Too Traditional: Law Firms “incorporating” new business models
September 16, 2019
2 min read
What's going on here?
Law firms are moving away from the traditional partnership model, as 47% of law firms in the UK are now incorporated businesses. This is up from 32% five years ago.
What does this mean?
Don’t be fooled, this increase hasn’t been caused by a change in the structure of Limited Liability Partnerships (LLP). According to analysis from the accountancy firm Hazlewoods, the increase has been driven by sole partnerships and traditional partnerships changing their structures.
Some definitions might be useful to make this a bit easier to understand. A sole practitioner is a lawyer who practices independently. A traditional partnership is when two or more people are in business together and share the risks of the company. A Limited Liability Partnership (LLP) is similar to a traditional partnership, but limits the liability of Partners, as they are considered to be a separate legal entity to the firm.
What's the big picture effect?
Sole partnerships and traditional partnerships often leave partners facing unlimited personal liability. If things go wrong, it is not uncommon to find that partners lose everything, including personal assets like family homes. However, in an incorporated company or LLP, the exposure of partners is typically limited to the value of their investment and their personal assets are protected.
So why don’t all firms just convert into an LLP? There are many benefits to incorporating a firm. Firstly, they can be more tax-efficient than partnerships, especially with corporation tax rates set to reduce further. Shareholders can also take money out of the business as dividends, which are subject to low rates of income tax. As well as reducing the firm’s tax burden, management boards are created to direct the activity of the business. This can free up time for fee earners, whereas, in an LLP, there is no difference between the owners and managers. Furthermore, and potentially most crucially, it can also limit partners personal exposure if a firm goes bust.
However, incorporating a firm is not always a perfect fix, despite the clear benefits that may come along with it. It is not wise for structural changes to be motivated by tax benefits, as these could be outweighed by many administrative costs or other factors. There is no single structure that works best for all firms. Having said this, the statistics show that it is looking increasingly likely that firms are changing their business models to structures that more closely resemble incorporated companies. This clearly shows how law firms must be equally concerned with how they operate as a business and not just the law they consult on.
Report written by Sarina Johal
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