Benefits of converting an LLP to a limited company

Converting from an LLP to a limited company offers significant benefits to certain businesses. Indeed, an increasing number of firms in the professional services sector, which includes lawyers, accountants, architects, and medical practitioners, are moving away from the traditionally preferred partnership structure toward the limited company model.

From general partnership to LLP and limited company

Before we look at the benefits of converting to a limited company, let’s take a look at the evolution of the partnership structure in the UK.

Many businesses that traditionally operated as general partnerships – some for hundreds of years – decided to adopt the LLP structure following the introduction of the Limited Liability Partnerships Act 2000, which combines some of the benefits of incorporation with the important aspects of the partnership model.

Several of the major accountancy practices, and a significant number of law firms, in particular, took the leap to limited liability partnership status.

The most obvious reason to convert from a general partnership to LLP is to benefit from the protection of limited liability. The traditional partnership structure does not provide any protection from bad business debts and other liabilities. Members of an LLP, on the other hand, are safeguarded from business liabilities in the same way as company shareholders.

Furthermore, a limited liability partnership is a separate legal entity. This means that an LLP can trade, purchase property, and obtain finance in its own name. This legal personality makes it easier to structure the business and gain investment.

However, some of the features of the traditional partnership are still retained within the LLP model, including individual taxation of members, and greater flexibility regarding the internal organisation of the business.

Nowadays, many professional businesses operating as LLPs are taking things a step further and converting to limited companies, to enjoy the advantages this structure has to offer.

What are the benefits of converting from an LLP to a limited company?

Without a doubt, the driving force behind converting from LLP to a limited company is the difference in taxation, and in particular a limited company’s ability to retain profits in the business and pay company owners dividends.

Retained profits

Limited companies can choose to retain profits within the business, rather than paying money out via salaries or dividends.

Any money ploughed back into the business is only subject to Corporation Tax, which has a lower rate than income tax. LLPs cannot retain surplus income, so all profits must be paid out to members, who incur Income Tax on these earnings.

Dividends

Unlike LLP members, who need to pay the full rate of income tax on their earnings, company owners (shareholders) can choose to pay themselves via dividends.

The highest rate of tax on dividends is lower than the highest band of income tax. This means that it is often more tax-efficient to draw a combination of dividends and a salary, taking into account tax-free allowances, etc.

However, taxation is only one of the advantages a limited company has over an LLP structure. Let’s take a look at the other reasons why you may wish to convert from LLP to a limited company:

Structural simplicity

Limited companies are generally set up and governed in line with the model articles of association. Meanwhile, LLPs are required to create their own LLP agreements. These may need to be amended to accommodate changes to operational matters, which can be cumbersome.

Sole ownership

Companies can be owned by just one person, e.g. someone can take over a business by themself, whereas LLPs always need a minimum of two members or partners.

If at any point there are less than two members, for instance, if one partner dies, the LLP will automatically revert to sole trader status, and the protection of limited liability will be lost.

Limited liability

Although both LLPs and limited companies enjoy limited liability, there are potentially more risks for members of an LLP if it becomes insolvent.

So-called ‘clawback’ provisions were introduced by the addition of section 214A to the Limited Liability Partnerships Regulations 2001, which means that members can be pursued for debts of the LLP in certain circumstances.

Expansion

Takeovers and acquisitions are generally easier and more straightforward for limited companies compared to LLPs.

In general terms, you cannot buy an LLP in the same way you can acquire a limited company by purchasing the shares. The acquisition of an LLP usually involves purchasing the goodwill and assets of the partnership, which often involves further complications, for example, the transfer of existing clients to the purchasing entity.

Flexibility

Although this is not a reason to convert from LLP to a limited company, it should be noted that limited companies can be just as flexible as LLPs in terms of ownership structure. This is due to the ability to introduce multiple share classes.

Investment

It is possible to purchase shares in a company without becoming a director, which often makes it easier to attract outside investors.

In contrast, investors in an LLP will generally become members, which potentially entails more responsibility. It is normally more straightforward to invest and sell shares in a limited company compared to investing in an LLP.

Stock market listing

Since LLPs do not have shares, they are unable to obtain external investment by listing on the stock market.

Private limited companies are also unable to trade their shares on public exchanges, but it is possible to convert a private limited company to a public limited company (PLC) and vice-versa.

Converting from LLP to a limited company – how to do it

There is no specific procedure that enables an LLP to re-register as a limited company. Instead, it involves a process of transferring assets from the old entity to the new one.

The following steps will be required:

• Register a limited company at Companies House. This can be done directly, or through a company formation agent such as 1st Formations
• Transfer assets and liabilities from the LLP to the limited company, e.g. under a contract
• Individual LLP members should resign and enter into employment contracts with the new limited company
• Dissolve the LLP

It is worth remembering that taxes may be payable in respect of the transfer of assets from the LLP to the limited company.

Sector focus: law firms

Whilst many professional services have moved away from partnership models to incorporated structures, the legal sector saw some of the most pronounced changes in this regard.

Law firms traditionally operated as partnerships, with the majority of profits being distributed amongst a small number of equity partners sitting at the top of a hierarchical business organisation. However, many firms were quick to convert to LLP status when it became a possibility in 2001. This provided limited liability, whilst also allowing them to maintain many of the attributes of a partnership.

The introduction of alternative business structures (ABS) in 2007 accelerated the move away from traditional business models towards a limited company structure that facilitated external investment.

ABSs essentially allows law firms to be owned and managed by non-lawyers (and companies outside the legal profession). In the pre-ABS era, it was much harder for law firms to obtain outside investment. The first ABSs were licensed in 2012, and numbers have grown steadily. A recent search for ABSs on the SRA website returned in excess of 1,000 results.

• What’s the difference between a shareholder and an LLP member?
• A guide to limited liability partnerships (LLPs)
• What are the starting costs of a limited company?

Gaining access to finance was particularly important in the wake of the 2008 financial crash. It may once again become crucial post-Covid if the economy suffers, as has been predicted in some quarters.

Speaking in 2011 to Legal Futures, George Bull of Baker Tilly (now RSM) said the driving force behind law firms converting from LLP to limited company structures revolved around finance after 2008:

“With firms finding banks less willing to lend, self-finance becomes more important. If you’re going to finance your firm out of post-tax profits, you want the tax bill to be as low as possible. In most situations, a limited company will be a more tax-efficient vehicle than an LLP for retaining profits for reinvestment in the firm.”

A few years later, Gateley became the first UK law firm to float on the stock market when it went public in June 2015, raising £30 million in the process. Speaking at the time, CEO Michael Ward said:

“The IPO will provide the platform for the continued success of the business, as well as accelerate its growth opportunities and facilitate value creation through an increased ability to acquire, incentivise, differentiate and where sensible, diversify.”

In 2020, according to statistics from the Solicitors Regulation Authority (SRA), almost half of all solicitors’ firms (48.8%) are now incorporated companies. Whilst 15.1% operate as LLPs, 14.8% remain as traditional partnerships, and 20.9% operate as sole traders. This is a marked shift compared to only 10 years ago, when a third of firms were traditional partnerships, 11% operated as LLPs, and only 17% were set up as limited companies.

It is likely that law firms will continue to move toward company formation as they increasingly merge or collaborate with accountancy practices and technology companies.

Obtaining access to external investment and expertise will likely become even more important as the economic shock from the Coronavirus pandemic kicks in, and law firms with incorporated structures may find it easier to secure funding for expansion.

This could help them to attract new talent, for whom the traditional partnership model feels increasingly outdated.