- Is it worth being a partner?
- What are the different levels of partner?
- How can I improve my chances of being offered partnership?
- Where can I find help in deciding whether to accept an offer of partnership?
- What information should I be asking for before I accept the offer of partnership?
- What personal financial risks am I taking if I join the partnership?
- How can I work out the likely financial returns of becoming a partner?
- How am I likely to be remunerated as a partner?Will I be required to pay to acquire a share of the partnership?
- Will I be required to pay to acquire a share of the partnership?
- How would I value my share in the partnership?
- What is a reasonable amount of capital to be asked to contribute as a partner?
- Can I build up the level of capital over a period of time?
- How can I finance any capital I am required to put into the firm to become a partner?
- What are the tax implications of becoming a partner?
- What will be expected of me as a partner in the firm?
- How can I obtain the necessary skills to become an effective partner?
- Will being a partner help me to win more instructions from clients?
- What additional levels of responsibility and influence am I likely to have as a partner?
- What obligations am I likely to take on?
- How can I make sure I am being treated fairly by the existing partners?
- How will becoming a partner affect my ability to move firm if I later want to?
- Will being a partner help me to obtain improved reward from another firm if I choose to move firm?
- What am I likely to receive when I retire from the partnership?
- How does retiring from the partnership impact any partnership capital loan I may have taken out?
- What are the tax implications of retiring from the partnership?
- What ongoing risks might I have when I retire from the partnership?
- How do I protect myself from any ongoing risks when I retire from partnership?
Andy Poole, Legal Sector Partner at Armstrong Watson, looks at the implications of becoming a ‘partner’ in a law firm - whether as a partner in a traditional partnership, a member in a limited liability partnership (LLP) or a director/shareholder in a limited company.
1. Is it worth being a partner?
It very much depends on the circumstances. Becoming a partner can be the pinnacle of the career of a lawyer, with increased reward and recognition. However, there are risks that go with those rewards that need to be carefully considered.
The questions and answers below highlight some of those potential risks and rewards. At the end of the day, it is very much down to personal choice based on the answers to the points raised, the particular circumstances and your own risk appetite.
2. What are the different levels of partner?
There can be many different levels of partner. Most of the differences are more internally focused than externally. To the outside world, a partner is generally a partner and all may be considered to be of the same level of seniority.
In practice internally, individual partners in a firm often have different levels of seniority, reward, risk, voting rights and capital.
Typically the different levels are:
- Salaried partner – although a partner to the outside world, remains on the payroll as an employee and an expense of the partnership, usually at a fixed salary; few if any voting rights; and no capital invested in the firm.
- Fixed share equity partner – usually self-employed (subject to certain tests for members in LLPs in particular); receives a fixed profit share out of the profits generated by the firm; has certain but typically restricted voting rights; and has a small amount of capital invested in the firm.
- Full equity partner – self-employed; receives a percentage of the profits generated by the firm; has voting rights; and has a larger amount of capital invested in the firm.
There can be levels in between these, particularly in a lock-step situation where partners move from fixed share to full equity in steps over a period of time. In such circumstances, the rewards, voting rights and capital usually increase with each step.
3. How can I improve my chances of being offered partnership?
With any promotion, it helps to be seen to be already undertaking the role that you are looking for. That tends to be the case in law firms making internal promotions to partner.
Partners are usually required to have high levels of personal fee income and to generate work for themselves and/or others. Such pre-partner ‘rainmakers’ are easily recognised in the firm and are usually on the radar of the partners as ‘partners of the future’.
However, it is not just enough to be a consistently high biller. Individuals looking to become a partner will also need to pass the ‘good egg’ test:
- be a positive ambassador for the firm;
- help others within the firm;
- undertake projects on behalf of the firm;
- be seen as a safe pair of hands;
- have strategic and commercial nous;
- be popular in the team.
Particularly in larger firms, it can be difficult to demonstrate these skills. It is important to find a way to let them be seen and valued by the partners, without shouting too loudly. Showing that you are keen for partnership and the future success of the firm will help, but being too demanding will not. A fine balance needs to be reached.
You may also want to look into development programmes that help potential partners learn (and then demonstrate) their business skills, in areas such as business development, people development, financial management and strategic management.
4. Where can I find help in deciding whether to accept an offer of partnership?
It is important to understand:
- the terms of the offer;
- the impact that will have on your rewards;
- the additional responsibilities you will take on;
- the additional risk that you will take on;
- your obligations under any governance document such as a partnership agreement.
Your decision on whether to accept will most likely balance the pros and cons of these, depending on your own personal risk/reward outlook. Having another person to discuss the factors with will often help the reasoning to crystallise in your own mind.
As well as informal conversations with your family, with fellow lawyers and existing partners in the firm, you may want to consider formal discussions with a specialist advisor. You should aim to have a series of questions for the law firm management team that will allow you to become comfortable in deciding whether or not to accept.
5. What information should I be asking for before I accept the offer of partnership?
We suggest that, as a minimum, prospective partners should initially ask for:
- an offer letter that outlines the deal being put forward and exactly how it will work;
- the full annual financial statements of the practice for the last three years;
- the monthly management accounts from the end of the last financial year to the current month;
- the relevant governance document ie partnership agreement/members agreement/shareholders agreement;
- any forecasts that may have been prepared.
If the firm is unable or unwilling to provide the above, then that in itself may be an indication that the offer is not right for you.
Reviewing this initial information can prompt a list of questions or requests for further information to be raised with the firm’s management team.
6. What personal financial risks am I taking if I join the partnership?
The personal risks depend on the particular circumstances and the structure of the firm.
If joining a traditional partnership, the extreme position is that all of your personal assets may be at risk, including your family home. This could be the case if, for example, the partnership becomes insolvent as a result of poor performance or a negligence claim that exceeds the professional indemnity insurance cover.
If there are insufficient funds in the partnership to cover the liabilities, creditors could pursue the individual partners in a traditional unlimited liability partnership, typically on a joint and several basis. That means that a creditor could choose to pursue one partner rather than another on the basis that one partner may have more personal assets than another, even if the partnership agreement contains mutual indemnity clauses.
For a limited liability partnership or a limited company, the exposure levels are reduced, typically to the level of investment you have made in the business. This investment could be capital or current accounts, directors’ loan accounts or undrawn profits. Your personal assets should be protected, though there are clawback provisions which could reduce that personal protection – particularly if you have taken funds from the business whilst knowing it was in trading difficulty.
Even in a company or LLP, there could be personal liabilities if you sign up to a personal guarantee. Personal guarantees are sometimes required for bank overdrafts, loans, rent or professional indemnity insurance.
In addition to these financial risks, you may take on reputational risk. Should the firm cease practising, or a fellow partner or employee undertake activities that they should not, you may be tainted by association or potentially sanctioned for poor supervision.
There are also regulatory risks to consider. If a law firm becomes insolvent, it is possible under the code of conduct for the SRA to place restrictions on practising certificates. That could prevent future employment and more likely future law firm ownership possibilities.
7. How can I work out the likely financial returns of becoming a partner?
The offer letter should be reviewed. This often includes projections of likely personal profit share allocations and what that means for your drawings. The drawings are likely to be lower than the profit, as poor cash flow may mean that not all profits are distributed. Retentions are often made to cover tax payments and as a buffer against underperformance.
The projections in the offer letter should be reviewed for accuracy against the financial forecasts of the firm and past performance. This should then be compared to current net take home pay.
In the early days of partnership, many new partners do find that their net take home pay has reduced when compared to their previous positions. For many, this is a short-term investment that may result in far larger financial returns in the future.
8. How am I likely to be remunerated as a partner?
As a partner in a traditional partnership or a limited liability partnership, you are likely to either have a fixed profit share allocation or a percentage of the profits. Variations may include lock-step increases to the percentage of profits, or profit allocations based on individual or team performance.
Cash drawings will be paid on account of those profits as the year progresses. These drawings may be lower than the profit allocations, with periodic cash distributions to catch up, depending on the cash flow of the firm.
If the practice is a limited company, the idea of the profit share and drawings noted above still apply. However, the actual legal position may be a mix of salary, bonus, pension contributions, benefits in kind and dividends.
9. Will I be required to pay to acquire a share of the partnership?
This depends on the particular partnership.
In many law firms, in order to aid succession, partnerships do not charge new partners for ‘acquiring’ a share of the partnership so goodwill is not paid on entry. In those circumstances, it usually follows that goodwill is not paid on exit either.
This is not always the case, particularly in firms that operate effectively with a relatively low number of equity partners compared to the size and profitability of the practice. That smaller band of partners may indeed ask for a goodwill payment in order to join them (and it may then follow that goodwill would also be paid on exit).
10. How would I value my share in the partnership?
Obtaining professional advice is particularly important if you are asked to pay to acquire a share of the firm – as opposed to making a capital contribution that is classed as a loan to the partnership.
Valuing professional firms is often cited as an art rather than science. There are a number of specialists that have built up a great deal of experience in this art – through involvement in law firm transactions, valuing firms for tax purposes and acting as expert witnesses in law firm disputes.
11. What is a reasonable amount of capital to be asked to contribute as a partner?
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.
12. Can I build up the level of capital over a period of time?
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.
13. How can I finance any capital I am required to put into the firm to become a partner?
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.
14. What are the tax implications of becoming a partner?
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.
15. What will be expected of me as a partner in the firm?
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:
- winning new work;
- maintaining relationships with clients;
- supporting and developing staff;
- and setting the strategy of the firm.
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.
16. How can I obtain the necessary skills to become an effective partner?
There are a wide variety of support measures.
Many firms allocate partnership mentors to help new partners become accustomed to their new role and to be a helpful source of counselling when required. Others make use of external coaches.
Development courses include those provided by local law societies and professional advisers. Courses can sometimes be delivered in-house to a single firm with a number of delegates from the firm undertaking the programme together, or as a public course with delegates coming from a number of different firms.
Issues you may want to cover include business development, people development, strategy, financial knowledge and the personal implications of becoming a partner.
17. Will being a partner help me to win more instructions from clients?
Although there may be an expectation that partners should win more instructions from clients, it is not a given. Partners may be allocated more business development time, which should make it easier to form the relationships that generate new business from new or existing clients.
In some cases, potential clients may only want to deal with a partner in the firm. From that perspective, it may be easier for you to convert a prospect to a client on becoming a partner.
Business development skills do not come naturally to everybody. To an extent, they can be learned over time and also by attending development sessions.
18. What additional levels of responsibility and influence am I likely to have as a partner?
In the vast majority of cases, the levels of responsibility and influence will increase on becoming a partner. The exception to that can be the very large firms which are managed by a small group of people, where most partners do not have much influence at all.
The levels will vary depending on the size and management structure of the firm, and also the personalities within the partnership. As partners become more senior, it is likely that their influence will increase and so the input into the strategic direction of the firm – and responsibility for delivering results based on the strategic plan – will grow.
More firms, even the smaller ones, are now moving to a management board structure where a small number of partners take positions on the board with certain powers delegated to them from the partnership. This prevents the need for all partners to discuss and then vote on all matters. Speeding up the decision-making process can allow the firm to move ahead of competitors.
In more progressive firms, board positions may be held by business professionals with the skills, experience and qualifications to run a business, rather than partners. This allows the partners to return to looking after clients and concentrate on what they do best.
In such situations, the level of influence of the partners is likely to be reduced. However, the partnership as a whole should still hold certain vetoes, voting on key matters and agreeing the strategic direction that the board will then be responsible for implementing.
19. What obligations am I likely to take on?
Specific obligations will vary for each partner role in each firm. In smaller firms, additional obligations are likely to include responsibility for heading certain internal functions of the firm, such as IT, HR and marketing. In larger firms, those internal roles are likely to be filled by non-lawyer professionals rather than partners.
Other additional obligations could include taking on department head roles with responsibility for the profitable growth of the department, technical development and people development/recruitment.
20. How can I make sure I am being treated fairly by the existing partners?
Trust is vital in partnership, so it should be hoped that the existing partners will put forward what they believe to be a fair offer of partnership. If you accept an offer that you later realise was not offered in good faith, that trust will be broken and the partnership will not operate as effectively as it could, harming both you and the existing partners.
That said, it is human nature to be swayed to offering financial and other terms that best suit one party or the other. This can be particularly so if the existing partners may not remain long in partnership.
It is best practice to engage external support in evaluating an offer. Full due diligence or a valuation exercise would be cost-prohibitive for many in this position. However, a ‘lifting the bonnet’ service from an experienced adviser does usually highlight risks, and provides questions for you to ask of the existing partners based on the specific circumstances.
21. How will becoming a partner affect my ability to move firm if I later want to?
Notice periods to leave the partnership will likely be longer than those you may have had as an employee; one to two years is typical. That extended notice period may mean that it is more difficult to move, but does not prohibit it. In many cases, bespoke individual agreements are made to release partners earlier.
Some partnerships also have a clause in their partnership deed that prevents the commencement of capital payments to more than, say, one partner in a particular year. This may not prevent you from leaving under the terms of your notice period, but may delay the point at which your capital is repaid to you.
Some partnerships also have restrictive covenants in their partnership deed that attempts to prevent an exiting partner from competing with the firm post exit. For example, this could be by reference to the geography of a new role.
22. Will being a partner help me to obtain improved reward from another firm if I choose to move firm?
Being a partner may make it more difficult to leave when you want to, but it does make you more marketable as an individual and potentially more attractive to other firms. It is far more likely that you would be able to move straight to another partnership position rather than an employed position if you do move.
A partner moving to another firm may therefore be rewarded more highly than an associate making the same move.
23. What am I likely to receive when I retire from the partnership?
The partnership deed will dictate the particular implications of a partner departure or retirement. In most cases, you would be likely to be entitled for your capital and current account balances to be repaid to you over a period of time, typically anywhere between two and five years.
You may also be entitled to an additional amount of goodwill, particularly if you paid for goodwill on entry, but this is not very common now.
24. How does retiring from the partnership impact any partnership capital loan I may have taken out?
Most partnership capital loans are required to be repaid on retirement. If a capital and interest loan was taken out, the loan may have been repaid by the time of retirement.
If the loan has not been repaid and repayments of capital are due to take place over a period of time, it may be that a replacement loan needs to be taken out to match the period of repayment. This replacement loan could be at a higher rate of interest.
25. What are the tax implications of retiring from the partnership?
When retiring from the partnership and ceasing work as a self-employed person, overlap relief may be triggered. Depending on the year-end date of your firm and the date on which you commenced self-employment, you may have had a period of trading on which you were taxed twice. That double taxing is termed overlap profits and the relevant amount is carried forward on your personal tax returns each year until you cease self-employment.
In the final period of self-employment, you would obtain relief for the initial double counting by deducting the relevant amount from the profits in your final period. This may be welcome, although depending on the number of years of your self-employment, the time-value of money may have significantly depleted the value of the deduction.
26. What ongoing risks might I have when I retire from the partnership?
The ongoing risks will depend on the structure of the firm. The risks are lower for limited companies and limited liability partnerships than for traditional unlimited liability partnerships.
Usually outgoing partners receive an indemnity from the ongoing partners against any future claims against the business, but this may not be the case in all situations. Even where there is an indemnity, that protection is only as good as the financial situation of the person providing it.
It is also likely that you would be released from any personal guarantees. The party required to release you may need to ensure that they are left with sufficient protection from the remaining partners before agreeing to the release.
27. How do I protect myself from any ongoing risks when I retire from partnership?
Properly prepared retirement deeds containing appropriate indemnities and releases from obligations are commonly used to provide protection from risk.
In some cases, such deeds are not prepared. Instead, the main partnership deed may contain all of the provisions for retirement.