Rising overheads are putting pressure on profits
The turnover of SME law firms in London and South East rose by 4% this year, according to an annual benchmarking survey by accountants HW Fisher & Co.
However, the survey warned that rising overheads would continue to put pressure on profits, “especially in a climate where downward pressure on fees seems to be felt strongly”.
The report said: “Growth is normalising around 4% per annum, not sufficiently greater than general inflation to be able to absorb continued ahead-of-inflation rises in overheads.
“For the long-term health of the sector, rents, and particularly professional indemnity premiums, need to stabilise.”
Among the 75 firms with turnovers of up to £35m that featured in the survey, the report found “firms at all size levels” that generated only £60,000 profit per partner.
“Whilst this may seem to be a reasonable return on capital, it is clearly scant reward when you factor in that it also needs to pay for a full year’s work as a partner of a law firm.
“With the picture of increasing pressure from overheads that we described before, these profit figures may well be squeezed lower still.
“Consolidation therefore remains an attractive option, allowing the pooling of overheads and relieving the pressure on firms that may otherwise be struggling to make it under their own steam.”
The survey reported an increase in average profit per partner from £154,000 in the financial year 2011/12 to £172,000 in 2012/13. The largest firms involved in the survey, with turnovers of over £20m, reported an 18% increase in partner profits to just under £260,000.
Some of the law firms in the survey, particularly the smaller ones, were “very highly geared”, with debt becoming the “sole source of finance” and no equity being retained in the business.
Around a third of firms said that they had seen more downward pressure on fees over the past 12 months, with only 9% seeing less.
Property was the strongest performer in terms of types of legal work, accounting for 26% of firms’ activity this year, up from 14% last year. Litigation, which made up 36% of the total last year, fell to around 26% this year.
The amount of personal injury work being done by non-specialist firms fell from 15% last year to just 1% this year.
Paul Beber, partner at HW Fisher, said: “While larger firms thrive, smaller firms could begin to feel the pinch as a divide opens up between those firms doing well and those that are struggling. Short-term lending to legal businesses is on the increase with a debt on the books of almost nine out of ten firms.
“With the threat of interest rate rises looming, any firm that becomes dependent on such borrowings could find themselves in a downward spiral that is difficult to recover from.”
I agree that merger can seem very attractive for smaller law firms who are struggling financially. However mergers are fraught with difficulty. One of the biggest problems is, perhaps, control – the most successful mergers are not really mergers at all – they are in reality takeovers where the new firm has clear leadership. Secondly far too many small firms don’t do their homework before getting into bed with another small firm – there are so very many traps for the unwary merging firm. Finally, and this is probably the biggest problem, if two firms get together because they are struggling, what is the result going to be. To me firms and naïvely believe that they will automatically turn into one large highly successful firm. The reality is, sadly, far too often simply a much bigger failing firm.