If you’re on the fence between forming your entity as a nonprofit vs. a for-profit company, hybrid entities are worth considering. There are two main types of hybrid entities: L3Cs and B Corps. We'll discuss both in this blog.
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Hybrid entities blend the nonprofit and for-profit worlds. Depending on the type of hybrid entity you chose, you can have the ability to take investments, receive grants, and offer tax deductions to donors. This will allow you to carry out the pro bono services of the organization under the nonprofit and the paid services under the for-profit business. And if you're looking for a comprehensive comparison to choosing a business entity, check out our ultimate guide to choosing the best business entity.
An L3C is an entity that focuses on social goals but also has profit-oriented objectives. It’s considered a “hybrid” entity because it combines the features of a regular LLC with those of a nonprofit.
An L3C is technically a for-profit company, sharing many similarities with an LLC, as covered in our LLC vs. S Corp comparison. For example, your profits are distributed to the owners. You have to pay the same taxes as LLCs, and the organizational setup is the same. Finally, most importantly, L3Cs can’t accept tax-deductible contributions—just like an LLC.
Not all states permit the formation of L3Cs. But you can always form your company in a state that permits it and then register your business as a foreign entity in your home state.
A couple advantages that you’ll receive from organizing as an L3C are that 1) the L3C designation gives the impression to outsiders that your organization is socially conscious and 2) being an L3C makes the organization eligible for a type of financing called “Program Related Investments.”
PRIs are investments made by foundations. Foundations are the type of entities you’re always hearing about that sponsor such things as NPR. Foundations are required to give away at least 5 percent of their assets each year to charitable causes in order to keep their tax exemption. And the IRS has decided that L3Cs can be on the receiving end of those donations. So, it does open up the possibility of getting grants, etc. from certain nonprofits.
Forming an L3C is almost identical to forming an LLC. You’ll file your Articles of Organization with your state government or file for foreign registration in your home state after incorporating in a state that recognizes L3Cs.
Because of the complexity of L3Cs, if you chose to go that route, you should consult an attorney. The laws on L3Cs are constantly changing.
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First, to clear up a common misconception: there are two different types of B corps. One is a certification from a company, called a “B corp certification,” and the other is an actual business entity called a B corp.
The B corp entity is structured and taxed the same way as a corporation. However, unlike a corp, B corps aim to provide social and environmental benefits.
To illustrate the difference from regular corporations: standard for-profit corps must always try to maximize profit—if they don’t, the directors could be sued for breaching their fiduciary duties.
B corps, on the other hand, are allowed to have social motives in their decision-making. The company’s effect on the community and the environment affects how directors manage the company. And if these decisions result in lower profits, the directors are not put at risk for liability.
Another aspect that distinguishes the B corp entity from traditional corporations is that states typically require a much higher level of transparency for B corps. So if privacy is a concern, a B Corp may not be a good choice.
The B corp certification is a recognition process managed by a Pennsylvania nonprofit organization. The org will conduct a test that measures the company’s social and environmental involvement. If you pass the test, you get certified. But to clear up some more confusion: you can be any entity, such as an LLC or corporation, and still qualify for this certification, so the “B corp” title is really something of a misnomer.
What are the benefits of earning a B corp certification or becoming a Benefit corp entity? These social entrepreneurship structures allow businesses to pursue social goals without breaching fiduciary duties owed to maximize profits. The certification is desirable because it makes your company look socially conscious from the outside. You may not receive any tax breaks for being a B corp, but it does allow you to contribute to society.
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If you’re all-in on being socially conscious and you have no intent to keep any profits, nonprofit corps make sense. If you might want to keep your profits and you think your business structure could receive funding from foundations, L3Cs are a good fit. If foundation-funding isn’t an option and you want your records to be transparent, B corps make sense. And of course, the choice left unsaid is that you can always just set up an LLC or corp and do some social good on the side.
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