Decision Making Structures

Many professional firms grow from one practitioner and evolve into a team of silo teams sharing a common overhead structure, but is this really what is best for the firm? Even sole practitioners can’t juggle all responsibilities, let alone every practitioner juggling the same responsibilities in an ad hoc inefficient way.

Across Australia, I see very dysfunctional information flow and decision-making structure. I see a lot unproductive discussion, lack of decision making and minimal if any implementation. If you want to get a different outcome, you need to do something differently.

Whether you run a professional practice by yourself, or with other business partners, it’s important to define decision making roles to gain efficiencies throughout the practice.

Split out your organisational responsibility

Organisational responsibility is the most underrated diver of success for businesses. This is partly due to control over decisions not being delegated and if they are delegated, they’re delegated without any rules and direction.

Delegating ​responsibilities for day to day business decisions enables a business to make decisions in a timely manner while freeing up owners to generate more revenue for the business, implement strategic projects without distraction, but more importantly allocates responsibility for those making decisions.

Right people making decisions = ​efficient and effective

Delegation of responsibility should only be allocated to those who have the ability to make decisions and have the time to do so. If you as an owner don’t have time or the skill sets, hire those who do. Only with effective delegation of responsibility will you get action.

Responsibility​ +​ accountability​ =​ action​

Who takes responsibility for what?

The owners of a business, or the board if referring to a listed company, need to be guardians of the business context. This is the vision of where you want the business to go. This same group should be the ones setting the goals and objectives that stem from the vision.

Decision making context = consistency

Strategies required to achieve the goals and objectives need to be set by the operations team. For most this maybe a combination of general/practice manager and key directors.

Once the strategies are set, it’s up to the team leads to monitor the team/department KPIs, both financial and non-financial, and become the key link in communication channels from operations team to individuals. This is a vital role that gets missed. How are your employees meant to understand their expectations or the businesses goals and objectives is they’re not communicated?

Finally, Individuals need to take responsibility for their own KPIs once known. They also need to understand what actions they take, and how these actions this links into businesses strategy. These actions should include the businesses core value.

Core values = behaviour

Why implement decision structures?

To create change in your firm, you must change the structure around how decisions are made, and the structure around how decisions are implemented. A culture of responsibility and accountability at every level is required for success

Decision making structures enable a business to run effectively if delegated to the right people who are empowered and have the ability to make those decisions. Decisions are likely to get made in a timeframe needed for effectiveness and in a consistent manner.

Finally, remember to focus on the good things (which are usually the majority) and manage the exceptions (which are usually the minority).  You can choose where to focus your attention.

The Different Firm Structures

There are many options available now for structuring your professional practice. These include:

  • Sole practitioner
  • Partnership of individuals
  • Partnership of discretionary trusts
  • Service entities
  • Companies

There are advantages and disadvantages for each structure, and the relevant choice, as always, is dependent on each principals’ and practice’s personal situation.

Sole practitioner

Being a sole practitioner has its appeal. You’re the only boss and the start-up costs are low. Establishing and operating your business is simple, you have maximum privacy and you keep all the profits. This is a great starting structure as it’s easy to change your structure later if circumstances change and wind up is easily should you change your mind.

What you need to be aware is that there are some dire disadvantages for being a sole practitioner. You have unlimited liability for debts as there’s no legal distinction between private and business assets. Your capacity to raise capital is limited, while you’re taxed as a single person. It can also be it can be hard to take holidays and retain high-calibre employees

Partnership

In a partnership, you have more people to lean on for decision making, access to more capital and greater lending capacity. There is opportunity for income splitting according to performance and you are likely to attract a higher calibre of employees over being a sole practitioner.

Your exposure to risk is much greater than being a sole practitioner, the liability of the partners for the debts of the business is unlimited with each partner ‘jointly and severally’ liable for the partnership’s debts.

There are higher risk of disagreements and friction among partners while each partner is an agent of the partnership and is liable for actions by other partners.

This is also another low-cost structure however one structure with the greatest future selling complications if partners join or leave, requiring value for all the partnership assets

Service entity

A service entity is a separate legal structure to provide asset protection by separating the running of the practice. Generally, it will employ all the staff, negotiate lease arrangements and sub-lease arrangements, purchase and provide equipment and incur all the expenses in the day to day running of the practice.

The disadvantage is that you will also need to run more than one structure corresponding with service entity. Service entities practical use, now that most incorporation restrictions have been removed, is to share resources and lease arrangements between different parties.

Incorporation

There are many advantages of incorporation, with the main ones being an ease of succession, asset protection, taxation and cash flow management.

Companies are also limited in liability and have greater access to leading capabilities provided the business is profitable and cash flow positive.

A company can retain business profits and be taxed at 30% (lower for SBEs), the company tax rate and can be paid out in future years to control the businesses cash flow and taxation consequences.

There are more associated costs in running your practice in a corporate structure than compared to a sole practitioner or partnership structure.

Remember

If you’re considering setting up and Incorporated Practice, make sure you seek advice to address all the issues that will impact on your decision.  Also be mindful of the significant advantages that incorporation provides and take a balanced view.

Incorporated Practice

There are many advantages of incorporation, with the main ones being an ease of succession, asset protection, taxation and cash flow management.

Companies are also limited in liability and have greater access to leading capabilities provided the business is profitable and cash flow positive.

A company can retain business profits and be taxed at 30% (lower for SBEs), the company tax rate and can be paid out in future years to control the businesses cash flow and taxation consequences.

Some incorporate facts when incorporating

  1. You only need to transfer Goodwill and Fixtures & Fittings to the Incorporated Practice (IP), not WIP and debtors. This keeps the stamp duty cost down;
  2. The IP provides a layer of asset protection;
  3. IP simplifies partner entry and exit as it is only shares that are bought and sold, not partnership assets;
  4. If you are eligible for the small business CGT concessions, which most partners in partnerships or sole practitioners are, depending on the value of your net assets, CGT can either be completely eliminated or significantly deferred to ultimately exit from the business. Even better, with correct shareholding structured, you can maintain your access to the small business CGT concessions into the future;
  5. With appropriate asset structuring and funding in place, debt can be restructured into the IP to provide personal debt relief and repaid from after tax profits of 70% with interest being tax deductible, lower if the business is an SBE;
  6. By utilising correct shareholding structures, you can spread your share of business profits over your family members, including non-working spouse, children over 18 and even cap your tax at 30% in a corporate beneficiary, lower if the business is an SBE;
  7. You will receive fully franked income as dividends. If the ultimate recipient has a tax rate higher than 30%, you only pay the top up. If the tax rate is less than 30%, you get the difference back from the ATO

Other considerations when incorporating

One other issue that some firms don’t consider when they incorporate is the shift for cash to accrual in terms of the timing of when income is assessable.

For firms that were previously on a cash basis for bringing to account their income, when they incorporate, they usually move to an accrual’s basis.  This means that the company (or principal if the company cannot retain profits) will pay tax on the income that has been invoiced, not received.

If when you sell your practice to a company, you do not sell the WIP and debtors, and you were on a cash basis, then during the next year the WIP and debtors will be collected on a cash basis in your name, but the company will be taxed on all invoices issued. This can cause some cash flow issues if it is not adequately planned for.

Remember

If you’re considering setting up and Incorporated Practice, make sure you seek advice to address all the issues that will impact on your decision.  Also be mindful of the significant advantages that incorporation provides and take a balanced view.

Structuring for Succession

Implementing succession into your professional firm can be an extremely daunting thing. For most, this can be a new experience. For others, this maybe a second attempt at a bad succession strategy. Regardless of the reason, many questions are common in any succession.

The most frequently asked questions I get are:

  • I’m wanting to retire, but don’t know how
  • What is my current practice worth?
  • Who is going to buy it?
  • How will I be paid?
  • Over what period will my succession process last?
  • What are the tax implications?
  • The two biggest questions that come from a selling practitioner once the decide they want to sell are:
  • How do it do it?
  • What’s the firm worth?
  • The first thing I need to tell you is … the closer to exit date without any plan the lower the value.

Considerations for enabling succession

To drive growth in your value, you need to increase your profits and reduce the risk. If you are considering your succession strategy and it is still a couple of years away, you need to start implementing strategies now to drive the value upwards.

To enable succession, you first need to put yourself in the potential purchaser’s position. This is harder than you think as you will always take a bias viewpoint of your own interest.

Many practices have engaged my services to manage the process just for this reason. Some taking up to two years to transition and agree because of said parties involved.

When enabling succession, you need to make the firm attractive. Key areas that need consideration are:

  • Current legal structure
  • Current debt and cash flow structure
  • Funding that is available
  • Distribution strategy
  • Risk mitigation
  • Partnership criteria

What are the common succession pain points?

You may have an idea of how you can exist your practice, or even how to make it more attractive prospective purchasers, but what about the biggest challenges you will face during the succession process. The most common challenges that I see facing practitioners are:

  • Lack of consensus
  • No defined strategy
  • Assuming instead of agreeing
  • Agreement on valuation
  • Current structures are inhibiting
  • Deciding on a successor
  • Bias decision making
  • Timing of succession
  • Letting go

Plan ahead

Prepare detailed strategy and advice document for the firm to implement the plan, including step-by-step project implementation action plan regarding:

  • Consider Incorporation to make it easier for the new partner
  • CGT implications and procedures required to apply the small business CGT concessions to the sale by the partnership and restructure to an ILP, including personal taxation impact for each partner
  • Debt restructuring implications and deductibility
  • Review your current finance structure, both personally and business, and develop a debt strategy to retire debt and support your business cash flows

Consider preparing a valuation for your practice for capital gains tax purposes and to support the correct allocation of purchase price of Goodwill as the transactions are between related parties

Different Legal Firm Structures

There are many options available now for structuring legal practices.  These include:

  • Sole practitioners
  • Partnership of individuals
  • Partnership of discretionary trusts
  • Service entities
  • Companies

There are advantages and disadvantages for each structure, and the relevant choice, as always, is dependent on each principals’ and practice’s personal situation.

Since 2007, legal practices in Queensland have been able to incorporate.  Provided  there is compliance with the Legal Practitioners Act 2007, legal firms can now enjoy the same structuring advantages as most other businesses in Australia.

There are many advantages of incorporation, with the main ones being:

  • Succession
  • Asset Protection
  • Taxation
  • Cash flow management

Whilst any eligible legal practitioner can incorporate, the taxation benefits commonly considered to apply to all companies, may not apply to all practitioners.  It has long been understood that a company can retain business profits and be taxed at 30%, the company tax rate.  However, where the income is regarded as personal exertion income, this generally cannot be retained in the company and must be paid out to the principal.  A simple distinction between business profits and personal exertion income can be made by looking to who has earned the income.  Where there are at least the same number of principal and non-principal fee earners, on a full time equivalent basis, the profits are more likely to be regarded as business profits.  Whether a paralegal is considered to be a non-principal fee earner is a point for discussion.  My view is that they would not be considered a fee earner because they cannot provide legal advice as a legal practitioner.  So an incorporated legal practice where the principal is the sole fee earner with one or more paralegals and administration people will generally not be able to retain profits.  These profits would need to be paid out to the principal as wages and taxed at their marginal rates.

These rules are different to the personal services rules, and should not be confused with them.

One other issue that some firms don’t consider when they incorporate is the shift for cash to accrual in terms of the timing of when income is assessable.  For firms that were previously on a cash basis for bringing to account their income, when they incorporate they usually move to an accruals basis.  This means that the company (or principal if the company cannot retain profits) will pay tax on the income that has been invoiced, not received.  If when you sell your practice to a company, you do not sell the WIP and debtors, and you were on a cash basis, then during the next year the WIP and debtors will be collected on a cash basis in your name, but the company will be taxed on all invoices issued.  This can cause some cash flow issues if it is not adequately planned for.

If you’re considering setting up and Incorporated Legal Practice, make sure you seek advice to address all the issues that will impact on your decision.  Also be mindful of the significant advantages that incorporation provides and take a balanced view.