Law Firm Incorporation – Limited Company or LLP?

Mar 12, 2019

There are still a surprising number of solicitors’ practices trading as sole practitioners and traditional 1890 Act partnerships.

We think incorporation is good as it provides limited liability and that is really useful. With a few exceptions, it means that a business failure may not affect your personal assets. It provides a vehicle for others to invest in your business and enables you to give a stake to key staff. It can also be tax efficient in some circumstances. The only reason to remain a partnership is if you are really obsessed by secrecy, although most smaller firms only have to disclose basic details in their published accounts.

The first question to decide is whether to become a limited company or a limited liability partnership (LLP).

There are pros and cons to each and you need to think about the key elements of your business and the way you run it – it’s not easy to change your mind later.

The key differences between limited companies and LLPs are around management and tax. A limited company has directors and shareholders. Shareholders own the business and are rewarded by dividends if the company makes a profit and by an increase in the value of the shares if the company becomes worth more. The shareholders appoint the directors who run the business. The shareholders only have the right to veto key decisions and have limited rights to information and no right to run the business on a day to day level. A majority of shareholders can remove the directors. In reality, in most small companies, the directors and the shareholders are the same people.

An LLP has members (often referred to as partners) who both own and have a right to run the LLP. There is no difference between owners and mangers in an LLP, although separate rights can be artificially created. Both structures require a detailed constitution document – a Members’ Agreement for an LLP and a Shareholders’ Agreement for limited company. We have experience of drafting both. It is possible to have a limited company that operates much like a partnership if the Shareholders’ Agreement is drafted in a particular way and an LLP that operates like a limited company if the LLP Agreement is drafted that way.

The second issue is around tax. A company is taxed on its profits and pays corporation tax, currently at 19% on its profits. The directors are employees and are paid salary under PAYE and the company pays employers’ National Insurance at 13.8% on their salaries. Shareholders can take dividends out of profits which are taxed at dividend rates.

A simple view of the difference in tax is as follows (please remember that this is just an example at one profit level and that individual’s circumstances will differ and you need professional tax advice from your accountant):

There may also be issues around pension contributions which need to be from relevant income and dividend income may not count for tax relief. Because directors are employees, benefits are also taxed.

If a company is making large profits which the owners do not need to extract, it is often better to shelter them in a limited company, having paid 19% tax, whereas if the owners remove all the profit each year, then an LLP can be more tax efficient.

There are other differences which will make a difference to your choice. Limited Companies can have tax efficient share schemes, which can be good for incentivising employees, especially if a sale is planned, although this may be easier for an ABS. However, in an LLP, especially ,one providing professional services, it is easy to make senior employees into members (it usually requires a capital contribution, but the firm can generally arrange the funding) saving the business 13.8% Employers NI and making them self employed which is usually an advantage.

LLPs have more flexibility, as there is no need to keep set amounts of capital and it is easy to change the capital between members form year to year.

When it comes to people leaving, an LLP is again more flexible. A retirement can be documented with a short, simple deed of retirement. In a limited company, there can be a lot of paperwork, especially if the company decides to buy back the leaver’s shares, which is more tax efficient.

I was instructed a while ago on two similar jobs; both were small firms where an older partner was retiring and the younger partners were continuing. One was an LLP and the other a limited company. For the LLP I drafted a four page deed of retirement and for the limited company I drafted 14 different documents!

The final issue to consider is that of culture. What feel do you want your organisation to have? Is it a collegiate style where everyone works together or a more corporate style with command and control? Again, there is no right and wrong – you need to decide.

In conclusion, the structures can be compared below:

Please contact me if you would like to discuss any of the issues raised in this article. It is for advice only and may not reflect your particular personal and business needs; it is not legal advice you should not rely on it.

My contacts details are:

07973 283678 @law4partners