's Promise <ul><li>Shifting economic risk to third parties </li></ul><ul><li>Financial self-sufficiency </li></ul><ul><li>Continuing foundation input </li></ul><ul><li>Effective leveraging </li></ul><ul><li>Capital flow to &quot;double bottom-line&quot; venture </li></ul><ul><li>A “win-win” for both for-profits and non-profits </li></ul>
  15. 15. Capital Structure Illustration #1 Foundation incurs high financial risk, earns low (1%) financial return, but high social return Social Return Financial Return Foundation
  16. 16. Capital Structure Illustration #1 Mezzanine investor Socially conscious investor incurs lower financial risk, earns higher (3%) financial return. Social Return Financial Return
  17. 17. Capital Structure Illustration #1 Market-driven investor Market-driven investor incurs market-rate risk, earns market-rate (6%) financial return. Social Return Financial Return
  18. 18. Blended rate of return: 4% - - which L 3 C can generate, but not without the catalyst of the foundation’s PRI.
  19. 19. Capital Structure Illustration #2 Development agency makes a grant, seeking high social return but earning no financial return. Social Return Financial Return Government
  20. 20. Capital Structure Illustration #2 Foundation earns low (2%) financial return, but high social return. Social Return Financial Return Foundation
  21. 21. Capital Structure Illustration #2 Outside investor incurs market-rate risk, earns market rate (7%) return. Social Return Financial Return Market-driven investor
  22. 22. Blended rate of return: Again, 4% - - which the L 3 C can generate, but not without the catalyst of the foundation's PRI.
  23. 23. Inherent Conflict of Interest <ul><li>Managers of for-profits must maximize financial returns to owners. </li></ul><ul><li>v. </li></ul><ul><li>PRI recipients must not produce income or property appreciation as &quot;significant purpose.&quot; </li></ul>
  24. 24. Solutions <ul><li>Reliance on applicable constituency statute </li></ul><ul><li>“ Expenditure responsibility” </li></ul>
  25. 25. 1. Reliance on applicable constituency statutes Texas Business Organization Code § 21.401 Sec. 21.401.  MANAGEMENT BY BOARD OF DIRECTORS. (a) … (b)  In discharging the duties of director under this code or otherwise and in considering the best interests of the corporation, a director may consider the long-term and short-term interests of the corporation and the shareholders of the corporation , including the possibility that those interests may be best served by the continued independence of the corporation. (Source: Acts 2003, 78th Leg., ch. 182, Sec. 1, eff. Jan. 1, 2006.)
  26. 26. <ul><li>(805 ILCS 5/8385) (from Ch. 32, par. 8.85) Sec. 8.85. In discharging the duties of their respective positions, the board of directors , committees of the board, individual directors and individual officers may , in considering the best long term and short term interests of the corporation, consider the effects of any action (including without limitation, action which may involve or relate to a change or potential change in control of the corporation) upon employees, suppliers and customers of the corporation or its subsidiaries, communities in which offices or other establishments of the corporation or its subsidiaries are located, and all other pertinent factors . </li></ul><ul><li>(Source: P.A. 86-126) </li></ul>
  27. 27. 2. “Expenditure responsibilities” requirements <ul><li>Manager’s Commitments </li></ul><ul><li>Use of funds for agreed purpose </li></ul><ul><li>Annual financial reporting </li></ul><ul><li>Maintenance and availability of adequate books of records </li></ul><ul><li>No support of propaganda, the influence of legislation, the outcome of public elections or voter registration drives </li></ul>
  28. 28. The Optimal Venture <ul><li>Socially beneficial mission </li></ul><ul><li>Consistent cash flow </li></ul><ul><li>Entrepreneurial </li></ul>
  29. 29. L 3 C Applications <ul><li>For social ventures seeking to secure PRI support from foundations that forgo market-rate returns and thus subsidize private-sector investors who can thereby earn market-rate returns </li></ul><ul><li>As single-purpose, wholly owned subsidiaries of tax-exempt organizations </li></ul><ul><li>For ventures that seek to draw consumer and funder attention to their status as social enterprises </li></ul><ul><li>For coalitions of nonprofits that join forces to tackle a social problem through the application of business principles </li></ul>
  30. 30. Proposed Philanthropic Facilitation Act <ul><li>Voluntary </li></ul><ul><li>Safe-harbor registration by entity </li></ul><ul><li>Annual reporting </li></ul>
  31. 31. L 3 C Legislation 2008 Vermont 2009 Michigan Utah Wyoming 2010 Illinois Louisiana North Carolina 2011 Maine 2012 Rhode Island
  32. 32. The Benefit Corporation: Creating a “Public Benefit”
  33. 33. <ul><li>The Requirements of a Benefit Corporation </li></ul><ul><li>The corporation must create a material, positive impact on society and the environment. </li></ul><ul><li>Impact must be measured by a third party. </li></ul><ul><li>A “benefit report” must be published annually. </li></ul>
  34. 34. <ul><li>The Benefit Corporation’s Benefit </li></ul><ul><li>Directors have </li></ul><ul><li>“ immunity from liability” </li></ul><ul><li>“ in the reasonable performance of their duties.” </li></ul>
  35. 35. But not too fast… <ul><li>Lack of policing </li></ul><ul><li>Litigation risk may shift </li></ul><ul><ul><li>From shareholder claims that the board is not maximizing profit </li></ul></ul><ul><ul><li>To shareholder claims that the board is not sufficiently pursuing the corporation’s general or specific public benefit </li></ul></ul>
  36. 36. Still… <ul><li>Most early adopters are more interested in branding than derivative lawsuit protection. </li></ul><ul><li>The Benefit Corporation codifies the entrepreneur’s social and environmental ethos. </li></ul><ul><li>It offers legal recognition of the venture’s core values. </li></ul>
  37. 37. Benefit Corporation Legislation * 2011: Benefit LLC legislation ** Sustainable business corporation legislation 2010 Maryland* Vermont 2011 New Jersey Virginia Hawaii**
  38. 38. Pay-For-Success Bonds (aka Social Impact Bonds)
  39. 39. Pay-For-Success Bonds <ul><li>Aligns interests of government agencies, private investors, and nonprofits around specific social outcomes. </li></ul><ul><li>Leverages private investment capital to pay for early intervention programs delivered by service providers. </li></ul><ul><li>Government pays financial returns to investors if and when improved social outcomes are achieved: </li></ul><ul><ul><li>If outcomes don’t improve, investors lose their money. </li></ul></ul><ul><ul><li>If outcomes are achieved, government returns principal plus specified return. </li></ul></ul>
  40. 40. Social Impact Bonds: The Seminal U.K. Example <ul><li>Of 40,200 adults serving short-term criminal sentences, 60% were expected to re-offend within one year, at great cost to society and taxpayers. </li></ul><ul><li>In October 2010, the Rockefeller Foundation among others invested £5 million (about $8 million) in bonds to fund counseling, employment, housing and other support services for recently released prisoners. </li></ul><ul><ul><li>If re-offending is reduced by 7.5% or more, investors will receive payments from the U.K. government reflecting a share of its long-term savings. </li></ul></ul><ul><ul><li>If not, investors will lose their money. </li></ul></ul>
  41. 41. Minnesota’s Pay For Performance Act of 2011* <ul><li>The Act would have established $20 million pilot program. </li></ul><ul><li>The State would have contracted with pre-qualified providers. </li></ul><ul><li>Funds would have come from “special appropriation” bonds issued in municipal bond market. </li></ul><ul><li>Providers would have been paid only if the State’s return on investment was positive. </li></ul><ul><li>* The Act was included within the State’s general appropriation bill, which was vetoes on May 24, 2011. </li></ul>
  42. 42. Massachusetts’ Pay For Success Contracts: The Ask <ul><li>The State’s Executive Office for Contracts Administration and Finance (EOAF) issued a Request for Information on May 6, 2011 to learn: </li></ul><ul><li>Which social services are the most promising candidates for pay for success contracts? </li></ul><ul><li>Are there innovative social solutions to social problems that have been demonstrated on a relatively small scale that have the potential to be scaled up using pay for success contracts in a way that would reduce costs/or improve outcomes? </li></ul><ul><li>Are there areas where targeted investments in preventative services would have a high likelihood of reducing future budgetary costs by more than the cost of the services? </li></ul><ul><li>Are there other areas of government activity where upfront investments and innovative contracting strategies could improve performance and reduce costs? </li></ul><ul><li>How should pay for success contracts and social impact bonds be structured to support these goals? </li></ul><ul><li>What information would be useful to EOAF in drafting a more detailed procurement solicitation for these contracts? </li></ul>
  43. 43. Massachusetts’ Pay For Success Contracts: Next Steps <ul><li>Responses were received by June 10, 2011. </li></ul><ul><li>EOAF will issue a Request for Response targeted at the most promising applications. </li></ul>
  44. 44. For further information: The Law Offices of M ARC J . L ANE A PROFESSIONAL CORPORATION 180 North LaSalle Street Chicago, IL 60601-2701 (312) 372-1040 (800) 372-1040 Fax (312) 346-1040