LLPs in Top 50+50: Will LLPs continue to be the preferred set-up?

The limited liability partnership (LLP) has been with us for over 16 years now. While certain firms – from accountants to lawyers – are exploring alternative models (including listing), others continue to convert to the tried and tested LLP. Despite being subject to certain reforms, it remains the model of choice for professional services firms.

In many ways, the explanation for the success of the LLP is simple: it offers the benefit of limited liability with the internal flexibility of a traditional partnership plus the attendant tax transparency. Back in 2001 when LLPs became a reality in the UK, the vast majority of accountants, and lawyers too, were partnerships and trading without the protection of the limited liability afforded by a private company. Predictably, the early adopters were what are now the Big 4 (who had been lobbying for the introduction of LLPs in any event) and the larger accountancy firms followed suit.

Some 60 plus firms in the Accountancy Age Top 50+50 rankings now operate as LLPs or use an LLP within their wider structure. This demonstrates that it has become the pre-eminent trading structure.  It’s worth noting that the majority of these firms had already converted to LLPs by 2014 – before two important changes were made to the tax regime applying to LLPs; namely, as a result of perceived abuse of the structure, HMRC introducing the salaried member rules and mixed member partnership rules. The first was intended to ensure that an individual LLP member has at least one badge of partnership (in the form of variable profits, a meaningful capital contribution or management influence) to be treated as self-employed for tax purposes. The second was designed to counteract the use of corporate vehicles in the LLP structure to reduce the tax liabilities of individual members.

However, most firms have addressed the salaried member rules to avoid an unwanted national insurance charge on the firm and its partners and, by and large, the attraction and benefits of an LLP have endured.

How to set up an LLP

Setting up as an LLP is a straightforward process, although there really is an absolute need for a formal and comprehensive LLP members’ agreement. Most existing LLPs have converted from a traditional partnership, but conversion is a slightly misleading expression as the process involves the transfer of an existing business by the partners to the new LLP.  As a consequence, all the normal issues arising from a business transfer have to be addressed, including assigning client engagements, debtors and creditors and staff.  However, given that this is in effect an internal re-organisation, these issues are not typically problematic.

Challenges are more likely to rise around the assignment of leasehold premises and dealing with the bank, which of course will be losing personal guarantees from the partners and may seek to impose new security arrangements on the LLP. It’s fair to say that over time a tried and tested path has been developed and, for most firms, the administrative aspects of conversion are a relatively straightforward process, albeit one that needs careful planning and project management. As noted, the LLP and its partners will need an appropriate members’ agreement which can offer the opportunity to revisit and update those parts of the partnership agreement that it will replace.

Barriers to conversion

Part of the price for limited liability is the requirement for financial disclosure as LLPs need to prepare and file accounts in the same way as companies. It is largely this financial disclosure that has put off a number of firms from moving from a partnership where there is no requirement for public financial disclosure. Other firms have taken the view that the conversion process is an unnecessary cost or that it may ultimately damage their partnership ethos, but many firms have already demonstrated that a corporate governance structure can be accommodated within an LLP.

With changes in the LLP tax regime and the overriding fact that tax transparency means that LLP partners have to account for tax on the firm’s profits as they arise irrespective of payment, there has been increasing talk of firms incorporating and adopting a private company structure. As with the legal sector – which has seen a few trailblazers but little appetite for wholesale reform – there has been no headlong rush to do this.

Unlike LLPs, companies are subject to strict capital maintenance rules, must have reserves available to distribute and there are legal requirements on making loans and returning share capital, by share buyback or liquidation. Members can come and go with greater ease and flexibility within an LLP structure.

For firms of a certain size, the tax benefits will be sufficiently attractive and the greater inflexibility of a company will be manageable. It becomes more problematic with size, although not insurmountable.  However, for any larger practices, the concept of a partnership model, albeit with an LLP wrapper, remains attractive and often there will be more pressing matters for management to contemplate.  Incorporation may continue for smaller firms and may be the model of choice for new entrants, but it is hard to foresee rapid movement away from the LLP model in the short-term.

Fergus Payne is partner and head of the Partnerships and LLPs legal practice group at law firm Lewis Silkin LLP.