The following information is designed to give you a better understanding of what a Limited Liability Partnership is and to assist you in making the decision of whether it is the appropriate solution for your business.
Background of LLP's
Limited Liability Partnerships (LLP's) are the latest business vehicle and were introduced on 6 April 2001 after The Limited Liability Partnerships Act 2000 received Royal Assent on 20 July 2000 The introduction date was used to coincide with the Inland Revenue tax year due to the way that LLP's are taxed. They may be seen as a hybrid between limited liability companies and traditional partnerships, in that they offer the limited liability available to limited company shareholders combined with the tax regime and flexibility available to partnerships. Prior to this legislation, it was only a Private or Public Limited company that offered all of its members limited liability.
The types of business that LLP's were originally designed for were professional partnerships such as lawyers, surveyors and accountants. In many of these cases, though not all, they have not been able to operate through limited companies because of restrictions from their professional associations and the option of using a LLP offers some advantages.
However other businesses may also benefit from using LLP's, particularly new start-ups who might otherwise have formed limited companies.
Benefits of LLP's
The key advantage of a LLP compared with a traditional partnership is that the members of the LLP (it is important that they should not be called partners but members) are able to limit their personal liability if something goes wrong with the business, in much the same way as shareholders in a limited company are able to.
Where business owners have wanted to limit their personal liability in the past, they have normally set up limited companies and any profits made by those companies are subject to corporation tax. Dividends paid by the companies can then be taken as income of the shareholders. LLP's are taxed quite differently in that the profits are treated as the personal income of the members as if they had run their business as a partnership. The taxation of companies and partnerships is very different but taxation should not be the main consideration in choosing a business vehicle.
As to flexibility, the great benefit is in the ability to separate out different rights. For example, an entity seeding a new fund might be given rights to income (and then, only income from the fund they are seeding). An individual being made a member, or a retiring member, might also be given rights to a fixed level of income only, leaving the founders with the majority of voting rights and rights to assets on winding up. Some founders or other key team members might be given a different percentage of, say, voting rights compared to income rights. All these matters can be comfortably accommodated in the members' agreement.
Management of an LLP
Management of a partnership can be a difficult issue. But in the same way that all partners participate in management, so can all members of an LLP. The members of an LLP are free to agree amongst themselves the relationship between them, rather as partners do in a partnership, the LLP itself is a separate legal entity, owned by the members. This means that the LLP is able to enter into contracts and hold property and the LLP is able to continue in existence independent of changes in membership. What is important is ensuring that the agreement between members addresses the issue of management, particularly as an LLP does not have to have a formal members agreement on creation.
Considerations when forming an LLP
The consent of third parties also needs to be born in mind. Anyone lending money to the LLP such as a bank may still require personal guarantees from the members, as they frequently do with shareholders in a company.
If you are converting an existing partnership to an LLP the bank's consent will be required to transfer overdrafts and borrowings of the partnership to an LLP. Furthermore as the bank's level of security will be less in respect of an LLP than a partnership, the bank may require personal guarantees from the LLP's members. Similarly a landlord's consent will be required to transfer a lease from the partnership to an LLP. The extent to which this consent can be withheld may depend on the exact terms of the lease. Again, personal guarantees may be required as the landlord's security will be reduced in respect of an LLP.
Consideration should be given as to whether any significant contractual liabilities of the partnership need to be transferred. In addition the treatment of annuities may cause significant difficulties preparing accounts on a 'true and fair view' basis.
Part of the 'price' to pay for an LLP is that it will be necessary to publish annual accounts. For some this will be unacceptable. LLP's will produce and publish financial accounts with a similar level of detail to a similar sized limited company and will have to submit accounts and an annual return to the Registrar of Companies each year. This publication requirement is far more demanding than the position for normal partnerships and some specific accounting rules may lead to different profits from those of a normal partnership.
The legislation also requires that the profit share of the highest earning member is published if the LLP's profits exceed £200,000. A further tax consideration arises in respect of overseas operations. LLP's will be tax transparent for UK purposes. However, it is unclear whether other jurisdictions will treat LLP's in this way. It is possible some jurisdictions will ignore the situation in the UK and treat them as corporations and tax them accordingly.
Whether or not to have an LLP raises many issues, but there is clearly a need to plan ahead particularly if considering converting to an LLP from a Partnership. At the very least the partnership's engagement letter should provide for a transfer of the engagement if that is the way the firm decides to go.
Limiting Liability
To what extent is your liability limited? Because LLP's are relatively new, there is little case history examining the extent of liability. The following is a guide as to the potential liability should anything go wrong with your LLP
If, for example, a member of a LLP were to give bad advice to a client and the client suffered a loss as a result, the client may be able to take the LLP to court and be awarded appropriate compensation
It may also be possible that the member who actually gave the advice be required by a court to pay compensation to the client
It is however probable that any other members who were not directly involved in the advice will not have any personal liability. In a normal partnership it is quite possible that they would have had a personal liability. This has not yet been tested.
It will still be essential for LLP's (and individual members) who might find themselves in this position to have suitable insurance cover.
The other area that needs to be considered is to do with what the law calls unlawful or insolvent trading. In just the same way as company directors can be prosecuted for these offences, members of a LLP can also be prosecuted (and can be disqualified from being a member of a LLP in the future).
