I was interviewed recently by LawFirmAmbition about the most common questions surrounding the topic of becoming a partner in a law firm. The questions below focus on the capital you are asked to contribute and what is expected of you as a partner. You can read the answers to previous questions here:
Contributing capital is different to making a payment for acquiring a share of the partnership. A capital contribution is effectively classed as a loan to the business and would be due back to you on exit. It would be included in your capital or current account in a partnership or limited liability partnership; or in a director’s loan account in a limited company.
There is no easy answer to how much is a reasonable amount of capital to contribute. This varies depending on the cash needs of the business, the risk appetite of the partners and the size of the firm.
Usually the larger the firm, the larger the capital contribution. For smaller firms, the contribution may be as low as £50,000 rising to typically around £150,000. For larger firms, it may be as low as £100,000 rising typically to around £350,000, but could be much higher.
Based on the Armstrong Watson benchmarking database, the average partner capital account is £194,000.
Some firms ask for all of the capital to be paid on entry to partnership, others allow the build-up of capital from reduced drawings over a period of time.
Most also require capital contributions to increase with seniority. In those circumstances, the capital build-up is often linked with an increase in profit share, although the two may not necessarily go hand in hand.
Most new partners will obtain a partnership capital loan. These loans are openly available from the high street banks and from some of the specialist legal sector funders. Options include secured and unsecured loans. You can also choose a capital and interest repayment loan, or an interest-only loan that is repaid on exit from the partnership.
Often there are clauses in the loan to require that your capital account balance in the firm does not fall below the level of the loan. The firm is sometimes required to sign up as a guarantor.
There are some equivalent loan products available for investing capital in a professional practice that trades through a limited company. They are not as freely available, but are becoming more common.
Some individuals, of course, may be able to provide the capital contribution from personal or family funds and thereby avoid the need for a loan. However, tax relief is available on the interest on partnership capital loans, which could make such loans a cheaper source of finance than mortgages, for example.
Specialist funding advice should be sought before making such borrowing decisions.
As tax is such a broad subject, it is not possible to cover all of the implications here. The tax implications will also vary depending on the structure of the firm. Partnerships and limited liability partnerships (LLP) are broadly the same, while limited companies are completely different.
In a partnership or LLP, you will probably become self-employed for tax purposes. However, there are certain tests to pass to become self-employed if you are a fixed share partner in an LLP.
If becoming self-employed, you will need to inform HMRC within three months of becoming self-employed. Your current situation is probably that tax payments are deducted by your employer and paid to HMRC on your behalf on a monthly basis. Upon becoming self-employed, this arrangement ceases and you are required to pay income tax twice a year, on 31 January and 31 July.
The opening year rules and the payment on account rules are fairly complex, and it may be some time after you become a partner that you actually make your first tax payment. It is important to take advice on the potential tax payments in your circumstances, and make the necessary provisions for making the payments.
Some law firms will retain money from drawings in order to pay tax on behalf of the partners, while others ask the partners to pay their own tax bills. Ask your firm how they will deal with this.
In a company, it is likely that you will be employed by the company, most probably as a director as well as a shareholder. The tax treatment would then depend on the sources of income from the company such as salary, bonus, benefits in kind, pension contributions and dividends.
The roles, responsibilities and expectations of partners vary firm by firm and also partner by partner.
In general, partners are expected to be more responsible for:
It is absolutely vital to be a team player. It may be possible to have frank discussions with fellow partners behind closed doors, but once a collective decision has been made all partners need to be visible advocates of that decision.
Partners also need to acknowledge that they should continue to be managed by others – whether that be a managing or senior partner, or an individual or group of partners. In some cases, issues are created when partners feel that they can act as they want without having any sanctions or performance management implications, just because they are a partner. We can all improve and being open to management will help the entire team to achieve more.