Bankruptcy

When should a professional services firm convert to an LLP?

Recent changes in the working practices and attitudes of the next generation of professional advisers have rekindled an old debate as to whether a limited liability company (“LLP”) is the most desirable legal structure for legal practices. professional services today.

Many practices are structured either as an LLP or as a limited liability company (“Company”). Some practices have also chosen to remain as an unincorporated partnership (“Business”). A small number of firms have taken the step to become a public limited company. However, over the past few months, we have seen a growing interest in LLP conversions from professional service companies.

What makes LLPs so attractive for professional services practices, and what issues can deter or prevent a firm from converting to LLP?

What makes LLPs so attractive to professional services firms?

Limited liability

The most popular catalyst for businesses converting to an LLP is reducing the personal financial risk for partners, should something go wrong. This seems to be a top priority since the collapse of a number of large companies in the wake of the global financial crisis.

The liability of a member of an LLP for the debts and obligations of the LLP is generally limited to the amount of capital that the member has contributed to the LLP.

In contrast, the partners of a firm run the risk of unlimited personal liability for the firm’s debts and obligations. When the Firm’s professional liability insurance does not cover all of the liability, the partner may face a real risk of personal bankruptcy.

In an industry where client negligence claims are a significant risk, the possibility for all partners of a firm to have a limit on their personal liability simply by becoming a member of an LLP is often too attractive to consider. be ignored (especially in practices with high valuing the work of clients and the risk of corresponding high value claims under difficult economic conditions).

Side hires and those promoted to partner rank are also likely to prefer the lower personal financial risk of being a member of an LLP.

Ownership of goods

An LLP is a legal person that is registered with Companies House. It has a separate legal personality from its members. This means that the LLP can own property and enter into contracts.

On the other hand, 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 used by the Firm is legally owned by a small number of individual partners (usually in trust for all current partners) and these partners are often required to give a personal guarantee in respect of the property. Trust agreements can create legal and administrative challenges in an environment where partners can come and go frequently.

Tax benefit

Members of LLCs and corporations get a tax advantage over members of a company due to the most recent budget announcement that the main corporate tax rate will increase to 25 % as of April 1, 2023.

Partners in companies and members of LLPs are taxed as self-employed at the income tax rate. Firms and LLPs do not pay any national insurance employer contributions for share in the profits of associates and members, which increases the profits available for distribution to associates and members.

A company pays corporate tax on its profits and its shareholders pay income tax on the dividends they receive in order to extract the profits. If they are also directors and / or employees of the Company, they will pay income tax and social security contributions on their remuneration.

Potential for merger or sale

An LLP is generally more attractive for a potential merger or sale than a firm.

Legal and practical complications can arise from purchasing a firm due to the lack of a separate legal personality within the firm. Legal title and personal guarantees to the leasehold property of the Firm may need to be transferred by the individual partners to the purchaser (which will require the consent of the owner). These issues do not arise with respect to property held by an LLP (although personal leasehold guarantees are sometimes given by some members of an LLP).

What issues can deter or prevent a business from converting to an LLP?

Confidentiality

An LLP is required to disclose certain information to the public, including its annual accounts (which may also require an audit) and details of those with significant control over the LLP, its members and registration details.

Failure to comply with these disclosure requirements may result in liability for the LLP and its designated members.

A company can keep its financial accounts and the details of its partners private from its customers, suppliers and competitors.

Time, cost and administration

The process of converting a firm or company to an LLP should be carefully planned, managed, and executed (read our article on key issues businesses need to consider before converting to an LLP. here).

The process can involve a significant amount of management time in planning and obtaining partner consensus for the LLP conversion, and each partner will need time to review proposals (which distracts them from their fee-generating client work. ). There may also be unexpected additional costs resulting from the exit of partners. Significant fees for professional tax, legal and regulatory advice are likely to be incurred.

Following the conversion, the LLP will incur additional costs to comply with and ensure that those affected are trained on the additional legal and regulatory obligations that apply to LLPs. However, these costs are likely to be relatively low and will decrease as the LLP adapts and establishes effective systems to ensure compliance.

Culture change?

The biggest barrier to converting a firm to an LLP is the perceived risk that the culture of partnership will be lost and result in damage to the firm’s competitive advantage and / or brand.

In reality, an LLP is a hybrid of a firm and a corporation. LLP members are taxed and governed by mutual agreement in the same way that associates of a Firm are taxed and governed. Members of an LLP can make decisions and share the profits in the same way as partners in a firm. The main difference is that members of an LLP have a limited liability safety net. 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 categories of partners (such as shareholders and partners with fixed or junior shares), with different financial and voting rights, the Firm is likely to be governed as one. Company (i.e. with management decisions being taken by a small group of partners who form a board of directors, and promotion and incentive decisions being taken by a remuneration committee).

The culture difference between a firm and an LLP is usually minimal, and the financial benefits of converting to an LLP often outweigh the issues of cost, culture, and privacy.