Are you aAre you a[.com] or a [.org]??

Marc J. LaneMarc J. Lane

June 30, 2011June 30, 2011

Copyright © 2011, by Marc J. Lane Advisors, L3C. All rights reserved.

The 1-2-3 PunchThe 1-2-3 Punch

Socially responsible and mission-related Socially responsible and mission-related investinginvesting

Impact investingImpact investing

Program-related investingProgram-related investing

Socially responsible Socially responsible and mission-related investingand mission-related investing

ScreeningScreening

Shareholder advocacyShareholder advocacy

Community investingCommunity investing

Impact investingImpact investing

Seeks to solve a social or environmental problem Seeks to solve a social or environmental problem while generating a financial return to investorswhile generating a financial return to investors

Complements philanthropy and government Complements philanthropy and government effortsefforts

Program-related investing Program-related investing and the Land the L33CC

Make grants of 5% of "non-charitable-use" Make grants of 5% of "non-charitable-use" assets to charitable causes annuallyassets to charitable causes annually

   oror

Make "program-related investments" of Make "program-related investments" of 5% of "non-charitable-use" assets annually5% of "non-charitable-use" assets annually

The Foundation's ChoiceThe Foundation's Choice

Venture capital and other high-risk investments that would otherwise Venture capital and other high-risk investments that would otherwise subject foundation and its manager to 10% jeopardizing investment subject foundation and its manager to 10% jeopardizing investment excise tax.excise tax.

Primary purpose is charitable - - religious, scientific, literary or Primary purpose is charitable - - religious, scientific, literary or educational, fostering amateur sports competition, or preventing educational, fostering amateur sports competition, or preventing cruelty to children or animalscruelty to children or animals

Income production or property appreciation not a significant purposeIncome production or property appreciation not a significant purpose

Purpose is not to attempt to influence legislation; or to participate in, Purpose is not to attempt to influence legislation; or to participate in, oppose or intervene in a political campaign of candidate for public oppose or intervene in a political campaign of candidate for public officeoffice

PRIsPRIs

PRIsPRIs come in many flavors come in many flavorsInterest-free or below-market-rate loansInterest-free or below-market-rate loans

Loan participationsLoan participations

Loan guaranteesLoan guarantees

Deposits in community development Deposits in community development banksbanks

LeasesLeases

Equity investmentsEquity investments

PRIsPRIs in Action in ActionLow-interest loans to needy studentsLow-interest loans to needy studentsInvestments in low-income housing projectsInvestments in low-income housing projectsLow-interest loans to disadvantaged business ownersLow-interest loans to disadvantaged business ownersDirect investments in businesses which create jobsDirect investments in businesses which create jobsInvestments in land conservation or brownfields mitigationInvestments in land conservation or brownfields mitigationInvestments in arts groups or cultural organizationsInvestments in arts groups or cultural organizationsInvestments in faith-based programsInvestments in faith-based programsInvestments in child care centersInvestments in child care centersInvestments in community development initiativesInvestments in community development initiativesInvestments in social services organizationsInvestments in social services organizationsInvestments in educational or workforce development training opportunitiesInvestments in educational or workforce development training opportunitiesInvestments in businesses that develop cutting-edge technology in rapidly changing Investments in businesses that develop cutting-edge technology in rapidly changing environmental or health-related fieldsenvironmental or health-related fieldsInvestments in historic preservationInvestments in historic preservation

Additional PRI Examples Additional PRI Examples ProposedProposed

by ABA Section of Taxationby ABA Section of TaxationDevelopment of new drugDevelopment of new organic-farming processLoan made to media in former Communist bloc countriesEconomic redevelopment of terrorism site or site of national disasterEnvironmental investments in Third World or economically depressed countriesForeign economic developmentInvestment that lessens the burdens of government

PRIs have been seen as complex PRIs have been seen as complex

and expensiveand expensiveNo process to guarantee that an investment complies with No process to guarantee that an investment complies with PRI tax regulationsPRI tax regulations

No standards to ensure that an entity is a proper recipient No standards to ensure that an entity is a proper recipient of PRIsof PRIs

IRS private letter rulings expensive and time-consumingIRS private letter rulings expensive and time-consuming

A Low-Profit Limited Liability A Low-Profit Limited Liability Company (LCompany (L33C) is an LLCC) is an LLC

• Non-corporate form of doing business that limits owners' Non-corporate form of doing business that limits owners' liabilityliability

• Affords them flow-through tax treatment, andAffords them flow-through tax treatment, and

• Offers operating flexibility through participation in Offers operating flexibility through participation in managementmanagement

But a special kind of LLCBut a special kind of LLCOne or more for-profit "members" and one or more One or more for-profit "members" and one or more non-profit "members"non-profit "members"Charitable or educational purposesCharitable or educational purposesWould not have been formed except to accomplish Would not have been formed except to accomplish those purposesthose purposesNo significant purpose to produce income or property No significant purpose to produce income or property appreciationappreciationBut But maymay produce significant income or property produce significant income or property appreciationappreciationNo political or legislative purposeNo political or legislative purpose

The LThe L33C's PromiseC's PromiseShifting economic risk to third partiesShifting economic risk to third parties

Financial self-sufficiencyFinancial self-sufficiency

Continuing foundation inputContinuing foundation input

Effective leveraging Effective leveraging

Capital flow to "double bottom-line" ventureCapital flow to "double bottom-line" venture

A “win-win” for both for-profits and non-profitsA “win-win” for both for-profits and non-profits

Capital Structure Illustration #1Capital Structure Illustration #1

Social ReturnSocial Return

Financial ReturnFinancial Return

FoundationFoundation

Foundation incurs high Foundation incurs high financial risk, earns low (1%) financial risk, earns low (1%) financial return, but high financial return, but high social returnsocial return

Capital Structure Illustration #1Capital Structure Illustration #1

Social ReturnSocial Return

Financial ReturnFinancial Return

Mezzanine investorMezzanine investorSocially conscious investor incurs lower financial risk, earns higher (3%) financial return.

Capital Structure Illustration #1Capital Structure Illustration #1

Social Social ReturnReturn

Financial Financial ReturnReturn

Market-driven investorMarket-driven investorMarket-driven investor incurs market-rate risk, earns market-rate (6%) financial return.

Blended rate of return:Blended rate of return: 4% - - which L4% - - which L33C can generate, but not C can generate, but not without the catalyst of the foundation’s without the catalyst of the foundation’s

PRI.PRI.

Capital Structure Illustration #2Capital Structure Illustration #2

Development agency makes a grant, seeking high social return but earning no financial return.

Social ReturnSocial Return

Financial Financial ReturnReturn

GovernmentGovernment

Capital Structure Illustration #2Capital Structure Illustration #2

Foundation earns low (2%) financial return, but high social return.

Social ReturnSocial Return

Financial ReturnFinancial Return

FoundationFoundation

Capital Structure Illustration #2Capital Structure Illustration #2

Outside investor incurs market-rate risk, earns market rate (7%) return.

Social ReturnSocial Return

Financial ReturnFinancial Return

Market-driven investorMarket-driven investor

Blended rate of return:Blended rate of return: Again, 4% - - which the LAgain, 4% - - which the L33C can C can

generate, but not without the catalyst generate, but not without the catalyst of the foundation's PRI.of the foundation's PRI.

Inherent Conflict of InterestInherent Conflict of Interest

Managers of for-profits must maximize Managers of for-profits must maximize financial returns to owners.financial returns to owners.

v.v.

PRI recipients must not produce income PRI recipients must not produce income or property appreciation as "significant or property appreciation as "significant purpose."purpose."

SolutionsSolutions

1.1.Reliance on applicable constituency statuteReliance on applicable constituency statute

2.2.““Expenditure responsibility”Expenditure responsibility”

1. Reliance on applicable constituency 1. Reliance on applicable constituency statutesstatutes

Texas Business Organization Code § 21.401Texas 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.)

(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.

(Source: P.A. 86-126)

2. “Expenditure responsibilities” 2. “Expenditure responsibilities” requirementsrequirementsManager’s Commitments

Use of funds for agreed purposeAnnual financial reportingMaintenance and availability of adequate books of recordsNo support of propaganda, the influence of legislation, the outcome of public elections or voter registration drives

The Optimal VentureThe Optimal Venture

Socially beneficial missionSocially beneficial mission

Consistent cash flowConsistent cash flow

EntrepreneurialEntrepreneurial

LL33C ApplicationsC Applications

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 returnsAs single-purpose, wholly owned subsidiaries of tax-exempt organizationsFor ventures that seek to draw consumer and funder attention to their status as social enterprisesFor coalitions of nonprofits that join forces to tackle a social problem through the application of business principles

Proposed Philanthropic Proposed Philanthropic Facilitation ActFacilitation Act

Voluntary

Safe-harbor registration by entity

Annual reporting

LL33C LegislationC Legislation

2008VermonVermontt

2009MichiganMichigan

UtahUtah

WyomingWyoming

2010IllinoisIllinois

LouisianaLouisiana

North North CarolinaCarolina

2011MaineMaine

2012Rhode IslandRhode Island

The Benefit Corporation: The Benefit Corporation: Creating a “Public Benefit”Creating a “Public Benefit”

The Requirements of a Benefit The Requirements of a Benefit CorporationCorporation

The corporation must create a material, positive impact on society and the environment.Impact must be measured by a third party. A “benefit report” must be published annually.

The Benefit Corporation’s BenefitThe Benefit Corporation’s Benefit

Directors have“immunity from liability”“in the reasonable performance of their duties.”

But not too fast…But not too fast…

Lack of policingLitigation risk may shift – From shareholder claims that the board is not

maximizing profit– To shareholder claims that the board is not

sufficiently pursuing the corporation’s general or specific public benefit

Still…Still…

Most early adopters are more interested in branding than derivative lawsuit protection.The Benefit Corporation codifies the entrepreneur’s social and environmental ethos.It offers legal recognition of the venture’s core values.

Benefit Corporation LegislationBenefit Corporation Legislation

2010Maryland*Maryland*

VermontVermont

2011New JerseyNew Jersey

VirginiaVirginia

Hawaii**Hawaii**

* 2011: Benefit LLC legislation

** Sustainable business corporation legislation

Pay-For-Success BondsPay-For-Success Bonds(aka Social Impact Bonds)(aka Social Impact Bonds)

Pay-For-Success BondsPay-For-Success Bonds

Aligns interests of government agencies, private investors, and nonprofits around specific social outcomes.Leverages private investment capital to pay for early intervention programs delivered by service providers.Government pays financial returns to investors if and when improved social outcomes are achieved:– If outcomes don’t improve, investors lose their money.– If outcomes are achieved, government returns principal

plus specified return.

Social Impact Bonds: The Seminal U.K. Example

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.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.– 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.

– If not, investors will lose their money.

Minnesota’s Pay For Performance Act of 2011*

The Act would have established $20 million pilot program.The State would have contracted with pre-qualified providers.Funds would have come from “special appropriation” bonds issued in municipal bond market.Providers would have been paid only if the State’s return on investment was positive.

* The Act was included within the State’s general appropriation bill, which was vetoes on May 24, 2011.

Massachusetts’ Pay For Success Contracts:The Ask

The State’s Executive Office for Contracts Administration and Finance (EOAF) issued a Request for Information on May 6, 2011 to learn: Which social services are the most promising candidates for pay for success contracts?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?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?Are there other areas of government activity where upfront investments and innovative contracting strategies could improve performance and reduce costs?How should pay for success contracts and social impact bonds be structured to support these goals?What information would be useful to EOAF in drafting a more detailed procurement solicitation for these contracts?

Massachusetts’ Pay For Success Contracts: Next Steps

Responses were received by June 10, 2011.EOAF will issue a Request for Response targeted at the most promising applications.

For further information:For further information:

The Law Offices ofThe Law Offices of

MMARC ARC JJ. . LLANEANEA PROFESSIONAL CORPORATION

180 North LaSalle StreetChicago, IL 60601-2701(312) 372-1040(800) 372-1040Fax (312) 346-1040www.MarcJLane.com