Which business structure is most advantageous for a law firm?

Dec 28, 2022

Written By Toby Clyde

Law firms are unique organisations. As a business, they can be structured in many different ways, and even firms that look alike at a glance can differ greatly in practice, based on variables like size, history and commercial focus. Consequently, which arrangement makes sense for any given firm will depend on a number of factors.

The basics of business structure

Firstly, it’s worth noting that this article will focus on solicitors’ firms only. Barristers’ chambers work very differently and deserve several articles of their own.

Broadly speaking, law firms in the UK come in three main flavours: partnerships, limited liability partnerships (LLPs) and limited companies.

You’ve probably heard of a partnership before. As a way of doing business, partnerships have a long history and are the traditional structure of a law firm. Essentially, a group of lawyers come together to share ownership, profits and liabilities (that is, the debts and obligations of a firm).

Limited liability partnerships are similar. Like a partnership, members of an LLP are joint owners. The crucial difference is that, in this arrangement, partners aren’t personally liable for the firm’s debts (hence the ‘limited’ in limited liability).

Finally, there are limited companies. Like any normal business, a limited company will have directors and shareholders. As with an LLP, directors aren’t on the hook for the company’s liabilities, although in both cases there are exceptions. However, limited companies have a share structure (and other requirements under the 2006 Companies Act) that make them much less flexible when it comes to management structure, changes in ownership and profit share.

Solicitors can also operate as sole practitioners. As the name suggests, this means that the practitioner is self-employed; they are the firm. Like in a partnership, sole practitioners are personally liable. Although a significant segment of registered firms in the UK, the business structure of a sole practitioner is, inevitably, not very complicated, and so our focus will be on the other three.

What does this mean in practice?

It's worth keeping in mind that business structure is not destiny. Two firms with the same structure may operate very differently depending on their size and practice area. But that doesn’t mean there aren’t significant similarities either.

The first is flexibility. Partners (and members in an LLP) potentially have more autonomy in the business compared to directors in a limited company. How this works in practice is decided by a firm’s partnership agreement (or an LLP members' agreement), and some large international firms make full use of this, with complex partner agreements that vary across jurisdictions.

This makes potential partnerships more adaptable. It’s easier to adjust how profit is shared between partners and easier for partners to join without, for example, haggling over share valuation.

Of course, getting lawyers to agree on pay is never easy: many top UK LLPs have struggled to expand into the American legal market, in part because of cultural differences in how equity partners share profit in the US.

Limited companies strike back

However, there are drawbacks too. Not only are general partners jointly and severally liable for a firm’s debts but, as with LLPs, they can actually be less flexible in some respects.

Partners can be narrowly focused on maximising their own billable hours and short-term profits. And getting to this level requires a long-term commitment from junior lawyers who may not want to stay in one firm for so long.

In contrast, a limited company can find it much easier to attract external investment and, therefore, expand quickly. Employees, shareholders and directors can be involved in a number of different capacities and this allows firms to experiment with new ways of working.

For example, some newly incorporated firms are opting for an Alternative Business Structure (ABS), where non-lawyers participate in a firm’s ownership and management. This allows firms to bring in staff with different skills and experience, and to issue different classes of shares to employees of all stripes.

Tax and disclosure

Finally, there are important tax and disclosure issues to consider. However, unless you’re planning to set up a law firm tomorrow, the fine details aren’t worth going into. In summary, partners and members are taxed as self-employed, whereas limited companies are taxed at the (currently) much lower corporate tax rate.

Unlike partnerships, LLPs and limited companies are also required to disclose some information to Companies House.

Conclusion

The UK legal market is changing all the time. Although it’s easy to focus on the established top-earning firms, most of which are LLPs or partnerships, these are in the minority.

Increasingly, for firms in a high-volume area of law and with staff from many different professions, a limited company structure is the obvious choice. As of June 2022, the Solicitors Regulation Authority reports that incorporated companies now make up 53% of registered firms in the UK (with LLPs at 15.4% and partnerships at 13%). This is compared to only 20% in April 2011.

You can see why established, high-revenue and top profit-per-partner firms might favour the partnership model, albeit with some form of limited liability.

But, the question of what gives a firm the greatest advantage is ultimately about what will allow them to serve their clients best. For this, there is no correct answer.

Law Firm Structure