Limited Liability Partnerships and Business Start-ups

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Jos Moule, Partner at award-winning regional law firm, VWV, shares his thoughts on the advantages that limited liability partnerships (LLPs) provide.

When founders seek to establish a new business to develop a new product or service, they will often set up a limited company as their preferred choice of legal entity.  However, limited liability partnerships (LLPs) can in some cases offer significant advantages over limited companies but are often overlooked.

Employment related securities

One of the most common difficulties that is encountered with limited companies is that it can be difficult to reward participants who join the business sometime after the business has been established and at a time when it has increased in value.

Some potentially difficult tax issues can arise in particular under what is known as the “employment related securities” legislation.  If all the participants in the business venture acquire their shareholdings at the outset then, as a general rule, it is unlikely that any tax charge will arise.  However, in practice many companies bring in additional members to their senior management teams at a later date.  Employees and directors who acquire shares in this way may therefore incur a potentially significant income tax charge on the difference between the market value of those shares and the price they actually pay for them.

What is the answer?

The problem can in part be addressed by issuing incoming shareholders with Enterprise Management Incentive (EMI) share options. Such options are helpful in that any income tax charge that might otherwise arise may either be deferred until the option is exercised. Or the options can be structured so that no income tax charge arises, provided market value (as calculated at the grant date) is paid when the option is exercised, which in most cases will be at the time of a sale or other exit, at which point the option holder will be in receipt of funds in order to pay the tax or exercise price.  However, such options are often not a satisfactory substitute for actual shares given that they do not carry any voting rights.

Use of LLPs

One of the main advantages of using an LLP as a start-up vehicle is that the employment related securities legislation does not apply to LLPs so that such tax charges can generally be avoided.  It should also be borne in mind that the business of the LLP can always be rolled over into a limited company in a tax efficient manner at a later date after all key management members have acquired their shareholdings.

Whilst there will be other taxation implications to consider when setting up an LLP, many of the perceived advantages of setting up a company may well be outweighed by the flexibility that LLPs are able to offer particularly in terms of avoiding the potentially draconian impact of the employment related securities legislation.  So before incorporating a limited company, carefully weigh up all relevant factors when considering which business medium to use.  In some cases using an LLP may be a much better option.

 Jos can be contacted on 07771 870741 or at jmoule@vwv.co.uk.

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