In this blog post, Anusha Rai, a 2nd-year student pursuing BA.LLB.(Hons.) from Dr Ram Manohar Lohiya National Law University and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes the most suitable business structure for opening a law firm. 

Law Firms come under the category of Professional Service Firms which provide services characterised by high knowledge intensity with special training in the related sector, in our case the legal sector, a professional workforce, a licence to practice in the related area and may also provide specialist business support to other businesses.

Before starting a business, it is very important to select a suitable business structure for it. But even before that, let’s look into the reasons and advantages of establishing a law firm. It could be that the individual wants to explore his full potential and is dissatisfied with the current job, is feeling restricted in the traditional family drove firms or is looking for professional independence. It could be as simple as fulfilling the dream of becoming an entrepreneur or could just be fuelled by the drive to earn money.

To find out the most suitable business structure for the opening of a law firm, we will consider the four main business structures available: Sole-Proprietorship, Partnership and Limited Liability Partnership (hereinafter LLP).

We will look into the main features of these four business vehicles and analyse their pros and cons with regard to the legal industry. Let’s get started!

Sole-Proprietorship

A Sole Proprietorship is owned and controlled by one person who has the whole authority and responsibility with regard to the business. This essentially means that the owner gets the whole share of profits, can hire and fire employees and pay their salaries. But on the downside, the owner is personally liable because the business and the owner are considered to be a single entity, and hence the legal responsibility for the obligations of the business is by the owner.

Advantages:

• Cost effective as no formal registration required. Hence the cost of formation is not much, but you will need to consider the cost for administration and obtaining various licences.
• Flexibility regarding decisions. As there are no shareholders or directors, all the responsibility and decision-making power rests with the sole owner. Also, no need to conduct general and board meetings.
• Confidentiality is maintained because the important information and trade secrets are not divulged because there being a sole owner.
• The owner has complete control over the finances of the company giving him the incentive to work to his full potential.
• No need for audit unless the business exceeds the threshold turnover of Rs. 10,00,000 or Rs. 1,20,000 in any of the 3 previous years or the previous year respectively, under the Income Tax Act 1961.

Disadvantages:

• The business only for as long as the owner exists. Hence, the business can’t be continued after his death. No perpetual succession.
• Difficult to hire and retain good employees as there is not much incentive for them to work hard. (No ESOP scheme, share in profits, ownership rights)
• Difficulties in raising funds as investors also don’t have much incentive to invest in your business.
• Unlimited liability of the owner which extends to his personal assets.
• A proprietorship is taxed with the person’s personal income and not separately.

This business structure is good if you are rich, can handle and attract good clients alone and do not want to share your profits, liabilities and authority with anybody. But even if you do not have a huge initial investment and want to start a small firm, it is the ideal business structure as it can be operated from your home and is cost effective as well because of the minimum requirement of formalities.

However, if you dreamt of starting a firm with your classmate or your colleague, do not want to be held liable personally and want some tax benefits, you may look into the other options.

Partnership

A partnership is regulated by the Partnership Act 1932 in the absence of a Partnership Deed between the partners and is defined as an agreement between the partners to share the profits and cooperate to advance their mutual interests of and by a business carried on by all, or any of them on behalf of all of them.

Advantages:

• The first major advantage of a Partnership is that the rights and duties of the partners can be created and varied by the contract (Partnership Deed) like remuneration, profit sharing, indemnity, dispute resolution method, a method to take a decision on important decisions, etc. Hence, most of the rights are subject to the contract between the partners.
• A partnership firm is suitable in the case of a business where the initial capital requirement is mediume. It is neither too large nor too small.
• Flexibility in registering the partnership with the Registrar of Firms.
• A partner may transfer his monetary interest in the firm. But the transferee does not enjoy the rights and duties of the partner except his share of profits.
• In a partnership firm, partners with different abilities, managerial talents, skills and expertise combine with each partner’s contribution based on his area of specialisation and experience.
• Each partner is considered an agent of the firm. Actions taken by him in the name of the firm will bind the firm.
• Income is taxed in the hands of the partnership, and the remuneration to the partners will be exempted.
• It is not necessary for Partnerships to prepare audited financial statements each year. However, a tax audit may be necessary based on turnover and another criterion.
• Multiple ways available to dissolve a partnership firm.

Disadvantages:

• Each partner is jointly and severally liable for the acts and/or omissions of the other partners. The firm is also liable to the same extent as the partners.
• Liability for holding out to be a partner of the firm even when not.
• Procedures to convert a Partnership firm into a Company or LLP are cumbersome, expensive and time-consuming.

As you can see, the advantages of a partnership are greater than the disadvantages. Yes, the partners are made liable for the acts of the other partners (unlimited liability), but this provision has been incorporated to maintain high accountability in a partnership firm as the rights and duties are created and monitored by the Partnership Deed. Since the partners are bound by the Partnership Deed, they have to work for the betterment of the common goal.

This business structure is also financially less burdensome as the initial investment is shared between the partners. Also, u/s 464 of the Companies Act 2013, a partnership can have shared between the partners. Also u/s 464 of the Companies Act 2013, a pa can have a maximum of 100 partners (and a minimum of 2). Hence the partnership firms have the exponential potential for growth and a law firm starting out as specialising in one area of law can rapidly diversify upon gaining industry trust and clients.

Limited Liability Partnership

An LLP is a body corporate having features of both partnerships and corporations. It is relatively new to India and was introduced by The Limited Liability Partnership Act 2008. The partners of the LLP have limited liability, and the LLP is known by its own name and is not linked to the identity of its partners.

Advantages:

• Perpetual Succession.
• Capable of entering into contracts and holding property in its own name.
• Has the flexibility of declaring one or more addresses for official correspondence.
• Governed by LLP Agreement.
• Any LLP whose turnover does not exceed 40 lakh rupees in a financial year or whose contribution does not exceed 25 lakh rupees in a financial year is not required to mandatorily get its accounts audited.
• Relaxation in filing and application of penalties.
• There is no requirement of minimum capital.
• Minimum of 2 partners is required to form an LLP but no cap on the maximum number of partners.
• It is a separate legal entity. So the partners and the LLP in are distinct from each other and the liability of partners is limited except in the case of unauthorised acts, fraud and negligence. Even in that case, the partner is not personally liable for wrongful acts/ omissions of the other partner.
• Raising and utilisation of funds depend on the partners will. Funds can be bought and utilised only as per the norms listed under the Companies Act 2013.
• LLP is exempt from Dividend Distribution Tax (DDT).
• Income is taxed in the hands of the LLP and the remuneration to the partners will be exempted.

 Disadvantages:

• An LLP cannot raise public money.
• Liability by holding out to be the partner of the LLP even when not.

Though the LLP structure has been introduced very recently in India, it has become the most preferred business structure among law firms because of the obvious advantages of the other business structures.

Professional Service Firms are not incorporated as companies in India because of regulatory restrictions. The LLP business structure trumps over both sole-proprietorship and partnership firms because of its more liberal regulatory compliances. Yes, the sole-proprietorship requires very less capital to start with, but it’s unlimited liability, and lack of motivation for employees does not make it appealing.

The reason why both partnership firms and LLPs are appealing is because they give a chance to associates to make partner and move forward in their careers.

The LLP structure wins hands down as the most suitable business structure for law firms because of its limited liability and career growth prospects as there is no cap on the maximum number of partners. It also has low auditing requirements and gives the partners the freedom to govern their rights and duties by an LLP Agreement. It would not be wrong to say that it has taken the best features of the partnership structure and improved upon it.