Starting a new law firm - what do I need to consider? Part II - Structure

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As specialist advisors to the legal sector, we have helped many firms to start practising.  In the last edition, I covered the top considerations that individuals should take into account in starting a new law firm, and focussed on the importance of planning.  In this edition, I look into one of those aspects in more detail – what business structure to adopt.

For new start ups, this is one of the very first decisions to be made.  Without knowing what business structure you will adopt, and then putting that in place, you will not be able to make any application to the SRA for recognition, or to the banks for bank accounts/funding, or to insurers for PII.

The main options are:

• Sole practitioner/partnership
• Limited Liability Partnership (LLP)
• Limited Company

In the past, hybrid structures have been adopted including corporate partners of partnerships, or partnerships of corporates.  Recent tax changes have made those hybrid structures a little redundant for new start ups.

The main considerations to take into account in making a decision on structure include:

1. Limitation of liability
2. Attracting additional owners
3. Flexibility of profit shares
4. Flexibility of incoming/outgoing owners
5. Public disclosure of results
6. Taxation

I deliberately leave tax to the end of the above list, but it does seem to be becoming increasingly important to those making the decisions.  I prefer to ensure that the commercial aspects take precedence, and that the tax is then minimised for the adopted structure as appropriate.  However, I do acknowledge its importance and for some it is the driving factor.  I will cover the tax aspects in the next edition.  For now, I will address some of the other factors at a very high level.

Limitation of liability/attracting additional owners

As a sole practitioner/partnership, there is no limitation of liability and the risk is increased for personal loss for any debts not repaid by the business and for claims not covered by insurance.  Essentially, non-business assets such as family homes are being put on the line.

Limited companies and LLP’s can limit the liability and should do what they say on the tin.  Care should be taken however, as some providers will still insist on personal guarantees and the limitation of liability may not apply in all circumstances.  There are ways to give the best chance of protecting the limitation and advice should be sought at the planning stage on how to best do that.

Despite not being entirely risk-free, limited companies and LLPs should be lower risk that sole practitioners/partnerships.  As a result, such limited liability structures can be more attractive to additional owners than unlimited liability structures.

Flexibility

Partnerships and LLPs are extremely flexible business structures that allow the partners/members to decide and change profit shares on a regular basis; to easily admit new partners/members; and to easily (cash permitting!) allow partners/members to exit.

Limited companies are not so flexible.  As they are governed by share structures:

• remuneration (profit share) tends to be based on shareholdings
• on entry, new shares need to be issued/existing shares acquired at a value which may need to be market value
• on exit, shares need to be acquired either by other shareholders, new shareholders, or possibly the company itself, again at a value which may need to be market value.

It is possible to overcome those perceived flexibility issues but prior thought and planning is required.

Public disclosure

Partnership accounts do not need to be filed in the public domain, whereas LLP and limited company accounts do.  In the past, abbreviated accounts, particularly for small LLPs and companies, have reduced the amount of disclosure in the public domain.  This is changing and the new filleted accounts regime may mean that slightly more information needs to be disclosed at Companies House.  For most small LLPs and companies, very little profit and loss information is required to be included.

Tax

In general the taxation of partnerships and LLPs are exactly the same, and the tax bills for limited companies are lower – I’ll explore this in more detail in the next edition.

One final point – whatever structure you adopt, it is vital to ensure that the appropriate legal governance documents (partnership agreement/members agreement/shareholders agreement) are prepared and enacted to protect all concerned.

In the next few editions, we will address other important factors such as tax aspects and the application/registration process with the SRA.

Andy Poole is the Legal Sector Partner at Armstrong Watson, specialising exclusively in advising law firms. Co-author of the Law Society toolkit on Financial Stability in Law Firms, Andy heads the legal sector team at Armstrong Watson, which has 17 offices and over 400 people. The legal sector team advises law firms throughout the UK on strategic, structural and other business improvement issues as well as providing efficient accounting, tax and SRA accounts rules services.  Further information can be found at: www.armstrongwatson.co.uk/legalsector

This article is a general guide to the issues that we see in practice. It is not a substitute for professional advice which takes account of your personal circumstances. No responsibility can be accepted for any loss occasioned by any person acting or refraining from action on the basis of this article.

The Law Society works in partnership with Armstrong Watson for the provision of accountancy services to law firms.