Structure Matters – Now And For The Future
Structure matters. It shapes what you can do now and the future options for your legal business. This article will give you an honest review of organisational structure and options. What works, what doesn’t work, and why – starting with the traditional side of structure. We will discuss the sole trader and partnership options, including Limited Liability Partnerships (LLPs), through to Limited Companies and Alternative Business Structures.
Traditional structures – do they have a place?
In the modern world that we work in, the number one priority for anyone who wants to set up a new business is protecting their own personal assets. Yes, you may need to put money into your business in order to support it for a reasonable length of time. However, why would you want to put at risk all of your other personal assets? This means that the traditional structure of a sole trader or a partnership that does not protect you is, in my opinion, no longer an option if you are looking to start a new business.
LLPs have been around for more than 20 years and are now understood by most people and, more importantly, by Banks and other lending institutions. They can see how much Members are investing into the partnership by going to the relevant page in the accounts.
LLPs are tax transparent, which in some ways is great, and in other ways, it is not. Tax is paid on profits, whether or not the Members draw it out. The LLP is straightforward and flexible. Flexibility is the key point here. Flexibility as an LLP means the flexibility to allocate profit entitlements and allocate capital rights through amendments to the LLP agreement.
Limited Company / PLC
Both are companies, albeit PLCs have a minimum share capital of £50,000 which as a startup may not be attractive, and therefore most people do not even consider this option. A limited company can be started with just £1 of share capital, but £50k of share capital indicates a much more serious capability than £1.
Limited companies are perceived as the modern approach for structuring a law firm, as historically, the partnership model dominated the profession. Approximately 90% of all startups that we assist are limited companies. A limited company is less flexible as ownership is directly linked with share ownership. Changing share ownership always involves at least some consideration of tax issues. For the unaware, this can result in some expensive tax liabilities if not planned for.
There are potential tax benefits in relation to structuring as a limited company, particularly if moving from a partnership. However, you need to think longer-term, as any structural changes should be about the practice’s long-term benefits and not short-term gains for the current shareholders.
ABS (Alternative Business Structure)
Many people think that an ABS is a new type of structure and something that you have to create. It isn’t. An ABS is a ‘wrapper’ around whatever legal structure your law firm is at the moment, be it a traditional partnership, an LLP, or a limited company. It is a requirement from the Solicitors Regulation Authority (SRA) if you want a non-lawyer owner involved. It is not something that you can apply for in advance of a future plan. The SRA will only grant approval at the point you want to bring in a non-lawyer owner, and they will also charge you for the privilege!
So those are the ownership options, but what is right for your law firm?
Of course, there is a lot of nuance to this, as every situation is different, but there are some high level pointers.
If you want simplicity, then a sole trader, partnership or LLP gives you that. In addition, the LLP option gives you the protection that your sole trader and traditional partnership does not have.
Limiting your personal liability should be the first priority for anyone when setting up a new firm. A good initial guide as to which structure may best suit you would be to ask yourself these questions:
- Do I need to retain profits to grow the business?
- Do I need to repay debt?
- Do I want staff to participate in the ownership of the business?
- Will I be able to draw out all of the profits that I make each year?
If you answer ‘yes’ to any of the first three questions, then a limited company may be a better option for you. This is because you are paying a lower tax rate on the profits needed to either repay debt or grow the business, giving you more available cash to do so. If you want to bring in new owners, then share schemes are only available to limited companies, but I suggest you proceed with caution as this is a complex area.
If you are lucky enough to generate substantial profits and want to extract it all every year, then trading as an LLP instead of a partnership may be a better route for you.
Are you a Career lawyer or an Entrepreneur lawyer?
The partnership structure has been around since 1890. It has survived quite a long time and works well for a lot of businesses. I often describe it as being on a conveyor belt, especially in the big law partnerships. You get on the conveyor belt, you work your legal career, you hope to earn a lot of money as you go through, and then you get off the conveyor belt when you retire. The idea is that you leave that partnership in a better state than when you joined it. Hopefully, you earn well over that period and invest personally to create your own personal wealth. So you are not necessarily looking for extra value on exit.
Value on Exit
The Limited Company structure becomes more of an interesting model when you are looking for value on exit. As soon as you create a law firm as a limited company, you are starting to talk about value all the time. This can create an expectation of value when you retire or when you sell. It also means more options in terms of alternative exits, such as listing if you are the right size, or opportunities to look at greater employee ownership (EOTs).
Proceed with caution and best of luck
So these are the basic principles. What will work for you in the future? If you use this as your guide, it will help you decide what works now and in the future, but do take specialist advice as it is complex, and it is not always easy to back out of a limited company if you decide it is not for you without some potentially expensive tax charges. Like anything in life, invest time from the beginning to make sure it is fit for purpose in the future, and then you are ready to embark on the exciting journey of taking an idea and transforming it into reality.