What business structure should your law firm have? At first glance, choosing a business structure for your California firm might seem fairly easy.
After all, the State Bar only allows two entity types for law firms: the law corporation (aka, the Professional Corporation or “PC”) and the limited liability partnership (commonly referred to as the “LLP”).
So, you just pick one and start practicing, right? Not so fast. As with any business formation analysis, the decision of whether to form a PC or a LLP requires multiple levels of analysis.
In this article, we’re going to try to help you make this decision by breaking the analysis down into a series of practical (yet critical) questions – ranging from the most simple to the decidedly-more-complex.
Before we dive into the nitty-gritty, however, please allow me to give you the caveat that I’m no longer a practicing attorney nor am I a business consultant. Consequently, nothing contained in this article should be construed as legal advice and you should definitely consult with the appropriate professionals before making your final decision.
Moreover, even on my best day, I can’t pretend to be a tax consultant. Thus, this article sticks to the practical considerations in choosing a law firm business structure. We’ll leave the critically important tax analyses to the accountants, as we should.
1. How many attorneys will be in your organization?
This question is of the utmost importance for those of you planning to open a solo practice. Why? Well, think about it … as a sole practitioner, you can’t be in a partnership, now can you? You can, however, be the sole shareholder in a Professional Corporation.
So, for those of you going it on your own, it’s time to get cozy with the State Bar Rules for Law Corporations.
2. How much do you want to pay the state in fees?
As with any formal entity (law-related or not), your organization is going to have to pay the state some initial fees (like an application fee) and annual fees for the pleasure of doing ongoing business within the state. Here’s how those fees differ between the two entity types:
PC
If the thought of paying ever-increasing fees gives you the heebie-jeebies, you may want to consider a PC. Law corporations must only pay a $250 application fee, with an annual renewal fee of $100 (and – if you miss your renewal deadline – a $110 Late Fee Penalty).
Keep in mind, however, that you’ll also have to pay an additional $100 to $210 each time you submit your annual report and renewal form (depending on the timeliness of your submission).
LLP
LLPs have a few more calculations to do. The initial application for a certificate of registration costs $110 for the first two partners and an additional $55 for each additional partner. Interestingly, while there used to be a $2500 cap on these initial fees, as of May 2023, the sky’s the limit.
As for annual fees for LLPs, it’ll cost you $85 for the first two partners and an extra $30 for each additional partner. Once again, the former annual cap of $2500 has been lifted, and LLPs must pay annually for every partner in the firm.
We’ll let you do the math on that.
3. Who runs the joint?
In any law firm, different attorneys bring different value propositions to the table. Some may have seniority, others may have superior leadership skills, and still others may be startlingly prolific worker bees. But when all those different people with different skills come together to jointly form a new firm, who gets to be in charge?
The answer, of course, is: it depends.
LLP
In an LLP, the partners can (and should) form a Partnership Agreement that sets forth the various rights and responsibilities of the partners.
When it comes to management issues, the agreement could be very simple. For example, every partner could have an equal vote on how day to day operations will be carried out.
In most cases, however, the Partnership Agreement sets up things like managing partners, management committees, or department heads, each of whom has a greater level of managerial responsibility than the run-of-the-mill partners.
Keep in mind that if you and your partners overlook the critical step of forming a Partnership Agreement, the California Revised Uniform Partnership Act will be your de facto instrument – and that sets up a scenario where every partner has equal control.
PC
For the most part, a professional law corporation is managed just like any other corporation. The shareholders appoint a Board of Directors who, in turn, decide on day-to-day managers with titles like President, Vice President, Secretary, and Treasurer.
In most cases, the President would act in much the same way as a traditional managing partner. Vice Presidents might be akin to department heads. Secretaries would oversee corporate formalities, and Treasurers would be in charge of the money.
Of course, many of California’s Professional Corporations are actually solo shops, so one person gets to wear an awful lot of interesting hats.
4. Who pays if something gets screwed up?
Let’s be honest here. One of the main reasons any business forms a fictitious entity is so that the individuals behind the business can avoid liability for any screw ups. Legal entities are no different.
So, in a very basic nutshell, here are the differences in liability potential between a LLP and a PC:
LLP
In an LLP, individual attorneys do not have to worry about personal liability for the LLP’s debts or the negligent acts of other partners. That’s not to say they’re immune from liability, however.
As you would expect, each attorney retains personal liability for their own screw ups (aka, professional malpractice or other misconduct). Generally speaking, however, the personal assets of other LLP partners are shielded from such claims, unless they are proven to have supervised or approved the wrongful acts.
One important thing to note here is that a LLP partner is not personally liable for the LLP’s contractual obligations (like paying for vendors). This sets this entity apart from General Partnerships and makes the LLP an attractive option for many multi-partner law firms in the state.
PC
PCs share many of the same liability benefits as LLPs: generally speaking, shareholders are not personally responsible for the corporation’s debts or the negligence of other shareholders. And, just like LLP partners, shareholders remain liable for their own individual malpractice or other wrongful conduct.
There is one significant difference worth noting, however. The Professional Corporation itself can be held liable for the malpractice of its lawyers. In other words, an aggrieved client not only has the right to sue the offending attorney, but can sue the entire corporation. Depending on the size of any resultant judgment, this could diminish the value of the shares, thus impacting all shareholders.
5. Who can join the party?
Now more than ever, law firms are complex businesses. Indeed, California’s law firms generate roughly $64 billion in annual revenue and employ nearly 200,000 people. Most modern firms have intricate IT systems, powerful cybersecurity protocols, and lawyers working from multiple locations.
Wouldn’t it be great, then, if California law firms could have shareholders or partners trained in the non-law side of the business? People like Chief Financial Officers, Chief HR Officers, Chief IT Officers, or Chief Operating Officers?
Well, you can forget about that, at least for now. While some states – like Washington and Arizona – have enacted rules allowing non-lawyers to have ownership and/or significant leadership roles in law firms, California prohibits PCs from having non-lawyer shareholders and LLPs from having non-lawyer partners (consistent with other laws they have around non-lawyers).
6. How the heck do I get started forming a PC or LLP?
Regardless of which business structure you choose for your law firm, you’re going to have to follow strict requirements promulgated by the California State Bar. Fortunately, they do a pretty great job at providing resources for lawyers.
If you’ve decided to create a Law Corporation, you’ll find all of the forms you need to file with the State Bar here.
If, on the other hand, an LLP is the chosen structure for you and your partners, you can find the necessary forms here.
If you want general information on starting and managing a law firm in California, the Bar has a web page filled with resources to get you started.
Ultimately, starting and running a law firm in California is a highly rewarding venture. That said, do your homework before deciding which business structure to use for your law firm – and that includes getting advice from those oh-so-brilliant tax accountants.
