Structuring for professional firms
There are two common ways a professional firm is structured. Both bring benefits and challenges, depending on the type of firm, number of partners (or shareholders) and its goals.
Limited liability partnership
Since limited liability partnerships (LLPs) were first introduced in 2001, they have become the structure of choice for UK professional firms. As a hybrid between partnerships and limited companies, LLPs have the advantage of taking the positives from each of these alternative structures.
The LLP structure is well suited to professional firms because it provides flexibility in dealing with both incoming and outgoing partners and varying profit-sharing arrangements between the firm’s partners from one financial year to the next. At the same time, as the name suggests, LLPs afford their members the luxury of limited liability protection. This protection ensures that the personal assets of the owners (LLP members) are not at risk if the firm incurs debts or faces legal claims.
In contrast, the main downside to LLPs is that members pay tax on their full share of profit for each year, irrespective of the amount of profits they have drawn from the business in that accounting period.
Private limited company
The second most popular choice of structure for professional firms, mainly amongst smaller firms, is a private limited company. The main benefit of a limited company over an LLP is that, whilst the company will pay corporation tax on its full profits made in the year, the partners/owners only pay income tax on profits they take out of the company in the form of salary or dividends. This means that any undrawn profits left in the company will only be subject to corporation tax, which is charged at a much lower tax rate than income tax.
The main drawback to private limited companies is that they issue share capital, so their ownership structure is fairly rigid. The only way companies can deal with the introduction of new partners/owners, existing partners/owners retiring and a change in profit-sharing is through either transferring shares or issuing new shares. As the firm grows and the number of partners/owners increases yearly, the rigidity of shares becomes increasingly problematic.
Your professional firm and its people
Whether operating as an LLP or a limited company, it is common for professional firms to employ their people through a service company. This is typically a private limited company that is a wholly owned subsidiary of the LLP/limited company. The main reason professional firms adopt a service company is to ringfence any liabilities, such as employment tribunal claims, arising from employing people in a separate limited company.
The rise of private equity in professional firms
There has been an influx of private equity (PE) houses investing in firms over the last five years. Initially, PE houses were attracted to invest in accountancy firms but they are increasingly looking to move into other sub-sectors such as the legal profession.
Historically, PE houses have made use of a structure consisting of a ‘stack’ of limited companies when investing in businesses. More recently, a few PE deals have been completed using an alternative structure of a stack of LLPs, instead of limited companies, which benefits from preserving the partnership ethos post-deal completion.
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.
