Law firms: time to lock-up before the Brexit election

Law firms: time to lock-up before the Brexit election

That we finally have another general election has been widely anticipated. So much for the Fixed-term Parliaments Act – something of a misnomer since this will be the third such election in four years. Now that the campaign is fully underway, the outcome nevertheless remains uncertain given the unreliability of opinion polls and the enormous swings that took place before the 2017 result was declared.    

So what burning issues are keeping lawyers awake at night as polling day approaches? Anyone who has skimmed through the headlines over recent years might think of several possibilities: Brexit, continually threatening to erode work emanating from the City of London; the impact of new technology, dangerously undermining their ability to charge clients high rates for commoditised document preparation; or the Big 4 accountancy firms, ominously breathing down their necks in the legal space and leveraging client relationships to offer legal services.  

Although each of these is indeed a very real concern to many firms, one factor stands head and shoulders above the rest: competition. That is the conclusion of the twenty-fifth annual law firm report published by Smith & Williamson (SW) in conjunction with the Lawyer. In canvassing the opinions of more than 130 senior executives at the UK’s top 200 law firms, the number experiencing a slight or significant increase in the competitive landscape has risen by 10 points to 84%.

Faced with increased competition from their peers and new market entrants, traditional law firms are also feeling the pressure from ever more demanding clients. The balance of power in the law firm/client relationship has shifted, perhaps irrevocably, in favour of the client. The result is yet more competitive pressure. According to Giles Murphy, Head of Professional Practices at SW, ‘Any lawyer will tell you that they have to fight for every piece of work. It reflects the highly competitive nature of the UK market.’

The clear messages from this year’s report are that retention of top talent in an increasingly competitive market is a priority, while law firms also recognise the need to invest in technology to keep pace with the competition and to fend off cyber-attacks. However, Murphy is sceptical. ‘Law firms want to be seen as forward-looking businesses that are up there at the cutting edge,’ he says. ‘There’s a significant element of PR: the PR benefit is greater than the direct cost-saving benefit. But it will change.’

So where is competition most apparent? ‘All firms are finding competition to be a significant threat to their businesses,’ says Murphy, who advises managing partners at multiple law firms. ‘The nature of competition differs, depending on whether you are one of the legal elite based in London, or a regional player. While London is undoubtedly the most competitive environment, it still is a significant legal market with potential to grow.’

Murphy describes the ‘envy’ of some regional firms about their metropolitan counterparts. ‘We see them regularly setting their strategy as to how they can have a presence in London because they feel they are missing out,’ he suggests. ‘Whether they can achieve success – by having a satellite office or a small London presence – is quite another matter.’

Notwithstanding the competition, levels of revenue growth have been significant for several years with a good number of firms reporting double-digit annual increases. ‘While it may be very competitive to win work, there’s a lot of work out there,’ explains Murphy. However, SW’s analysis also shows that things are tighter than these headline figures might suggest: at the top 50 law firms, operating margins have declined by 1% on average for three years running. ‘Profit per equity partner (PEP) is still being maintained at high numbers, but we sense that profits are being squeezed,’ says Murphy.

He explains that ‘although there is a lot of work, and prices may not obviously be changing, firms are perhaps struggling to turn pounds of revenue into pounds of profit.’ The profit squeeze is exacerbated by various factors, not least the dramatic increase in costs, such as investment in technology, support staff salaries and real estate.

Commenting on partner profitability, Murphy argues that PEP is ‘a ridiculous KPI to use – it’s a number that can not only be manipulated, but clearly it can be managed by keeping the equity tight. Certainly, the larger firms do keep their equity pretty tight and track their PEPs because they see it as a key metric in the recruitment market, despite the fact that accountants like me tell them it’s an absurd number to be tracking.’

As revenues continue to rise, confidence has started to ebb. The SW report notes that ‘confidence has taken a significant dip from last year’s all-time high with the US-China trade wars, tensions in the Gulf, the ongoing Brexit saga and signs of a weakening global and domestic economy all taking their toll on the levels of optimism across the industry.’

Specifically, retaining the right people is reported as the number one concern for the next three years by more than half of respondents. No surprise when the legal media is awash with stories of high-profile moves of individuals and entire teams as firms vie for position in jurisdictions and product specialisms across the globe.

The SW report notes that ‘In 1994, when we started running the law firm survey, movement of partners between firms was the exception rather than the rule and trainees often built a lifelong career at their firm. Today, stories run on almost a weekly basis, highlighting the tensions between the traditional UK firms and those US firms seeking to strengthen their position in the UK market.’ The march of US firms in London, notes Murphy, is being felt more in relation to partner acquisition than client acquisition. 

The report notes: ‘In each of the past 25 years firms have said they will improve lock-up and every year the figures only show a marginal change.’ It is Murphy’s greatest concern on behalf of his clients. ‘Getting the bills out and getting them paid is particularly relevant at this time of year,’ he says. ‘That’s why Brexit and the election are interesting because a firm’s lowest cash position is almost certainly at 31st January when they have to pay sizable tax bills. In the past, where firms have got into trouble and some have gone into administration, it tends to be towards the end of January.’

Murphy’s concern centres on ‘the volatile nature of the economy, uncertainty, plus Brexit and now an election. From a cashflow law firm perspective, time-wise, this is certainly not ideal.’ He points to SW research on LLP accounts filed by the top 50 law firms. ‘From their latest accounts, there is roughly £450m of net cash on the balance sheets at year end. Compare that with their monthly wage bill of around £600m and they have about three weeks of wages they can afford to pay.’

He concedes that some debt is long term and there are overdraft facilities, ‘but it shows how thinly capitalised law firms are and how reliant they are on clients continuing to pay bills on time,’ he says. ‘In a stable environment the model works quite well. But we’re not in a stable environment. If you are a £50m turnover law firm and your clients, on average, decide to defer payment for a week that will cost you £1m of cash. Tell partners that clients are slow in paying by seven days and they would not appreciate the impact.’

The report pointedly concludes that this ‘should encourage law firms to build strong cash reserves.’

Dominic Carman

Written by:

Dominic Carman, journalist, writer and legal commentator.

Author: Dominic Carman