Law firm structures are often a hot topic of debate in the legal profession. The traditional partnership or sole practitioner approach used to be the norm. However, there are now a host of options and choosing the right one for your legal business can be tricky.
It is important to remember that the structure you choose has implications. These range from how you operate the business to the way the taxman looks at you.
There is no single structure that works best for all firms. Let’s take a look at the options.
Disclosure.
Whichever structure you choose does not make a great deal of difference. Only limited companies and LLPs must register with Companies House and HMRC. Partnerships and sole traders are only required to notify HMRC.
For limited companies and LLPs, there is an extra requirement to file accounts on an annual basis or at any time when a significant change is made to the business.
It is more complicated when it comes to the Solicitors Regulation Authority in England and Wales. The process of applying for authorisation can take at least one month or more. If you apply to be licensed as an alternative business structure, including non-lawyer principals, the process can be even more long-winded.
Managing Liability.
It might seem obvious that limited companies and LLPs offer a reduction in your liability. Clearly, if you are a partnership or sole practitioner, your personal assets are at risk.
However, companies and LLPs don’t provide complete coverage. If the business goes into insolvency, directors of limited companies could face claims for wrongful trading. Similarly, members of an insolvent LLP may face recovery of payments.
When setting up a new firm you may have a requirement to provide personal guarantees. These help you cover start-up costs but come at a price. Make sure you limit the scope of these as much as you can.
Read 8 key characterics of highly successful law firms.
Taxation.
Partnerships and LLPs taxation arrangements are similar. Partners face income tax at the standard rates for self-employed people. As a partner, you pay this on your share of the profits.
For limited companies, HMRC applies corporation tax to profits. The rates for this are lower than those for income tax. Salaries paid to employees or yourself are also subject to income tax and National Insurance contributions.
When you come to selling your holding in the firm, capital gains tax is likely to apply on any gain you make. Similarly to corporation tax, the rates for this are generally lower than those for income tax.
Before deciding which structure is the right one for you, take advice from an accountant. A good accountant will provide a model to illustrate the most tax efficient business structure for your circumstances.
Business Agreements.
In a partnership, the partnership agreement document determines the relationship between those involved. For an LLP the members’ agreement fulfils the same role. For a limited company, it is both the shareholders’ agreement and the articles of association that determine arrangements.
Whichever route you take, the agreement is critical. It is the opportunity to tackle issues such as:
- Profit sharing.
- Business strategy.
- Removal of under performers.
- Exit strategy for partners / directors.
- Approaches to business valuation for those who wish to leave.
- Areas of responsibility for specific people.
It is always the best policy to tackle these issues from the outset. Disagreements will occur as time passes and people’s priorities change.
Succession.
This is often the last thing you consider when starting out on a new venture. Failure to do so can come back to bite you. Think hard about mechanisms for the retirement or exit of partners or members in a partnership or LLP. These should include stakeholding valuation mechanisms designed to avoid conflict when the day arrives. The reverse also requires thought. If you wish to attract new, senior talent to the business, how will the existing agreement cope with that?
In a limited company, the shareholding of an existing director is usually the key determinant upon exit – provided you can agree a valuation!
However, limited company status offers more scope for the engagement of staff. They can be employees, directors or shareholders. Providing a shareholding in the business to key staff is a sound way of ensuring their retention.
Find out more.
The following guidance and information is available online:
- The Law Society of England & Wales.
- The Law Society of Scotland.
- The Solicitors Regulation Authority.
Whatever Law firm structures you are contemplating, LawWare has a practice management solution tailored to your needs.
Mike O’Donnell, March 2023.
Frequently Asked Questions
What does LLP stand for in a law firm?
LLP stands for Limited Liability Partnership.
Why are law firms LLPs?
The change to LLP status brought with it the benefits of a partnership arrangement with control over liability. An LLP has members (often referred to as partners) who both own and have a right to run the LLP. There is no difference between owners and managers in an LLP, although separate rights can be artificially created. Both structures require a detailed constitution document – a Members’ Agreement for an LLP and a Shareholders’ Agreement for limited company. We have experience of drafting both. It is possible to have a limited company that operates much like a partnership if the Shareholders’ Agreement is drafted in a particular way and an LLP that operates like a limited company if the LLP Agreement is drafted that way.
Why are law firms partnerships?
Traditionally, law firms operated either as sole traders or partnerships with no other real alternatives. In more recent times, this rule has been relaxed to permit a variety of business structures.
Can law firms be limited companies?
Yes. The limited company approach was brought in initially to enable the building of multi-disciplinary practices.
