Consultants · Startups

What's the best structure for consulting firms or agencies?

Richard Pridham Investor, President & CEO at Retina Labs

June 25th, 2015

If 2 or 3 consultants get together to form a consulting firm or agency, what's the best way to structure the business? Company, limited partnership...? There is very little capital investment upfront other than the company setup, web site, perhaps a small marketing budget to get the ball rolling. Each "partner" will be required to bring business to the firm from their business network and all partners will be likely involved in some aspect of each mandate as each one has complimentary expertise to the other. So if partner A brings in a mandate that partners A, B and C contribute to, how to you divvy up the revenues? Do you keep X% in the company to cover operating expenses and spit the rest evenly or by % contributed (in terms of hours based on time sheets)? Contract consultants will also be brought in and paid according to their hourly rate or on a project basis. There could also be cases where a given partner is the one who delvers the mandate from A-Z without any implication from the others. How would that scenario work?

Thanks!

Alejandro Corpeño Co-founder & Consulting Manager at Icoms Technologies

June 25th, 2015

I have a consulting/software development firm and the structure that has worked best for us since the beginning is:

1) A simple legal structure (Limited Liability Corp) LLC, each partner has a % of it, negotiated based on initial $ or sweat equity brought to the table at the time of founding

2) Separate the concept of % of profits (dividends) that each partner gets at the end of the year, from the month to month income (salaries) and project sales (commissions):

2.1) So, all partners get a monthly salary at a level that the company can support and sustain, you make that part of your fixed costs along with other things like rent, services, taxes, etc...

2.2) You can establish a commission to be paid as a bonus for the partner that brings in projects... so if you bring a $50k project, you get a commission of that upon successful completion of the project and full payment makes it into the company.

2.3) At the end of the fiscal year, you will have some profits or losses, if you lose then it's mostly an accounting loss... you as individuals have been making your salaries and commissions all year long... so its not a big problem. If you have profits, you can decide if you want to pay those in the set ownership % to the partners as dividends (there are tax implications with this) or if you want to keep it in the company as retainer earnings that can be used as a cash reserve (buffer) to keep operations running for 3 - 6 months even if no new projects make it into the pipeline... or invest in growth, marketing, equipment, training, conferences, etc.

3) You have to be able to trust your partners and have a great working relation where each one is putting his/her 100% into the company, all working their asses to get the most $ in and the most productive time... if you see that one partner is not pulling his/her weight, you have to address that and kick them out ASAP ... there need to be some rules about how you kick out and bring in partners in your company's Operating Agreement, Incorporation and Bylaws documents that make all this very clear.


Vijay MD Founder Chefalytics, Co-owner Bite Catering Couture, Independent consultant (ex-McKinsey)

June 25th, 2015

If you're thinking about structure issues for firms, great resource is David Maister's Managing the Professional Service Firm.

Read it while I was at McKinsey and it made that model vs. Accenture vs. others make a whole lot more sense...which has implications for structure, equity, recruiting, etc.

Charlene Li Helping leaders thrive with disruption as a Principal Analyst at Altimeter, a Prophet Company

July 1st, 2015

Definitely recommend the LLC, easy to set up and maintain, add new partners, make changes to the agreement, etc. It's unlikely you will IPO a professional services firm, but if you are ever so lucky to do that, or more likely, get bought, it's pretty easy to restructure into a C-corp if needed. 

To echo Alejandro, think through what you want the relationship to be like. When I started Altimeter it was an "eat what you kill" approach with a % off the top for overhead. That doesn't promote an "all for one, one for all" approach. Think through also how you will make decisions, and if one person will act as the managing partner -- and how you'll rotate that responsibility and provide extra comp for that role as well. 

Maister's book was highly recommended to me as well, but while I found it helpful to understand some of the basic underpinning, it didn't provide me with The Answer. I've found that the only way to figure it out is for each partner to really understand what you each want to get out of the working relationship -- and to also agree *upfront* how you would like to end the relationship, if needed, some day. Smooth exiting of partner is a key part of the agreement, and you should have a frank discussion about it upfront, along with everything else. 

Richard Pridham Investor, President & CEO at Retina Labs

June 29th, 2015

Thanks. Good advice. Ordered the David Maister's book.

Leif Elgethun Entrepreneur, Engineer, Change Agent, & Environmental Capitalist

June 30th, 2015

I am on vacation and unable to check email until June 30th. If urgent, please email the company email account corresponding to your query below for the appropriate urgent contact info. Thanks! Intermountain Energy Partners: leif@intermountainenergypartners.com Site Based Energy leif@sitebasedenergy.com Retrolux leif@retrolux.com Leif Elgethun 208-301-2293

David Johnson CEO

June 25th, 2015

S-Corps are the most tax efficient.  

Good luck on the splits, it's more of an art then a science

Michael CISSP Attorney/Consultant at Self Employed

June 25th, 2015

There are some interesting legal/formation issues here.  To be a general partnership, you just have to believe and act like a partnership.  LLP/LLC is designed to protect non-managing partners.  C-Corp may seem like a lot of overhead and tax but depending on the situation could be a good way to go.  The vehicle that you choose for formation will inform the rest of the conversation about ownership and control of assets as well as retention/distribution of revenue and even sale of the company if you are successful and later acquired.  I would suggest finding an attorney and talking for an hour or two.  It is very important to get this right up front rather than have problems down the line. 

Russ Gilbert Founder & Managing Director at Blue Sun Media

June 29th, 2015

It really varies by state, but generally speaking I've found LLC to be the most flexible and can have all the same tax benefits of an S Corp.

C Corp provides the best asset protection and is the only entity that can IPO, but has onerous regulation and paperwork and your cashflow basically ends up being taxed twice.


Anonymous

July 9th, 2015

From my own experience, everything must be simple but documented.
There are processes that must be done, you can hire someone or do by yourself and pay yourself or someone else. That must stay as is, no such things as "I have done more or less, I should be compensated more or less". Because at the start you bring your own clients, but later they come themselves (of course you will be very good), or you hire sales personnel and you are left with only working with them not bringing. As this point you loose your value as a person who brings clients and only work with hem. So as my experience dictates you should split all activities like "bring client, work with it" lets say, bringing a clients can be a fixed compensation (single) or small % if you just bring but not work with it. One part of the income can go to company, other to partner, at the end of the year shareholder get their % as they have invested $. I tried to write so much into so short text, there are so many variations, but I hope that makes sense and you can use some principals.

Tim Scott

August 28th, 2015

Let's see if I can awake this old thread. My question is, when does a C-corp become tax advantaged over LLC?

Let's say the consultancy expects to grow fast. As you grow, you probably want a decent cash balance to get through feast-or-famine cycles. LLCs are not double-taxed until they retain earnings over $250k, at which point it turns punitive.

How big before C-corp wins? Ten consultants, fifty? Anyone have any experience with this calculus?