Murphy: Cash flow risk
There are “many good reasons” for larger law firms to considering listing on the stock market, especially with growing competition from alternative legal services providers (ALSPs), a survey has warned.
But most will stick with LLP status, despite it starting to look “outdated”, despite the Big Four accountants in particular being in “prime position to exploit the opportunities in the legal sector”.
A fifth (21%) of firms said they had already moved away from the partnership model, while a further 18% said it was proving to be a constraint on their growing business.
Smith & Williamson’s 25th annual law firm survey was completed by 132 managing partners and senior management personnel from across the UK, 40% of whom were in London.
It recorded that firms had seen competitive pressures increase in the last year and expected them to ramp up over the next 12 months.
While this was mainly from their current direct competitors, the survey said firms were “finally realising” that the threat of the Big Four and ALSPs “is here to stay and this group is beginning to make serious inroads into their market”.
Large law firms were reacting by creating their own alternative service: “Firms are continuing to make investments in technology to help streamline legal service delivery, creating or acquiring low-cost service centres to offer certain types of legal work at more competitive rates and, most recently, starting to create entirely new non-legal services.”
Smith & Williamson partner Tim Adams noted that, without much fanfare, the Big Four have amassed an estimated global fee-earner base of over 10,000, using technology to deliver a more cost-effective approach.
“Rather than being full service (and potentially having to subsidise those practice areas that don’t perform to the same level), they have focused on those areas of law more complementary to the rest of their practice and where they believe the financial returns are the greatest.
“The Big Four operate some of the most successful professional practices firms on the planet and, after many years of experience of auditing the majority of the top 100 law firms in the UK, they are well placed, highly knowledgeable and well-funded.
“In other words, they are in prime position to exploit the opportunities in the legal sector.”
This did not mean that all law firms were doomed, Mr Adams stressed, but said they needed “a strategy not just to fight off the current usual suspects but also the emerging threat of the ALSPs”.
It may only be 15 years since law firms started adopting LLP status en masse to reduce the financial exposure of individual partners, but Smith & Williamson said this risk-structured approach was beginning to look outdated.
“Arguably, the LLP model does not possess the decision-making agility of a PLC. Attempting to carry consensus across the partnership (which could be made up of in excess of 500 partners) can be cumbersome, while it can also force too narrow a focus on annual results, rather than the benefits of long-term investment.”
There were, it said, “many good reasons” to move towards listing, “including an enhanced ability to attract top talent through attractive share option models. It also negates the need for mergers as a route to growth, a model often disliked by partners”.
But the survey said such radical change was unlikely to happen soon for most large law firms, with 58% of respondents indicating that they were most likely still to be an LLP in three to five years’ time, despite its shortcomings.
“One option therefore is for firms to incorporate additional companies into their structure to operate alongside the LLP in the way that Eversheds Sutherland is aiming to do with Konexo.”
Eversheds Sutherland revealed in June that it is hiving off three of its legal services teams into an alternative business structure, from which it will seek external investment to help the new venture more than double revenues to £100m by 2024.
Partner Fiona Westwood wrote in the report that the LLP model did not make embracing new business lines easy: “There is no right or wrong answer but if working capital, staff retention or the division of the business are a concern, then it is worth considering a change.”
The research showed how law firms always talk about improving lock-up but do not back it up with action.
It said: “The strategy for improved lock-up appears to centre around improved information for partners so they can make better billing decisions. In larger firms, these activities extend further into providing client access to granular information, thereby providing transparency across the billing process.
“Coupled with ‘agile’ and accurate time capture, the firms that have invested in these systems and processes can potentially reap large rewards. History has taught us, however, that relying solely on an IT solution to fix problems that are deeply rooted in the operational psyche of a business will not deliver the desired results.
“A strong change management and training programme is required and for this to be truly successful firms need to instil the importance of best practice in their lawyers as trainees, rather than just changing the habits of partners and senior associates.”
Giles Murphy, partner and head of the professional practices team at Smith & Williamson, said its work had found that, by the 2017/18 year-ends, there was over £5bn of outstanding invoices due to the top 50 law firms.
But he cautioned that even a short-lived economic shock – such as Brexit, a change of government, US foreign policy or terrorism – cold cause real problems for law firms’ cash flow.
“In any one of these scenarios, assume the instant impact is that clients delay paying their lawyers, albeit only by a week,” he said.
“If you operate in a £50m turnover firm, this would permanently reduce your cash balances by around £1m; a £100m turnover firm and the impact would be around £2m. If the delay is longer, the reduction increases by £1m or £2m each week.
“Suppose the economic shock then dampens work levels over November, December and into January (while costs remain at their historic level). VAT and rent will be payable in December or January and then for most firms, there is the prospect of settling the partners’ tax liabilities at the end of January.
“So if you don’t currently know how many weeks of wages your firm can support and the likely impact of the events above on your practice, maybe it is a question you ought to ask.”
The Legal Futures Innovation Conference on 28 November will hear from the CEO of Rosenblatt, one of the six listed law firms.
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