It is an astonishing fact that 14 per cent of the 14,000 or so advice firms in the UK operate without limited liability.
This is according to Apfa’s (now part of Pimfa) excellent report, The Financial Adviser Market: In Numbers, which was published earlier this year and provides data up to the end of 2016.
There are four main ways in which advisers can trade: as limited liability companies (either private “limited” or public “PLC”), limited liability partnerships, sole traders and full partnerships.
The breakdown of firms is 79 per cent limited companies, 7 per cent limited liability partnerships, 10 per cent sole traders and 4 per cent partnerships.
The number of advisers operating without limited liability protection has declined over the years from 22 per cent in 2009. The number of full partnerships has halved from 8 per cent but sole traders have only declined from 14 per cent to 10 per cent of the total.
Of course, firms that do not have the protection of limited liability are virtually all at the smaller end of the spectrum.
This means the number of individual advisers they represent is far less than 14 per cent of the 24,761 there were at the end of 2016. Larger firms almost all work in limited liability entities, sole traders are almost all very small and many of the partnerships are probably husband and wife firms, or similar.
So three questions about this metric occur:
- Why is this figure of 14 per cent of firms choosing to spurn limited liability so very astonishing?
- Why do these advisers hang onto unlimited liability?
- What should they do about it?
First, why is it so astonishing 14 per cent of firms have unlimited liability? The answer is in the name; business entities 101. A sole trader business is owned by a single individual, who is personally responsible for all the debts and liabilities of the business. So if a sole trader business makes a mistake and gives incorrect advice or perhaps fails to put a client on risk and the client subsequently dies, the adviser is potentially personally liable.
The position with partnerships is arguably even worse. The individual partners could be personally responsible for the liabilities of the business if the partnership cannot meet its debts. So an adviser could find themselves picking up the tab for their partners’ mistakes. They are potentially jointly and severally (individually) liable.
Limited liability protection in a limited company in principle means shareholders’ losses are limited to the amount of unpaid shares that may be outstanding. An LLP is similar to a limited company in they cannot normally lose more than they have invested and, in particular, they are not normally individually or severally responsible for other partners’ actions.
Why would these advisers hang onto unlimited liability? Well, some are very confident they will not make mistakes. And some seem to be just as confident that their partners will not slip up either.
Professional indemnity insurance provides valuable protection – and advisers have to hold it. But it may not turn out to be a perfect protective shield, as some have found out to their cost.
The level of cover may be insufficient, perhaps because the total claims exceed the sum insured. In some cases, the aggregate cost to the business of the excess payments on claims can add up to terrifying amounts where individual cases are treated as separate claims, each subject to a substantial excess.
Of course, there are also circumstances in which the protection of limited liability is not perfect. Fraud or wrongful trading can lead to directors/shareholders or LLP partners having personal liability for corporate debts.
More relevant in this context is the possibility that the regulator could find individual senior managers personally responsible and liable for their actions. This could become rather more common under the new senior managers’ regime due to be introduced for advisers very soon.
What is more, the courts can occasionally decide that directors have acted in an egregiously blameworthy way and made them personally liable for corporate debts – but that is very rare.
It may not cover every possible eventuality but most advisers should feel hugely safer behind the protection of limited liability than without it.
That said, there are tax and National Insurance advantages to being self-employed as a sole trader or a partnership, compared with trading through a company or LLP. Some advisers might feel optimistically that they have traded so long without limited liability that a few more years probably would not lead to much harm.
All in all, though, advisers who are sole traders or in full partnerships should almost certainly convert to a limited company or limited liability partnership. The tax and other costs of rolling the business across is typically not enormous. The potential costs of unlimited liability, on the other hand, could be catastrophic.
Danby Bloch is chairman of Helm Godfrey and consultant at Platforum