Recent changes to working practices and attitudes of the next generation of professional advisers have reignited an old debate on whether a Limited Liability Partnership (“LLP”) is the most desirable legal structure for today’s professional services practices.
Many practices are structured as either an LLP or a private limited company (“Company”). There are also some practices which have chosen to remain as a traditional unincorporated partnership (“Firm”). A small number of practices have taken the plunge to float as a public limited company. However, in recent months, we have seen growing interest in LLP conversions from professional services firms.
What makes LLPs so attractive to professional services practices, and what issues can deter or prevent a Firm from converting to an LLP?
What makes LLPs so attractive to professional services practices?
The most popular catalyst for Firms converting to an LLP is the reduced personal financial risk for partners, should things go wrong. This seems to be a top priority since the collapse of a number of major firms following the global financial crisis.
The liability of a member of an LLP for the debts and liabilities of the LLP is usually limited to the amount of capital that the member has contributed to the LLP.
In contrast, partners in a Firm face the risk of unlimited personal liability for the debts and liabilities of the Firm. Where the Firm’s professional indemnity insurance does not cover the liability in full, the partner can face a real risk of personal bankruptcy.
In an industry where negligence claims from clients are a big risk, the ability for all partners in a Firm to have a limit on their personal liability simply by becoming a member of an LLP is often too attractive to ignore (especially in practices with high-value client work and the risk of correspondingly high-value claims in tough economic conditions).
Lateral hires and those up for promotion to partner are also likely to prefer the lower personal financial risk of being a member of an LLP.
Ownership of property
An LLP is a body corporate which is registered at Companies House. It has a legal personality that is separate from its members. This means that the LLP can own property and enter into contracts.
By contrast, a Firm does not have a formal process for its creation. It is a relationship that exists between the partners who are both owners and managers. Any property that is used by the Firm is legally owned by a small number of individual partners (usually on trust for all of the current partners) and those partners are often required to give a personal guarantee in respect of the property. The trust arrangements can create legal and administrative challenges in an environment where partners may come and go frequently.
Members of LLPs and Firms have a tax advantage over members of a Company as a result of the most recent budget announcement, that the main rate of corporation tax will increase to 25% from 1 April 2023.
Partners in Firms and members of LLPs are taxed as self-employed individuals at income tax rates. The Firms and LLPs do not pay any employer’s national insurance contributions in respect of the partners’ and members’ profit shares, which increases the profits available for distribution to the partners and members.
A Company pays corporation tax on its profits, and its shareholders pay income tax on the dividends they take in order to extract the profits. If they are also directors and/or employees of the Company, they will pay income tax and national insurance contributions on their remuneration.
Potential for merger or sale
An LLP is usually more attractive for a potential merger or sale than a Firm.
Legal and practical complications can arise from the purchase of a Firm due to the absence of a separate legal personality in the Firm. The legal title and personal guarantees over the Firm’s leasehold property may need to be transferred by the individual partners to the purchaser (which will require the landlord’s consent). These issues do not arise in relation to property held by an LLP (though personal guarantees over leasehold property are sometimes given by certain members of an LLP).
What issues can deter or prevent a Firm from converting to an LLP?
An LLP is required to disclose certain information to the public, including its annual accounts (which may also need to be audited), and details of persons with significant control over the LLP, its members and its registration details.
Failure to comply with these disclosure requirements can result in liability on the LLP and its designated members.
A Firm can keep its financial accounts and details of its partners private from its clients, suppliers and competitors.
Time, cost and administration
The process of converting from a Firm or Company to an LLP needs to be carefully planned, managed and executed (read our article on the key issues for firms to consider before converting to an LLP here).
The process can involve a significant amount of management time in planning for and obtaining partner consensus for the LLP conversion, and each partner will need time to consider the proposals (which distracts them from their fee-generating client work). There may also be unexpected additional costs resulting from partner exits. Significant fees for professional tax, legal and regulatory advice are likely to be incurred.
Following the conversion, the LLP will incur additional costs in complying with and ensuring that relevant individuals are trained on the additional legal and regulatory obligations that are applicable to LLPs. However, these costs are likely to be relatively small and will reduce as the LLP adapts and establishes effective systems for ensuring compliance.
The biggest hurdle to a conversion from a Firm to an LLP is the perceived risk that the partnership culture will be lost and result in damage to the practice’s competitive advantage and/or brand.
In reality, an LLP is a hybrid of a Firm and a Company. The members of the LLP are taxed and governed by a mutual agreement in the same way as partners in a Firm are taxed and governed. The members of an LLP can make decisions and share profits in the same way as the partners in a Firm. The main difference is that the members of an LLP have a safety net of limited liability. However, there are a small number of exceptions to their limited liability and members are often still liable to the LLP for any wrongdoing or misconduct (as agents of the LLP and under the terms of the LLP agreement).
In Firms with both a large number and different classes of partners (such as equity partners and fixed share or junior partners), with differing financial and voting rights, the Firm is likely to be governed like a Company (i.e. with day-to-day management decisions being taken by a small group of partners who form a management board, and promotion and profit sharing decisions being made by a remuneration committee).
The difference in culture between a Firm and an LLP is usually minimal and the financial benefits of converting to an LLP often outweigh the issues relating to cost, culture and confidentiality.
If you are interested in converting to an LLP or have any queries regarding LLPs and LLP conversions, please contact our experts in non-contentious partnership issues, Zulon Begum (Partner) and Wendy Chung (Senior Associate).