Because there is a wide variety of consulting firms, these firms use many different structural arrangements. Structure must never become a straitjacket. Our review of structural arrangements, including the legal forms of business, will therefore refer to some typical arrangements, but without aiming to provide a blueprint for all situations. Every consulting firm is unique and its structure reflects many factors, including the nature and volume of activities, personalities, the strategy chosen, traditions, and the legal and institutional environment.

35.1 Legal forms of business

In most countries consultants can choose among several legal forms of business organization. This choice is not always completely free. Local legislation may include special regulations for organizing and operating professional services, or for firms with foreign ownership. Therefore an international consulting firm may have to use different legal forms in different countries. Unless the consultant is sufficiently knowledgeable in legal matters, he or she should seek a lawyer’s advice. An accountant’s or tax adviser’s viewpoint is equally important because the forms of business organization differ as regards registration, taxation, record-keeping, reporting and liability.

Sole proprietorship

A sole proprietorship is a business owned and operated by a single person. The owner may be a single practitioner, or may have a number of associates. While normally and legally there is no limit to the number of staff, it is usual for a “sole owner” to employ only a few associates, and perhaps only for the duration of specific assignments. The firm’s net income is taxed as the owner’s personal income; the owner’s liability for debts incurred by the firm is unlimited.

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Sole proprietorship is a simple form, suitable for those who are starting in consulting but have some previous management experience, or who prefer to remain completely independent in their consulting career. In addition to working on assignments, the sole practitioner has to market future assignments. The risk is quite high in the case of sickness. Even if the single practitioner has health insurance and income-loss insurance, a prolonged illness may adversely affect business contacts. The firm normally ceases to exist with the death or retirement of the owner (although his or her estate remains liable for outstanding debts).

Partnership

Partnership1 is a common form of business in management consulting and in other professional service sectors. It entails a contract between two or more people to set up a firm in which they combine their skills and resources, and share profits, losses and liabilities. Under most legal systems, the partnership does not have to be on an equal basis: a consultant may enter a partnership with a junior colleague on a 60–40 or other basis; or one or more of the partners may wish to devote less time than the others to the partnership and will accordingly accept a smaller share of both profits and losses.

The advantages of partnership include the division of labour to optimize the use of the partners’ skills, the possibility of undertaking more important and complex assignments, the possibility of continuing the business in the absence of one of the partners, and a better utilization of resources such as office space, equipment and secretarial support.

The disadvantages include the unlimited liability of each partner for errors and obligations of all other partners arising from the business, the need to reach agreement on every important decision, and the difficulties involved in harmonizing the personal preferences and styles of the partners.

It is generally recommended that a clear and unambiguous partnership agreement should be drawn up, even if local legislation does not explicitly require one. Much more important, however, is the composition of the group: individuals who have difficulty working together, have different conceptions of professional service and ethics, or do not trust each other for any reason should avoid becoming partners. Even if partners respect and like each other and are generally happy with their firm model, problems may arise and grow into conflicts that can destroy the partnership. Many professional partnerships survive because the partners have developed a high degree of tolerance to different personal values and behaviours and are prepared to compromise. It is also necessary to reach agreement on the different roles that partners can best play, including a voluntary delegation of general management authority and responsibility to one of the partners.

In some legal systems it is possible to establish a limited partnership, which includes one or more general partners (with unlimited liability), and one or more limited partners, whose third-party liability is limited to a specific amount (which can be zero).

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Partnerships are usually not limited by law as to size, but in practice are often confined to a comparatively small number of people. If a unit expands, while it may retain something of the spirit and title of partnership, it might be advisable to consider transforming the business into a corporation.

Corporation

Many consulting firms are established as corporations or limited liability companies.2 The corporation has two fundamental characteristics: (1) it is a legal entity that exists separately from the owners (i.e. does not cease to exist after an owner’s death or withdrawal from business); and (2) the owners have no personal liability for the obligations and debts of the corporation (the shareholders are protected from liability incurred by the company, except in certain cases, especially when it is established that the corporate form was abused in order to avoid personal liability). The major advantages of incorporation include:

–considerable flexibility in doing and developing business;

–the possibility of easy changes in the number of co-owners or shareholders; there can usually be a sole owner, and therefore even a sole practitioner can incorporate a business;

–the possibility of transferring ownership interests or shares;

–the possibility for individuals to be simultaneously owners and employees of the corporation;

–greater flexibility in raising finance;

–the possibility of retaining earnings for reinvestment in the firm;

–separate taxation of personal income (salary, bonuses and dividends) and the corporation’s profits, and the possibility of deducting certain employee benefits and certain types of corporate expenses from taxable income (the level of taxation is often a major factor in deciding whether to incorporate or not); it should be noted that this may sometimes operate as a disadvantage due to double taxation on the corporation’s income and on the dividends paid to shareholders.

On the other hand, a corporation must comply with a number of requirements stipulated in the company or other law of the country. These include, in particular:

●compulsory registration (incorporation) prior to starting business, which involves certain costs;

●a statement of corporate purposes (objects of the company); in some countries the corporation is not authorized to do business outside the scope of this statement;

●keeping of accounts and other records, with periodic reporting;

●in certain circumstances, public auditing of company reports and (in some countries) the publication of these reports;

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●the organization and definition of responsibilities of corporate bodies and top management (shareholders’ meeting, board of directors, officers, etc.).

Moreover, corporate directors can be personally liable both civilly and criminally for certain corporate acts of malfeasance or misfeasance.

Management consultants in various countries have adopted special arrangements in using the corporate form. With few exceptions, they do not “go public”, i.e. the shares are not available on the stock market, but ownership is reserved to a group of senior consultants (officers, principals, partners, etc.). Promotion to this level in the hierarchy may include not only an entitlement, but an obligation to purchase a certain number of shares and thus invest in the firm. The maximum number of shares that can be owned by one member of the firm is often limited (often to between 1 and 5 per cent of the shares) and the owner must resell these shares to the company (thus recovering the money put in) when retiring or leaving for any other reason.

In some consulting firms there is one – or more – majority owner who actually controls the firm. Usually he or she would be the sole founder, or one of the partners who established the firm, who at some point decided to transform the firm into a corporation and widen the ownership base. In a small number of cases, consulting firms are owned by other business corporations (by banks, accounting firms, engineering firms, or others), management schools, employers’ associations or other bodies.

Some consulting firms use all the profits for developing the business and creating reserves, while others distribute a part of the profit to the shareholders, or to all employees (see section 36.4).

Many consulting and other professional firms have maintained the partnership form even when they have become larger, or have continued to be managed and to behave as partnerships after having been restructured as corporations. Currently this traditional approach is being challenged. If there are hundreds of partners and consultants, the ideas on which the partnership formula is based (undivided responsibility, direct participation, full consensus for key decisions, etc.) are increasingly difficult to apply. Further difficulties are encountered in raising capital needed for expansion, product development and modernization, and in facing liability issues (see section 6.5). Some large management and IT consultancies have therefore chosen to become corporations and to sell a part of the shares to the public through an initial public offering (IPO) rather than sticking to the classical partnership formula.3 Of course, if a significant number of shares are in the hands of outside investors, the professional firm is as exposed to the uncontrollable forces of financial markets as any other publicly quoted firm.

Legal aspects of working with other consultants

Consultants may consider working with other consultants in a number of situations, for instance when they need to draw on specific expertise or to

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collaborate on a larger project. When consultants (individuals or firms) cooperate with other consultants on specific projects, they usually retain their independence and legal form of business and the relationship is governed by an agreement defining the objectives and scope of cooperation. For example, if a consortium is established for a complex consulting project, one firm would normally act as the consortium leader and be in a contractual relationship on one side with the client and on the other side with firms that are consortium members but legally act as subcontractors.

In these instances, the following legal issues generally need to be considered:4

–Under whose name are the consulting services performed when several consultants are involved? If a consultant engages a subcontractor who has no contractual relationship with the client, the consultant will generally bear responsibility for the work of the subcontractor. In addition, the consultant may, in certain circumstances, face joint liability for malpractice or breach of contract by another member of the consortium, even if that member is not the consultant’s subcontractor, to the extent that the consortium is deemed to constitute a partnership. The consultant should examine whether such risks are covered by his or her malpractice insurance.

–The need for a non-competition undertaking prohibiting the other consultant from providing services to the client during a specified period of time.

–The ability of the other consultants to make commitments on behalf of the leader or to change the terms of the assignment.

–The protection of confidential information received from the client and shared with the other consultants.

–The protection of confidential information, know-how and intellectual property of the leader provided to the other consultants for the purposes of the project.

Other forms

Not all management consulting units are independent businesses. Some units are established and operate as divisions within private corporations that have wider purposes and offer other types of service (accounting, auditing, engineering consultancy, etc.) in addition to management consulting. In such cases, the legal entity may not be the consulting unit in its own right, but the organization to which the unit belongs.

There are also consulting units established as, or within, associations, foundations, public agencies and other non-profit-making organizations. However, the corporate form tends increasingly to be used for these units in order to enhance their independence, motivation, responsibility and liability. For example, a management institute can often be organized as a corporation, or a public agency can create (and own) a professional service company that sells services to clients in both the public and private sectors.

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