Ten things you need to know before making partner
Making partner or joining a new firm as a partner is always a very exciting time in a person’s career. However, it is important to be aware of some of the nuts and bolts as well as the opportunities. This article discusses some of the issues to look out for.
1. Limited liability
We still refer to partnership but in almost all cases professional partnerships are now limited liability partnerships (LLPs) rather than pure partnerships. The benefit of this is that the LLP itself is a legal entity with limited liability to its clients and suppliers (much like a company) and the individual partners (or “members”) do not have unlimited liability. Extra care should be taken if you are asked to join a pure partnership.
2. Profit sharing
In most cases you will be joining as a fixed share or salaried partner. This means that you will be entitled to a fixed amount by way of profit share, much like an employee’s salary. By contrast, equity partners are not entitled to a fixed amount but instead will take a percentage of the profits of the firm, whatever those profits might be, and will contribute capital to the firm.
However, even if you join as a fixed share partner do not be surprised if you are asked to contribute some capital and/or have part of your profit share fluctuate depending on the firm’s profits as a whole. This is as a result of tax changes made in 2014 so that partners are classed as self-employed for tax purposes, which is beneficial to the firm as a whole as it will no longer be required to pay employers’ NIC on your profit share.
Drawings are the monthly amount paid to partners on account of their profit share. For a fixed share partner this will usually be one twelfth of your annual profit share. With equity partners, monthly drawings are paid but at the end of the year the actual profits are calculated and a top up profit share will be payable. Check the LLP Agreement for when these top up payments are made as there may be some delay to smooth the firm’s cash flow. Equally, if the end of year profits are less than anticipated then partners can be required to pay back the amount overpaid.
4. Tax reserves
Self-employed partners are responsible for paying their income tax to HMRC. Some LLPs will pay their partners gross of tax and so you will need to save part of your drawings to cover your tax bill (and not blow it on that new kitchen!). Alternatively some LLPs set aside part of your drawings in a tax reserve, on the basis that when the tax becomes due the LLP will pay it on your behalf.
However beware: the tax reserve may not actually be put into a separate bank account and may be used by the firm for general cash flow. This means that you could be vulnerable if the firm does not have enough cash to pay your tax bill when due.
If you are asked to contribute capital the firm will usually arrange a personal loan from the firm’s bank. The firm may pay you interest on the capital contribution to cover the interest payable on your loan. The capital will be repaid to you (or rather to the bank direct) when you leave the firm (but see below). Again this money will be used for the firm’s general cash flow and as such is at risk if the firm cannot repay you.
6. Employment rights
On becoming a partner you cease to be an employee and so lose normal employment rights, for example the right to bring an unfair dismissal claim. Check the LLP agreement for those grounds on which the firm can dismiss you as a partner. The LLP Agreement will often say the firm can dismiss a partner simply on notice. Also check which benefits continue to apply to you as partner; these may not be the same as when you were an employee (for example you may fall outside the firm’s group pension scheme). Is there provision for paid maternity or paternity leave?
If things don’t work out, what else should you look out for on exiting a firm?
7. Notice periods
How much notice do you need to give the firm if you want to leave? Although some firms may agree to allow you to leave early, often partners are required to work out their notice, and can be prevented from working for their clients during that period.
8. Restrictive covenants
Most firms will have these, preventing you from actively soliciting your clients, and sometimes preventing you from simply dealing with clients who track you down at your new firm and want to instruct you. Read these carefully and negotiate if possible. If you are joining a firm as a partner try and agree on a list of clients you are bringing with you who should fall outside the restrictive covenants, so you take them with you if things don’t work out.
9. Repayment of capital
Check this carefully. The firm may want to repay your capital in instalments to smooth its cash flow but make sure the firm cannot hold onto your capital for too long and that it continues to pay interest.
10. Release from liabilities
If you are asked to give a personal guarantee for the firm’s liabilities (e.g. bank debt), make sure you are released from this when you exit.
The above aspects should not put you off being promoted to partner but it is best to be aware of what this change of status brings.
Tanya Shillingford is a Partner in the corporate team at Goodman Derrick LLP, the London law firm.
This guide is for general information and interest only and should not be relied upon as providing specific legal advice.
Originally published in Economia on 20 February 2018.