Private equity 'dry powder' being used to invest in professional services firms

There has been a significant increase in private equity investments in professional services firms in recent years. We have seen continued evidence of this trend in 2023 and in relation to a wide range of professional services firms, from legal and accountancy to PR and management consultancies.

Professional services firms offer good investment opportunities for private equity firms, many of which have record levels of ‘dry powder’ available to invest. They are attractive because they provide reliable workflows and revenue streams; can be consolidated and merged with other businesses; and have the potential to deliver attractive exit opportunities (such as IPOs).

A vast number of professional services firms are set up as limited liability partnerships (LLPs) (being viewed as preferable to traditional partnerships because LLPs provide partners with limited liability). However, LLPs are generally not an appropriate business structure for private equity investment. 

A key preliminary step in the process of private equity investment in a professional services firm is often to ‘convert’ an existing LLP into a more appropriate vehicle for investment (such as a private limited company). It is not possible under UK company law to simply convert an LLP into a private limited company; instead, the assets and liabilities of the LLP must be transferred to a newly incorporated private company. 

The key steps when ‘converting’ an LLP to a limited company include:

1. Incorporating a new private limited company which is a separate entity from the LLP (with a different registration at Companies House and company number) (Newco);
2. Transferring the assets and liabilities of the LLP to the Newco (pursuant to a business transfer agreement);
3. Members of the LLP becoming shareholders in the Newco; and
4. Dissolving the LLP.

Careful consideration must be given to the process, particularly the legal, tax and insolvency aspects which we summarise below.

LLP agreement

The terms of the existing LLP agreement will need to be reviewed to establish whether the consent of the members/partners is required to transfer the assets and liabilities to the Newco. The LLP agreement may include provision for a particular voting threshold or unanimous approval may be required. The partners will want to consider early on if a particular threshold is likely to be achieved.

Shareholders agreement and articles of association

New articles of association will need to be prepared and a shareholders’ agreement or investment agreement entered into to govern the rights of the shareholders and investor in the Newco.

Warranties

Generally, the business transfer agreement will not include extensive warranties because the members of the LLP will hold shares in the Newco in the same proportion to their holding in the LLP. However, the private equity investors will require warranties and undertakings in connection with their investment and these will be incorporated into the investment agreement.

Assets

The assets should be carefully identified to ensure that all the assets used to operate the business are included in the transfer. This could include property (such as an office lease), equipment and contracts with clients and suppliers.

Key contracts

All material contracts of the business need to be identified. For example, supply agreements, distribution agreements, IT contracts and IP licences. 

The LLPs key contracts should be reviewed to establish if they can be assigned to the Newco.  If it is not possible to assign a contract, a new contract may need to be negotiated and entered into between the Newco and the relevant contract counterparty. 

Clients

Client engagements will need to be transferred from the LLP to the Newco and this will require careful management to ensure that applicable professional duties are complied with. 

Employees

The employees of the business will transfer automatically from the LLP to the limited company under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). TUPE requires that the employees of the LLP are given specified information and are consulted within a specified timescale. Employees are also protected under TUPE from any changes being made to the terms of their employment.

Tax

Assuming the LLP is tax transparent, there are a number of tax charges to be considered by the individual partners because the disposal of the LLP’s assets will be treated as a disposal by each of the partners of their share in those assets. For example, capital gains tax and stamp duty. There may also be tax reliefs available which could reduce or defer the tax charges.

Regulatory approval

Depending on the nature of the professional services firm, regulatory authorisation may be required for both the LLP and the Newco before the transfer can complete. 

Administrative requirements

There will be various administrative tasks to be undertaken in respect of tax matters, such as amending HMRC registrations and the operation of PAYE from the LLP to the limited company. In addition, the non-salaried members of the LLP will be employees in the Newco so employer’s NICs may be due.

Other practical aspects to consider for the Newco include creating new bank accounts, insurance policies, branding, the website and email accounts.

Dissolving the LLP

All creditors of the LLP will need to be transferred to the Newco rather than being left in the LLP. The LLP can usually be dissolved or wound up once all key contracts have been formally assigned or novated to the Newco.

Hill Dickinson has considerable experience advising on investments in professional services firms in a variety of sectors. There are many different aspects to consider to ensure that such transactions are structured effectively. We can advise at all stages of the process, from initial discussions through to drafting the transfer documents and post completion matters.

For further information and support, please get in touch.