An L3C can create a tiered capital structure, allocating risk and returns differently across different types of members. In an L3C, Program Related Investments (PRIs) by private foundations can be allocated the highest risk and lowest rates of return. Thus, the investing foundations are essentially subsidizing returns on commercial investment. In exchange, private foundations may retain decision-making powers in the L3C in order to ensure that the investment qualifies as a PRI.
Private socially responsible investors may be willing to accept below-market returns from a venture with charitable goals. In an L3C, these investors may assume less risk and receive a higher share of profits than private foundations, but in general they may also have fewer management powers.
Private commercial investors seeking market-rate returns may be allocated the highest returns and lowest risk in an L3C. Such investors may include pension funds, banks, insurance companies, or endowments.
Whether or not the L3C's tiered capital structure imposes excessive risk on private foundations remains an open question. If the IRS determines a private foundation's investment in an L3C to be a jeopardy investment, the foundation is subject to significant penalty taxes. Even if the investment qualifies as a PRI, the foundation must still ensure that its charitable goals are accomplished and guard against private inurement. If any part of the foundation's net earnings accrue to the benefit of a private individual, such as a commercial investor in the L3C, the foundation will lose its tax exemption. To minimize these risks, a private foundation may require approval authority on L3C investments, regular reports and other controls.
