When we first started working together, our plan was to set up a company. So when we read Mike Moyer’s original book, thoughts of alternatives were not on our minds. That’s why our first grunt fund startup was a company structure.
However, about a year later Mike mentioned that 9 out of 10 grunt fund startups he sees suit partnerships better. And we’re so glad he did, because that really helped when we set up Fairsquare. As a result, we’ve now got grunt fund solutions for the three most common UK startup vehicles:
- private limited company
- partnership, and
- LLP (limited liability partnership).
The question is, which one should you choose?
We really like grunt fund LLPs – even though we have a grunt fund company too. However, it really depends on what’s right for your business. For example:
- private limited companies work well for tech-based startups which need future investors;
- LLPs are great for long-term income-generating businesses, e.g. professional services, because liability is limited and profits and gains can be shared fairly; and
- partnerships suit straightforward businesses that don’t have liability issues or need fancy investment and want less corporate paperwork.
There are many resources to help startups choose. We looked at lots of them (and you should too). However, we discovered a couple of points that are exclusive to grunt funds, and one or two extra things that we’d like to share.
So here’s a list of 10 things to think about when choosing your Slicing Pie legal structure. Let’s start with the ones that people talk most about first…
10 things to consider when choosing your grunt fund legal structure
1. Liability: This is easily one of the biggest factors in any business set-up decision: how worried are you about risk and the need to protect yourself personally? If you’re worried at all, then you’ll probably lean towards limiting your liability – which means you should choose a company or LLP. These help protect founders, because if the business gets sued, then generally only the business-owned assets are at risk; personal assets are safe.
As lawyers, we’re naturally risk-averse (surprise), so we generally like limited liability safeguards. However, if:
- you’re not doing anything risky, or
- you are, but can afford to buy insurance that provides adequate cover, or
- you’re prepared to live with the risk1,
then unlimited liability – which is what you get in a partnership – may be just fine. However, if you do want limited liability, you can cross partnership straight off your list.2
2. Tax: Tax is grim, but inevitably really important. That’s because companies are taxed differently from partnerships and LLPs – and people are always keen to pay less tax! Deciding which vehicle is most tax-efficient for you and your business really depends on how you plan for it to make money. For example, some Silicon Valley-type startups aim to build a technology and then be acquired (or acqui-hired) – making a profit is not on their immediate radar – whilst others aim to provide a regular income.
Knowing which kind of business you are can help to decide what structure is best. If your business is profit-generating, then income tax planning may be more important.
2017-18 headline tax rates on startup profits
- Partners pay up to 40%+ on their partnership share of net profits;
- Members pay up to 40%+ on their LLP share of net profits; and
- Companies pay 20% corporation tax on their net profits which, after being paid out as shareholder dividends, are then taxed again at up to 32.5%+ (which people often forget about).
(We’ve quoted rates for higher rate taxpayers. ‘+’ means the rate goes even higher if your profits exceed £150k. This is a nice problem to have.)
2017-18 headline tax rates & reliefs on startup share gains
- Partners pay up to 20% CGT – or 10% if Entrepreneurs’ Relief applies – on their share of partnership gains;
- Members pay up to 20% CGT – or 10% if Entrepreneurs’ Relief applies – on their share of LLP gains; and
- Company directors, officers and employees pay up to 20% income tax – or 10% if Entrepreneurs’ Relief applies – on employee shares only if either:
- the company has an appropriate restricted share scheme in place; or
- the shares aren’t restricted (e.g. so they don’t have to be forfeited if that person leaves).
Otherwise they pay up to 40%+ income tax and NI on their gains.
We can help with company share scheme solutions if you use Slicing Pie.
(Various qualifying conditions apply before you can get Entrepreneurs’ Relief. For example, you can only claim as a partner if you’ve owned the business for at least a year before the date that you sell it. And you can only claim as a director, officer or employee if you owned 5% or more shares and voting rights in the company in the year before sale. There’s also a £10 million lifetime Entrepreneurs’ Relief limit – but if you’re worried about coming close to that, then that’s a really nice problem to have.)
Whichever type you fall into, on top of that, various other rates and reliefs may apply. It’s very easy to get bogged down in detail – but talk to accountants as they can help.
3. Accounting: For most people this is more of a fact, than a decider. However, it’s worth noting that companies, LLPs and partnerships each have different accounting and financial reporting requirements, and that some entrepreneurs do have a preference. For those that don’t, we always suggest that you check your accountant can deal with it (or shop around for one who can). This applies particularly if you choose an LLP (because some accountants are less familiar with these as they haven’t been around for so long).
It’s also worth noting that having a grunt fund partnership or LLP requires a little bit more “pie accounting”.3 That’s because you can use a grunt fund to share profits fairly as well as gains. But that’s not a bad thing – it just means you’ve hopefully got some actual money to count!
4. Disclosure and paperwork: Everyone always has to report to HMRC. But companies and LLPs come at an additional cost. That’s because they also have to report information to Companies House, which is then published. So if you’re keen to keep more corporate and financial details private, an ordinary partnership may serve you better. Also, companies and LLPs involve more paperwork, so they’re harder to look after, and sometimes you will need professional advisors to help.
5. Investment: If you need to raise money by selling an investor a stake in your business, then it’s generally good to start out with a vehicle that investors understand. Some sectors tend to favour one vehicle over another. For example, most law firms are partnerships or LLPs, whereas most tech businesses are set up as companies. As a result, most tech investors prefer to invest in companies, because that’s what they’re used to. If you’re bootstrapping and don’t need formal investors, then this factor won’t matter so much. However, if you are, then start with an investor-friendly structure that makes sense in your sector. (Switching later is complex, and could result in you paying more tax.)4
6. Customers and suppliers: On a similar note, do key customers and suppliers care whether your business is a company, partnership or LLP? Maybe not. But if they’re used to seeing your competitors set up in a particular way, then not choosing the same will mark you out. That may or may not be good. But if you’re standing out from the norm, then it should make sense for your business.
7. Grunt fund duration: Another key factor is how long you want your grunt fund to last. As you know, Slicing Pie works out everyone’s shares up to the point that a company becomes profitable. However, nothing’s at risk once a company crosses that line, i.e. if it’s got profits left over after meeting all of its costs (including salaries). After that point, everyone’s slices stop changing so your pie effectively freezes. Now, that’s not a problem for most – after all, the whole point of grunt funds is to reward those who put themselves on the line. However, it does mean that new incentives are needed after that point because you effectively move to fixed split.
If you choose a partnership or LLP though, grunt funds provide a great way to share long into the future. That’s because equity partners usually accept below-market salaries in order to share in the pie. Thus, partnership and LLP grunt funds can be used as a way to share equity for a lot longer. So if your business is intended to generate income long-term, a partnership or LLP structure can work out well.
8. Paying grunts: One of Slicing Pie‘s top features is that it rewards grunts who are not getting paid. But all startups aim to make money – we hope yours does too! So take a moment to think how you might eventually pay everyone. Even though that may be a while away, it’s worth knowing that:
a) money can be taken out of different legal structures in different ways, for example by paying:
- directors’ advances if in a company,
- drawings if in a partnership or LLP, or
- salaries or consultancy fees; and
b) you can use these ways to pay grunts before grunt fund split, e.g. if a grunt is part-paid.5
9. Prejudice: Grunt funds are really logical. However, we’re all only human, so emotion is always a factor. And the fact is that some people just like the sound of a company, even if an LLP or partnership would suit their business better – or vice versa. That’s fine. We are how we are. However, grunt funds also help increase trust (a side-benefit that we really love). So talk through any hangups you have with your fellow grunts. That way, you’ll all feel better and be able to brainstorm potential solutions. (For example, you can get creative with job titles if you’re concerned about status.)
10. Regulation: This isn’t a factor for everyone – and indeed it may not be for you. However, if you’re in a regulated sector (like we are) then your regulator may have a view. For example, the Solicitors Regulation Authority seems to find partnerships easier – we guess because they’ve been around for so long. As a result, it takes a lot more effort, time and money to set up or convert a legal business into something that isn’t a straightforward partnership. So if you are regulated, try to choose a vehicle which your regulator – if you have one – will be happy with. And whilst you’re researching the laws that apply to your business, think about whether these will also affect your choice of legal setup.
See what ticks most of your boxes
As you’ve no doubt worked out by now, every structure has both pros and cons. However, see what ticks most of your boxes. And if you’d like us to help, get in touch.
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1 We don’t like this, but technically it is an option.
2 It’s also possible to start with one structure and then switch later on to another, e.g. to convert a partnership into an LLP or a company. However, you shouldn’t plan on doing this lightly, especially if you’re just starting out – because this can have huge time, cost and tax implications. So if you’re planning this route, definitely get some advice.
3 You know about tax accounting and management accounting, right? Well, we call all the stuff you have to track for your grunt fund, “pie accounting”.
4 Plus you’ve already got a grunt fund. You don’t want to make things too weird.
5 However, it’s worth noting that you can’t use company dividends as a way to reward grunts whilst your grunt fund is active, because by definition, a pie is baked once a company hits profitability – and that will almost certainly happen if your company has enough money to pay dividends out, because dividends can only be issued if a company has distributable profits.