This article was written for SME web
Limited liability status is an extremely valuable protection for entrepreneurs. The limited liability company has long been the default choice for business owners who wish to protect their personal assets should disaster strike and their business fail. Owners of businesses which give rise to potentially unlimited personal liability for the debts of their business, such as sole traders or partnerships, may have been comfortable in the boom years, but in leaner times will likely wish to move to a business structure which offers greater protection. Transferring such businesses to a limited liability company is an obvious move, but, since their introduction in 2001, a further alternative has been growing in popularity: the limited liability partnership or ‘LLP’. LLP offer a number of important benefits both for existing businesses and start-ups.
LLP’s were designed to meet the needs of UK-headquartered professional firms, such as accountants and solicitors, which had traditionally been organised as partnerships. Although professional firms often carry large insurance policies, there was always a fear that such policies would be insufficient to meet claims, either in a doomsday scenario where a claim exceeded their insurance coverage, or in circumstances where a liability was not covered by any insurance. The lack of limited liability in partnerships was accordingly considered a serious issue by many in those professions and encouraged a very conservative approach to business management. There was also a perceived need to match developments in other jurisdictions, where limited liability partnerships had been permitted for some time.
To meet the demand for change, the government created the LLP, which, despite its name, is in many respects more like a company than a partnership. Even the partners of an LLP are, somewhat oddly, referred to in the relevant statute as ‘members’, in the same way that shareholders are properly called ‘members’ of a company (although most LLP’s have simply ignored the statute and publicly refer to their members as partners). A key similarity between companies and LLP’s is that they are both bodies corporate (i.e. exist as a separate legal person). An LLP can therefore enter into contracts, create charges over its assets, hold land and sue and be sued in its own name. Subject to certain exceptions only the LLP and not its partners will be liable on contracts entered into by partners in the normal course of business of the LLP. As the name “limited liability partnership” implies, the liability of its partners will ordinarily be restricted to their investment in the LLP.
Although having its roots in professional partnerships, the LLP structure is available for any kind of business to use, except sole traders (the only requirement is “two or more persons associated for carrying on a lawful business with a view to profit”). Despite being a relatively recent invention, there are now over 30,000 LLPs registered in the UK, including businesses from virtually every sector. The vast majority of LLP’s are small and medium-sized businesses, although the largest LLP’s have multi-billion pound turnovers.
LLP’s are appealing for many reasons. They are extremely flexible in terms of management arrangements and profit sharing (particularly when compared to limited companies). The tax regime for partners in an LLP is the same as for partnerships, so the LLP does not have to pay employer’s national insurance contributions on the profits the partners receive, which can be a substantial saving over paying them a director’s salary. LLP’s have similar disclosure obligations to limited companies, but the partnership agreement is a private document between the partners and does not need to be filed at Companies House (in contrast to the articles of association of a company which must be made available for public inspection). Arguably, there may be cultural benefits in being an LLP, as it removes the split between shareholders and the board of directors and can promote a collegiate partnership-style way of working.
The tax advantages of LLP’s have been seized upon by the financial sector in particular, where individuals who might otherwise have been highly paid employees (with correspondingly high employer’s national insurance contributions) have been made partners. Such arrangements seem unlikely to survive the scrutiny of HMRC forever, but whilst they last they can make a big difference to staffing costs.
Of course, every business structure has its downsides and perhaps the most important for smaller businesses is the lack of familiarity of outsider investors with the LLP structure. Investors are much more comfortable with becoming shareholders than they are with becoming partners in an LLP. Also, share option schemes can be a useful way in which companies incentivise staff. LLP’s, which do not have shares in the traditional sense, cannot offer tax-efficient share options, although carefully structured bonus arrangements can achieve a similar effect. The way in which LLP’s are taxed encourages profits to be taken out as they are earned, rather than left in the business as working capital, which may not be the best way to run a business. Although such issues need to be borne in mind, such problems are not insurmountable and are irrelevant for many businesses.
For a business which is still finding its feet, it is the internal flexibility that may prove an LLP’s most useful attribute. The management and profit sharing arrangements can be agreed on day one and, if found wanting, torn up and rewritten the very next day. Limited companies impose certain formal processes on such changes, which can get in the way of an entrepreneur’s operation of their business. Although not suitable for every business, the days of choosing a limited company by default should now be considered over.