The personal risks of joining a partnership depend on the structure of the firm. The extreme position is that of a traditional partnership where all your personal assets may be at risk to creditors, including your home as your liability is unlimited. This could happen if, for instance, the partnership becomes insolvent as a result of trading difficulties or there’s a negligence claim that exceeds the professional indemnity insurance cover.

Most law firms today are limited liability partnerships (LLPs), which reduces the exposure level considerably—typically to the value of the investment you have made in the firm. This investment could be capital accounts, undrawn profits or directors’ loans. Your personal assets should be protected, though clawback provisions could reduce your personal protection if there’s proof of trading while the firm is technically insolvent.

You are about to have significant wealth tied up in the partnership

It is usual when you become a partner to contribute capital into the business. Each firm has its own approach; however, you likely will need to make a lump-sum contribution either straightaway or phased over a couple of years.

How much money will you have to commit? A recent benchmarking database from the Law Society’s Law Management Section (Law Society’s Law Management Section, Financial Benchmarking Survey 2021) found that the median partner capital account was £228,381 in 2020, a 9.2% increase on the previous year. As you might expect, partners’ capital increases in line with the size of the firm. The lowest entry point for a small firm may be £50,000 rising to around £150,000.

The capital you contribute will be placed on your capital account and forms part of the overall equity of the LLP. This will stay untouched in many circumstances, right up until you retire or leave the firm, unless further contributions are required as you progress to full equity partner.

If the firm is successful, the capital contribution may well be the best investment you will ever make. But there’s no avoiding the fact that the money, whilst remaining a personal asset, is not liquid, is at risk and rarely attracts a return.

Borrowing to buy in

Unless you have access through personal or family funds, a partner equity loan is the most efficient way of financing the capital contribution. These loans are openly available through high street banks and from some of the specialist legal sector funders. Firms usually have a relationship with their bankers to provide a competitive rate of interest and the interest is typically deductible on your tax return (based on the 2022/23 tax rules).

So far, so good. But tax benefits aside, if you borrow the money to fund your capital contribution, you have just added:

• An overhead in the interest payment
• The risk of losing the money if the firm is unable to repay you when leave the partnership
• More risk because you are now leveraged – even friendly bankers get grumpy when payments are missed!

Borrowing to buy in isn’t the mistake here and, for most new partners, it’s unavoidable. The mistake is failing to recognise the partner equity loan for what it is—a debt to raise cash that you won’t get back until exit—and failing to adjust the rest of your portfolio to balance out the risk.

Adrian Johnson