Capital requirements for LLP professional firms
When it comes to determining the level of capital that members should contribute to a limited liability partnership (LLP), there is a lot of flexibility in approach with no one-size-fits-all solution. Commerciality and strategic decision-making should be the key drivers of any planning for setting levels of member capital contributions. The added complexity of the salaried member rules requirements enforced by HMRC means that setting levels of capital contributions can be a minefield.
Minimum requirements and considerations
LLPs do not have a mandatory minimum capital requirement. This allows members to decide the level of capital contribution based on the nature and needs of their business. This has led to many firms having a large imbalance in the levels of capital among different generations of partners. Often, those nearing retirement age have low levels, as they have not been revisited since the original capital injection was made. Inflation and changes in the cost of living are generally not reflected in capital requirements, although this is beginning to change.
There are three main considerations when deciding on the levels of capital for each member of the LLP. These include:
- The working capital requirement of the firm;
- Equality between similar categories of members;
- Future investment needs and longer-term financial goals.
Working capital requirement
The working capital requirement is often the key thing that the members need to fund. Firms often have different working capital cycles in terms of the length of time to raise fees and collect debts (lock-up). Having a higher lock-up means the capital levels need to be higher, so it can often be in member’s interests to bill and collect debts quickly. Some firms even link drawings to cash collection, meaning the level of capital could potentially be lower.
Equality between members
Equality between members can be an emotive point. We often see the scenario where higher-earning equity members have less capital at risk than more junior members of the LLP. A more recent trend within professional services has been to have set amounts of capital at different levels of member. For example, this could be set at £30,000 for fixed share members (not linking capital to earnings for salaried member rule purposes), £50,000 for non-equity members and £75,000 for full-equity members.
Future investment
Next, consider the need for future investment, be it in people, infrastructure (IT, real estate) or M&A activity, as well as the longer-term financial goals of the LLP. Capital contributions can be structured to support the growth and expansion plans of the business. Having flexibility in capital levels means that it can be beneficial for members to periodically review and adjust their capital contributions to align with the LLP’s evolving needs and goals. We have seen this work in practice by reviewing the capital levels every two years, stepping them up or down accordingly depending on the investment needs of the firm.
Attitude to risk
The firm’s attitude to borrowing is also a key factor in deciding the levels of capital. Many firms have a low propensity to taking on debt, be it in the form of an overdraft, term loan or revolving credit facility. A low desire to borrow has the knock-on effect of increasing capital requirements, although members may be borrowing personally to fund the capital contributions.
Not linking capital levels to earnings is crucial for ensuring compliance with the salaried member rules. HMRC continues to focus on LLPs and investigate firms where it believes tax or employer’s national insurance contributions are being avoided. Instead, successful capital structures often have a few levels contributing equally or based on their expected roles and responsibilities within the LLP.
Clear policy on contributions
It is crucial for the LLP agreement to clearly outline the terms of capital contributions, including how additional contributions will be handled and the implications for profit-sharing and decision-making. Ensuring that members earn interest on their capital at a rate above the Bank of England base rate means members are more inclined to risk their money and raise levels of capital if required. An interest premium is also sometimes used to encourage members to fund additional capital contributions if required. This is generally at a cheaper borrowing rate than external funding so can be a useful tool for both the LLP and its members.
Ultimately, the level of capital members contribute to an LLP is a strategic decision that should be made collaboratively, considering the specific needs and goals of the firm. By carefully planning and regularly reviewing capital contributions, members can ensure the financial health and success of their LLP.
How Moore Kingston Smith can help
Every professional firm is different. Your firm’s structure can affect tax, ownership, partner succession and future investment. If you would like to discuss whether your current arrangements continue to support your firm’s objectives, get in touch with our professional firms specialists.
