Starting a new law firm (Part 2): Structure

In part 1, I covered the top considerations for those starting a law firm. In this article, I explore 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 Solicitors Regulation Authority (SRA) for recognition, to the banks for bank accounts / funding, or to insurers for professional indemnity insurance.

Types of business structure

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.

Key considerations

When deciding on structure, the main considerations include the following:

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 LLPs 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 best to do that.

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

Flexibility

Partnerships and LLPs are extremely flexible, allowing partners / members to regularly decide and change profit shares, 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, and as shareholders are officers of the company, reward is paid through salary as it is for other employees:

• Return on investment in the form of dividends is based on % shareholdings.
• On entry, new shares need to be issued / existing shares acquired at market value, and funding this can be prohibitive.
• On exit, shares need to be acquired either by other shareholders, new shareholders, or possibly the company itself, again at market value.

It is possible to overcome some of the flexibility issues, but significant prior thought and planning is required, and advice should be sought.

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 accounts filing regime may mean that more information (such as profit and loss accounts) needs to be disclosed at Companies House, even for smaller entities.

Tax

I have deliberately left tax to the end of the list; however, 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 tax is then minimised for the adopted structure as appropriate. Nevertheless, I do acknowledge its importance, and, for some, it is the driving factor.

In general, the taxation of partnerships and LLPs is the same. In the past, the tax bills for limited companies have potentially been lower, but that gap has narrowed in recent years, and, in some cases, there is no real difference.

I will cover the tax aspects 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.