The accountancy and legal services markets have changed. But is the LLP structure a growth blocker?
Twenty years ago today, the Limited Liability Partnerships Act (2000) came into force. Many legal and accounting firms took the opportunity to transition from traditional Partnerships to LLPs and take advantage of the new rules, particularly around limiting personal liabilities.
Twenty years on, the market for both accountancy and legal services has changed. As many clients grow and their needs become more complex, they increasingly want to engage with multi-disciplinary legal and accounting service providers. To respond to this demand, firms are having to become larger, with broader capabilities and extended geographic reach. To deliver on client demands, they are consolidating their heavily fragmented markets, often with the help of supportive investors. And those investors are demonstrating a clear preference for Limited company structures over LLPs.
Consequently, over the last two years, we at Sovereign have seen a renewed interest in LLPs exploring the shift to becoming a Limited company. So, on the 20th anniversary of the LLP, we thought we should recap the five issues we find ourselves discussing with businesses in these sectors and ask: How investable is an LLP?
1.Vehicle for investment
The problem: LLPs are difficult structures to invest in for growth strategies
In many industries investment from external capital providers is creating opportunities for the best businesses to consolidate their markets and accelerate organic growth. With increasing private equity investment in these markets, it can be hard for businesses unable to source such investment to keep up with the competition.
An external investor will usually want equity in return for their capital and, as a result, LLPs are difficult vehicles to invest in, because investors want to be shareholders, not partners in an LLP.
2. Decision making
The problem: decision making can be slow or difficult (especially if there are lots of partners)
We’ve lost count of the number of times we’ve been asked to ‘re-play a conversation in front of the other 30 partners’ to build consensus within LLPs.
In a Limited company, a board is constructed appropriately to allow critical decisions to be made at speed. A Limited company board will usually comprise a Chairman, a CEO, a CFO, one or two executive directors with specific domain expertise, and non-executive directors. Roles and interests of each board member are clearly defined, as is the process for empowering the Board to make decisions, markedly improving the pace at which the company moves and takes advantage of opportunities.
There are, of course, very human issues to consider. Long-standing partners may not want to relinquish decision-making powers that were previously distributed throughout the partnership. The advantages – such as leaving industry specialists more time to practice their craft than get bogged down in group level administration – need to be clearly mapped out and the proposed transition communicated with care. This is something a supportive and experienced investment partner can help with.
3. Profits vs salary
The problem: it is more attractive for Partnerships to distribute all profits than to maintain steady salaries and re-invest
In most LLPs, equity partners receive a share of the profits from the previous year. In a Limited company, remuneration usually takes the form of a set base salary plus a bonus based on individual and/or company-wide performance. While the latter has the advantage of providing greater predictability of household income, the former typically results in more income in profitable years. The difficulty is that with profits being fully distributed each year very little is left to re-invest in the business. Over time, the business becomes under-invested, lags in technology, and the overall value of the business can decrease.
In a Limited company, shareholders work together towards building capital value that can be realised via an IPO, a trade sale, or a secondary buy-out. Such an event can be significantly more lucrative than even many years of partner drawings and also tends to build better businesses with more appropriate levels of re-investment for the modern corporate landscape
4. Buy-in vs awarding shares
The problem: LLPs often require ‘buy-in’ to fund the retirement of a departing partner or founder
Partnerships usually require ‘buy-in’ to join the partnership, which often funds the retirement of an older partner. This inter-generational battle requires a level of liquidity often unavailable or undesirable (mortgages, school fees, and so on still need to be paid) to those at the level below partnership, creating frustration for partners who want to retire and frustration for eager and loyal employees who want to continue their rise within the firm.
Limited companies can be more meritocratic and treat career progression and ownership progression as separate topics. The best employees can ascend the ranks regardless of liquidity and can be rewarded with lucrative equity-based incentives without having to remortgage their homes
5. Retaining / attracting staff
The problem: Aspiring employees often find their career paths blocked by ageing partners
Many partners find it difficult to understand how they can retain and attract staff if they transition to a Limited formation. While historically not the norm in legal or accounting services, most businesses in the UK that are larger than sole traders are Limited companies.
There are many templates available for calibrating salaries, bonuses, and benefits in a way that retains and attracts top talent. A common challenge is around persuading those immediately below partnership level in the current business – who may have felt they were about to receive an invitation to the partnership – that the new structure will be just as rewarding. A large part of this will be in explaining the strategic vision under the new Limited company structure which, with investment, can create exciting and broader career opportunities for all individuals in the firm. It is critical in these discussions to be open and to make clear that part of the benefit will be being able to take investment and grow the business, and that there will be incentives and opportunities around that to compensate for the altered career path.
How can an investor help?
Investors clearly bring capital, but that merely defines them as an investor. An investment partner will bring much more. They will:
- Provide an experienced strategic sounding board at senior level, introducing and challenging ideas to strengthen strategy and develop ambition.
- Identify, filter, and execute acquisition opportunities, freeing the team to focus on planning and executing on the integration plan. This is especially important when a business has no M&A experience.
- Be interested, but not intrusive. Management’s job is the day-to-day running of the business – not the investor’s.
- Identify top-tier talent, whether a Chair, NED, or as the business grows a more experienced CFO/COO, ideally using an in-house resource and network of contacts.
- Support portfolio companies in relation to other strategic objectives, for example, internationalisation, strategic acquisition, organic roll-out, and digital transformation. While the detail of these strategies is specific to the company involved, there are common facets across businesses and a good investor should have a strong track-record of supporting successful growth with other businesses in your sector.
Sovereign - supporting your company's growth ambitions
At Sovereign, we are keen investors in the accountancy and legal services sectors. We love backing top-quality experienced and ambitious management teams and partnering them on an exciting growth journey over several years to create market leaders in their respective industries. We are experienced at working to transfer LLPs into Limited companies as part of an investment process. If you would be interested in an informal discussion to learn more and explore options, please contact JamesBuckhalter@sovereigncapital.co.uk or EmmaFlin@sovereigncapital.co.uk