Partnerships: Time for Conversion?

Written by Stephen Fuller

For many years, the vast majority of professional practices were constituted as simple partnerships. In recent years, more and more businesses have either started life as limited liability partnerships (LLP) or as limited companies, and significant numbers of partnerships have now converted to limited liability status.

For many partnerships and LLPs, there can be substantial tax advantages to converting to a limited company and, although each circumstance is different and too numerous to be addressed in this article, there are a number of practical potential benefits.

A partnership is not a legal entity and is regarded merely as a collection of individuals with each individual being jointly and severally liable for all of the liabilities of the whole, no matter what the respective profit shares or investments in the partnership are. In most cases, fixed share or salaried partners may also have to share the potential liability, and any indemnity from other partners is only worth the value of such partners.

Therefore, the primary advantage of incorporation, either as an LLP or a limited company, is that the LLP or company is itself a legal entity and is therefore liable for the company’s debts; the members of the LLP or directors of the company will only be potentially liable if they have done something wrong, such as trading whilst insolvent.

Of course, the reality of the situation is that lenders and landlords may require personal guarantees from the individual LLP members or directors and shareholders but, at least, the individuals will know what the extent of those liabilities are.

Aside from personal guarantees, personal liability will be limited to the current level of undrawn profits (in a LLP) or the amount of the loans from directors (for the limited company). The individuals will not generally be liable for the trading debts, nor for the amount of any claim against the organisation.

Another potential benefit for corporate entities is that limitation of liability can make it easier for new individuals to enter into, and for those retiring to exit from, the business.

In a partnership, a potential new partner may be concerned about liabilities he might inherit, particularly if initially he is joining on a significantly smaller share of profit. Equally, a departing partner may be concerned that liability incurred before he left may come back to haunt him at a later date.

The structure of a limited company in particular can be attractive to those entering the business and taking only a small share and indeed can offer the benefits of incentivisation through option schemes, including the Enterprise Management Initiative Scheme. However, for either corporate entity, an incoming individual will be able to understand the level of potential liability to which he is committed. Whilst a departing individual must ensure that any personal guarantees given are released, he can be comfortable that his only ongoing risk is any capital being repaid by instalments.

Another advantage can be the imposition of a more corporate structure than in a partnership. The differences between ownership and management responsibilities can often be blurred, but this can be clarified in an LLP by having designated and non-designated members, and in a limited company, by having shareholders and directors, who are not necessarily the same people. That corporate structure is more efficient for running a business and can be used to ensure that the efforts of the individuals are directed correctly to maximise efficiency.

Generally, there are few advantages to establishing a partnership today other than perhaps confidentiality as the accounts of an LLP or a limited company have to be filed annually at Companies House. However, even then, accounts only need to be filed at Companies House nine months after the year-end, so any information available to the public is historic only.

Conversion from a partnership to an LLP or a limited company is a relatively straightforward process, although there are a number of important issues to be considered. It is important to remember that a new entity is being created and, therefore, any agreements entered into by the partnership will need to be renewed. This will include banking facilities, leases and any other finance arrangements. Where the partnership is authorised by a professional body, that authorisation will also have to be renewed. As far as employees are concerned, TUPE will apply and employment contracts will automatically carry over into the new business.

The decision between converting to an LLP or a company will often come down to different tax treatments and what will be best for the individual business.

If you would like more information on this subject, please contact a member of the Corporate Commercial Department.

Contact the Author

Stephen Fuller

Gordon Dadds