By Zulon Begum and Wendy Chung (CM Murray LLP)
The legal form and structure of any business can contribute to its success or failure, especially in difficult trading conditions such as the economic slump caused by the COVID-19 pandemic. A successful structuring strategy will enable a business to:
- take advantage of lucrative opportunities for growth with more speed and ease than its competitors;
- incentivise and reward its senior people whilst motivating the next generation to join the ranks; and
- adapt and respond to changing market conditions.
International and national organisations have a number of structural options in the UK. The most successful structure will depend on the organisation’s aims and objectives and may involve a combination of different forms of legal entities. Each structure has advantages and disadvantages (as summarised below). In every case, a regular structural review is recommended to maximise opportunities for growth and to mitigate the effects of an economic downturn.
The most widely recognised entities in the UK and internationally are a private limited company (Ltd) and a public limited liability company (Plc).
The familiarity of Ltds and Plcs mean that they tend to be more attractive to external investors. Investors can be offered equity securities (such as shares) or debt securities (such as loan notes and bonds) with a varying voting and economic rights. Investors benefit from limited liability, which means that, in the event of the Ltd or Plc’s insolvency, their liability is usually limited to the amount of capital that they paid for their securities. Plcs have the added advantage in that can be listed on a stock exchange; which enables a business to raise funds in the capital markets. During difficult trading conditions, access to capital can be crucial to prevent liquidity and cash flow problems spiralling into an insolvency situation. It can also enable a business to take advantage of strategic opportunities to fund mergers or acquisitions for expansion or to diversify in response to changing customer demand.
Ltds and Plcs can also incentivise and reward their employees and directors with an ownership stake in the business through tax efficient share schemes.
Although Ltd and Plcs are relatively easy to set up, they are subject to wide-ranging regulatory restrictions (including restrictions on the use of capital and distributions to shareholders) and governance controls (such as rules governing shareholder decisions). They are also subject to public scrutiny through public disclosures of their annual accounts. Listed Plcs are subject to even greater governance and disclosure rules.
LLPs and Partnerships
Organisations which provide professional services (such as legal, accountancy, tax, consultancy and architectural firms) tend to be structured as a limited liability partnership (LLP) or, in an increasingly small number of cases, as an unincorporated partnership (Partnership). Partnerships are also commonly used in the private equity, asset management and real estate sectors.
LLPs and Partnerships are taxed differently to Ltds and Plcs. For example, LLPs and Partnerships do not pay employers’ national insurance contributions (currently at the rate of 13.8%) in respect of genuine self-employed members of the LLP or partners of the Partnership (who tend to be their highest earners). LLPs and Partnerships are treated as “tax transparent” and are not subject to corporation tax. The profits of an LLP or Partnership are taxed as income/capital gains in the hands of their members or partners. In contrast, the members of a Ltd or Plc receive their dividends from profits after corporation tax has been paid by the Ltd or Plc.
LLPs and Partnerships are free to determine their own profit-sharing, capital and decision-making arrangements, which can be all be changed with relative ease and speed (e.g. by an oral or written agreement or by a vote of a specified majority of the members or partners). This flexibility can make LLPs and Partnerships more agile during turbulent trading conditions.
As with a Ltd or Plc, the members of an LLP benefit from limited liability so that their personal exposure for the debts and liabilities of the LLP is usually limited to the capital that they contributed. This provides an important degree of protection if the LLP is facing potential insolvency. In contrast, partners in a Partnership have unlimited liability and are at risk of personal bankruptcy if the Partnership becomes insolvent.
An LLP is a hybrid between a Partnership and a Ltd. This can cause issues for international businesses as some countries do not recognise their hybrid status. LLPs are also required to comply with many of the regulations governing Ltds and Plcs (including public disclosure of its annual accounts and the identity of its members).
International businesses can register as an overseas entity with a branch office in the UK.
A branch office is relatively easy and cost-effective to establish. However, there are potential tax, regulatory and risk management issues in operating an international organisation through a series of branch offices in each country. In particular, a branch office does not have a separate legal identity from its overseas parent, which means that the parent will be liable for the debts and liabilities of the branch office, creating a high risk of group contagion should one branch office fail.
International and national organisations may operate through a network of independent entities which are connected by a contract between them or through membership of a common governance entity (such as a Swiss verein, an English company limited by guarantee or a European Economic Interest Grouping). These types of international structures are commonly used by professional services firms such as the “Big 4” audit firms and international law firms.
An association allows for rapid expansion and is an attractive and (relatively) low-cost alternative to mergers and acquisitions (which can often involve a lengthy process of negotiations, implementation and integration). This is useful for taking advantage of growth opportunities quickly.
If desired, each member of the association can be legally and financially separate from the other member entities. This helps to prevent any group contagion should any member entity face financial difficulties. This is also particularly useful where there are regulatory obstacles that prevent members of the association being fully integrated.
However, the separation between the member entities can often make it more challenging to create a unified culture. To combat this, the member entities often agree common governance arrangements, use of a common brand name and align their standards and strategy and share centralised services (such as IT systems, intellectual property and training).