Selling a partnership: key considerations
Increasing levels of deal activity in the professional services market from both trade purchasers and private equity funds has inspired many consultancies to consider selling their business. But what are the implications for companies trading as a limited liability partnership (LLP), and how does that impact the sale process?
The fragmented consulting industry is still dominated by companies trading as a partnership. The partnership structure has many benefits, including being a more tax efficient vehicle than a limited company (assuming the bulk of distributable profit is drawn on an annual basis); and the flexibility to transfer member interests without incurring tax charges (assuming the partner does not return a profit on their capital). It therefore is particularly suitable in people-based professional services firms, where members are taxed as self-employed, and often provides a supportive talent management structure as individuals aspire for partner status.
Historically LLP’s were perceived to hold nominal capital value and as such M&A activity was relatively subdued. The typical exit for an incumbent partner was to transfer his/her interests to an incoming successor. In more recent years, we have seen increasing levels of M&A activity, in part due to a more favourable market backdrop, but also the record levels of pent-up capital and a highly supportive banking environment. Importantly, LLP’s are entitled to entrepreneur’s relief in the same way a limited company is, as such a 10% capital gains tax rate of up to £10m.
The sale of an LLP is generally considered more complex than that of a limited company and there are a number of key considerations, a few of which are outlined below:
When selling any business it is important to present the company in the best possible light and this naturally includes the level of profit. In a partnership the true underlying earnings are not always immediately apparent, as partners are typically compensated through a combination of base salary and significant remuneration attached to the level of profit. It is therefore necessary to adjust for what a buyer would consider a market remuneration policy i.e. a fully costed profit & loss to determine the “corporatised” EBITDA figure. This point is particularly pertinent as it not only determines the number a multiple will be applied to but also the compensation package partners are prepared to work for post transaction.
The statement that all members are aligned at the point of commencing any form of strategic review sounds obvious in principle, but reality can often differ. Partnerships are often more difficult than limited companies due to the number of members, who are often at different stages in personal career development. A junior partner with no/minimal equity may be reticent to consider a sale, whilst a more senior partner approaching retirement will be looking to maximise value. Stakeholder engagement is also important throughout the process, as collective decision making can often be more drawn out as members debate key considerations.
Structure & succession
Irrespective of the capital structure in people-based businesses, where there is no annuity income and senior personnel are responsible for business development activities, strategic purchasers will present a deal structure that looks to lock in work winners. There is no market norm and structures can vary widely by each buyer, but it is not uncommon to have between 25%-50% of the deal value attached to key future performance targets. This presents a challenge if a partner is looking to exit day one. The ability for a target to articulate a clear succession story can often lead to more favourable terms.
Trade purchasers have a number of levers to pull when structuring an offer. It is the norm for listed trade consolidators to issue shares with specified hold periods. This acts as a further tie in and helps incentivise the newly acquired team moving forward. In the case of private equity, a deferred structure is more challenging and as such one of the attractions is the majority of deals are all cash on day one. Partners are often required to roll a proportion of equity and incentivised through a sweet equity pot.