Limited company practices

There are many good reasons to operate a practice through a limited company, but doing so brings its own problems.

It is now common for accountants to carry out practice through a limited company. While there are good commercial reasons to do so, complications will eventually arise through the elapse of time and the realities of company law. The result can be difficulties and, more likely than not, acrimony.

Heading off trouble through a shareholders’ agreement (SA) is best. An SA in the context of a professional practice is the equivalent of a partnership agreement, but more complicated. In effect, it is best for an SA to mirror as far as possible what would otherwise be a normal partnership agreement.

Partnerships are governed by the Partnership Act 1890, a concise and well-written law that has never been amended. Originally drawn up to oversee business relationships before the advent of the limited company, the Act’s relevance since the early 20th century has largely been to professional partnerships; though this was not the intended purpose.

The Act itself, in effect, constitutes a partnership agreement, though it can be amended by written agreement. There is an ease to the formation, administration and dissolution of professional partnerships. This is not the case with limited companies. In time, partnerships dissolve through resignations, retirements and death, or are restructured into new arrangements through mergers, new partners and so on.

However, an actual ‘share’ in a partnership has no independent status and has no title or continuity save vis-à-vis the other partners; unlike a shareholding in a limited company, which has a distinct legal status and continuity. Also, in a professional practice operating through a limited company, the ‘partners’ (i.e. the shareholders) will be paid salaries, taxed in the normal way, as compared to drawings in a partnership.

All is well in trading as a limited company until, inevitably, an event happens. It may be the resignation, retirement or death of a shareholder; or it may be difficulties regarding a marital separation or a row with a difficult or non-performing partner. One way or another, the partner concerned or his/her estate will have a shareholding in the company that will continue to hold rights and entitlements. In the absence of a properly constituted SA, the disentanglement of the outgoing partner’s shareholding will be problematic and probably acrimonious. Remember too that clients belong to the limited company.

It follows that an SA is essential to the good order and continuity of a professional practice. Legal advice thereon is essential, particularly to ensure that the SA does not contradict the constitution of the company and that the SA is capable of being interpreted and understood, rather than being vague and aspirational. This includes a careful review as to the ability to enforce all aspects of the SA.

The primary focus of an SA in the context of anticipating events, as referred to above, falls under three headings. First, the relevant shareholding may be compulsorily acquired by the other shareholders (probably by the company itself acquiring the shareholding); second, a basis of valuing the shareholding; and third, a structure or schedule as to payment for the shareholding. Realistically, that basis of valuation is likely to be the outgoing partner’s issued share capital together with his or her share of undrawn profits.

It is almost always contentious as to whether or not a profit share in an accounting practice has a capital value beyond the above basis of valuation. The existence of a limited company will make this more contentious. A short article cannot encompass the arguments thereon. The Valuation of Businesses and Shares, written by the author of this article and published by Chartered Accountants Ireland, sets out the fundamentals on valuing a professional practice. It also covers the area of partnership agreements and related matters.

There are a range of issues not yet tested by experience as to professional accountants trading through a limited company. Remember that company law prevails, and not the traditional embodiment of professional practice. For example, a row with a partner may develop into a claim for minority oppression as set out in company law. A surviving spouse of a deceased partner may pursue a continuing share of the practice profits through inheritance of the related shareholding. There will be difficulties should a partner go through a marital separation.

As always, there will be tax complications – quite different from partnerships – in the acquisition or devolution of shareholdings. Practitioners, late in life, can find themselves embroiled in disputes simply through the elapse of time. A careful, well-thought out SA is therefore essential.

Des Peelo FCA is author of The Valuation of Businesses and Shares, 2nd edition, published by Chartered Accountants Ireland.