I was fortunate to be at an event organised by Rix & Kay Solicitors http://www.rixandkay.co.uk/ a week ago where Steve Billot of Duff and Phelps http://www.duffandphelps.com/expertise/our_team/Pages/bio.aspx?itemid=546&list=People gave a presentation on opportunities and challenges in the legal market.
What struck me was that whilst law firms are playing in an increasingly competitive market where the need for an external focus on market changes and fast adaptation to client needs means that they must devote significant efforts to develop new business, numerous factors means that they must also take a much stronger line with numerous internal management issues. My observation is that many firms are struggling with insufficient management resources as it is, so the future looks even more challenging.
Steve’s presentation covered following key points:
Structure of the legal market
The UK legal industry is worth £29.7 billion.
Citing the Law Society Annual Survey 2013:
- 10,000 entities provide legal services in England and Wales
- 85% of these entities have four partners or less
- 44% sole practitioners
- 41% 5 to ten partners
- 10% have more than 10 partners
Many of the smaller partnerships have an ageing partnership – Steve called this “male, pale and stale” succession syndrome. He made an interesting observation of the changing balance in the difference between clients (who ask for help) and customers (who ask “How much?”).
New business models and consolidation
Whilst there have been some new entrants adopting the ABS structure, 57% of firms are sole traders and partnerships although there is an increase in the number of Legal Disciplinary Partnerships (LDP), Limited Liability Partnerships (LLP) and Limited Companies.
Looking at the accountancy market which is dominated by the Big 4 (the largest UK law firm is about half the size of PWC) and the Mid 3 which are significantly larger than other practices he observed that it continues to consolidate.
Below the top 50 law firms there are 130 law firms turning over between £10-£50m and amassing £2.8billion fees amongst them. In the accountancy sector, below the largest firms there are only 45 accountancy firms earning cumulatively £879m.
He predicted that the Big 4 announcing their intention to create legal practices was not so much to threaten the large City firms but to attack the legal mid-market. He also mentioned that over 70% of legal firms questioned indicated that they are considering mergers.
Previously, firms and their lenders benefitted from the interest rates which generated significant interest income from client accounts – for some firms this was as much as £50,000 per partner. The recent low rates have reduced the risk reward profile. So lenders are now challenging firms to tighten their financial management.
Furthermore, new banking regulations (Basel III reforms) will come into effect in January 2015 meaning that banks will need to increase their capital requirements to match lending so this will lead to further financial pressure on their law firm clients.
Steve mentioned some of the high profile law firm insolvencies including Cobbetts, Atleys, Blakemores, Manches, Challiners (Midlands) and Linda Myers LLP (Manchester).
As an aside, he mentioned that when he trains bank staff who are dealing with law practices, they should be aware that:
- Law firms are usually run by those who do not separate business and legal issues
- They are poor at making decision
- They do not understand the numbers
- They are terrified of the SRA
- In terms of complexity, you need to multiply a law practice’s turnover by 10 in order to compare it with a non-legal business (i.e. a £7 million turnover legal practice is as complex as a £70 million non-legal business)
Continuing impact of Legal Aid Authority (LAA) reforms
Smaller family and criminal practices had suffered dramatically from past reforms and the impact continues to have a serious and negative impact. Additional onerous compliance requirements and slower payments (from 4-6 weeks to 8-10 weeks) have added to the pain and increased demand for funding from law firms to their banks.
This is also impacting many medium sized firms as previously firms reliant on Legal Aid are offering services in the private market at rates as low as £40 to £50 an hour.
SRA financial regulation and PII
Firms are facing increasing financial regulation and have to demonstrate their financial stability and governance. The removal of ARP means insurers have to price not only for the claims risk but also for the financial risk they bear as well. Last year saw 180 law firms without insurance on the renewal date. Proposals to change the minimum terms required by firms increases the uncertainty.
The new rules affecting members of LLPs who gain benefit from self-employed status without bearing any financial risk if the business fails were introduced by HMRC in April 2014. Many Fixed Share Members (FSM) have had to introduce capital into their firm as a result. This may cause further discontent between equity and non-equity partners and there will be further cash pressures in January 2015.
Risk of overtrading in recession recovery
Historically, recession recovery marked a decline in interest rates whereas in this one the interest rates will increase. This was also the first White Collar recession. As firms grow in response to stronger market demand they will have an even greater demand for working capital finance as their costs increase whilst they must wait for payment. His comments on the “living dead” firms contaminating the rest of the market were worrying.
This additional layer of financial pressure may lead some super-performing teams to depart from their current firms to greener pastures which piles on further pressure to the “abandoned” firms. This should spark concerns for those firms which rely on one or two particularly successful teams – bringing portfolio management once more to the fore.
Top tips for business survival
Steve offered the following tips:
- Keep a tight control on cash
- Understand the working capital cycle of the firm by department
- Have a defined and agreed strategy
- Look after the staff
- Make good use of IT investment
- Market the services you offer
- Keep your partners happy
- Do not forget the risk management
- Watch the competition
- Plan for your succession
Interestingly, he also commented that firms are most likely to differentiate through their use of IT and marketing (both personal and firm brands).
About Steve Billot
Managing director in the Global Restructuring Advisory practice based in London and specializes in dealing with professional practices. He has over 30 years’ experience in this sector, having been the Practice Manager and then Joint Managing Partner of a mid-tier accountancy firm.
Steve joined Duff & Phelps in February 2014 having previously been the National Head of the Business Review team at a mid-tier accountancy firm. Before that he worked in the DTI Insolvency service for ten years before moving to Levy Gee where he was the Practice Manager and then Joint Managing Partner.
Steve concentrates on advising banks and other financial institutions in relation to their exposure to professional firms; advising firms and their partners on their duties and strategic options; and recent legal sector-related transactions.
In the last five years Steve has carried out over 300 reviews into legal firms ranging from sole traders to 100 partner firms. The associated bank debt has been between £100k and £25m. Steve has a BA in economics and is a licensed UK Insolvency Practitioner.