This article was originally published on the Current Awareness Service on LexisLibrary on 1 November 2011

Abstract

Figures from the Solicitors Regulation Authority reveal that during the last year the number of firms choosing to incorporate has risen by 26 per cent. Diana Bentley talks to George Bull of Baker Tilly, Steve Kirwan of Nowell Meller and Alex Bevan of Bevans Solicitors about the trend towards incorporation

Analysis

The latest figures from the Solicitors Regulation Authority (SRA) reveal an interesting trend. In the last year to July the number of firms choosing to incorporate rose by 26 per cent, bringing the number of companies to 2,400 out of a total of 10,973. The number of limited liability partnerships (LLPs) rose too--by ten per cent to 1,398. However, the number of traditional firms and sole practitioners fell by nearly ten per cent to 3,309.

So what accounts for the increase in the popularity of incorporation? George Bull, Head of Professional Practices Group, at accountants Baker Tilly says: "There are three reasons for this trend. First, partners in some firms have incorporated their own limited companies, through which they exercise their membership of the law firm for tax reasons. Second, some firms have incorporated to provide a shareholding structure which may in due course make it easier to accept external equity, or to self-fund future growth through the retention of profits within the company. In the company, profits will be taxed at a lower rate than in the hands of individuals.

"The third reason for this trend is the creation of hybrid structures, with an LLP law firm having a limited company member which will be owned by some or all of the partners which also provides flexibility for external investment. Once alternative business structures are permitted under the Legal Services Act 2007 reforms, such structures will become particularly attractive as they also enable firms to widen share ownership through an all-employee share incentive plan."

The benefits that flow from incorporation will depend on the circumstances of the firm and the strategy which it is seeking to implement Bull says. "The key benefits are a shareholding structure that will be well understood by potential investors and the facility to effect mergers or attract lateral hires or teams throughan allocation of shares to the incoming individuals." Incorporation also provides the opportunity to recognise capital value which may produce a capital event for existing members/partners he advises. Future growth can be self-funded, or funded using external equity and a regular dividend flow from the company will help build capital value in the shares."

One firm that was attracted to the tax benefits described by Bull, was Nowell Meller of Stafford which became incorporated in 2005. "Our accountant suggested it due to the treatment of retained profits in companies," explains managing director Steve Kirwan. "When profits are distributed to shareholders as dividends the tax treatment is more favourable than when they are distributed to partners and there are no National Insurance contributions."

For others, the issue of management is a significant consideration. "For some years I had decided the partnership model was outdated and LLPs seemed to be a poorish half-way house between company structures and partnership," says Alex Bevan, a director of Bevans Solicitors of Bristol and London. "Partnership involves joint ownership and management whereas the limited company separates ownership and management--though in a smaller limited company the separation is not always present. The main notion was to have a separate entity--Bevans Bray Walker Limited--that grew and developed notwithstanding individuals coming or going." The result, he says, has been a much more business-like approach to direction and management.

The reaction within the firm to the change has been positive, says Bevan. "People were intrigued but they can see the way the board controls the business and plans ahead in ways more old-fashioned partnerships do not. Of course, there are modern and business-like partnerships and LLPs, but the structure and law relating to companies is geared to business and that is what the law now is." Bevan notes that incorporation offers clearer applicable law than a partnership, less liability for shareholders and, as Bull notes, easier ingress and egress for owners. "There's also no way a partner with a small share can veto direction and hold everyone to ransom," he says.

However, Bevan admits there is more regulation to contend with after incorporation. "There are more accounts to file so there is less secrecy but in this 'era of transparency' this doesn't worry us. Also some people think lawyers don't mess with 'trade' but we have only met with respect from clients and other lawyers."

So how should firms assess if they should incorporate? "It isn't suitable for all firms," insists Bull. "I'd say firms should develop a clear strategy first then develop a business model to achieve that strategy, then put the right structure in place to support the business model. Incorporation wouldn't suit, for example, a firm which wished to remain an 'income partnership' distributing its profits in full each year." Structures involving incorporated entities can take a wide variety of forms he advises and firms should take care to determine the best structure for them, comparing all the financial and non-financial benefits and disadvantages. "There's no one size fits all," he insists.

Once a firm decides to incorporate various steps must be undertaken which will depend on the circumstances of the firm and what it is trying to achieve. A common task however, will be the need to allocate shares to the existing partners. "This may raise difficult generational issues," notes Bull. "Older partners may feel they ought to receive a greater proportion of the shares because their efforts have brought the firm to where it is. Younger partners may feel that 'that was then, this is now': it is their efforts which will secure the future profitability of the firm. You have to develop an approach which balances the interests of all the parties."

There are other issues that need addressing too says Bull. "In terms of the 'big picture' it's vital the management team communicates clearly with the partner group at all times. If partners don't understand what is proposed and all the implications of it, then any proposal to incorporate is unlikely to reach a happy conclusion. On another level there may be particular tax issues which have to be addressed for partners of the firm who were previously employees in the same firm."

In Bevans' case the process proved to be easy and inexpensive says Bevan. "We drew up a shareholder agreement and that cost some money but so does a partnership or members agreement." Steve Kirwan also says the process was not complex but warns people to allow plenty of time to complete the necessary work. "Insurance cover can differ with companies too. We found that we had to increase our cover from £1m to £3m which was a little more expensive," Kirwan reports. "You also have to consider having service agreements with shareholders and the way leases and agreements with banks have to be dealt with." All of that he says, is a matter that firms should be able to work their way through with relative ease. "One issue we had to confront though was how to deal with wills in our will bank in which partners had been appointed executors." However he notes this is no longer an issue as the Probate Registry recognises that the company has succeeded to the business of the partnership.

Bevan is enthusiastic about his firm's transition to a corporation. "It's been brilliant for the direction of the firm and also for the capital gains tax benefits. Now we'll also have greater flexibility to be affiliated with or to acquire other practices." What advice would he offer firms considering incorporation? "Take good accountancy advice, stay close to your accountant and come and talk to us!" he says.