SME law firms eye mergers as good times return

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8 April 2015

Cash: median net profit per equity partner up 17%

Cash: median net profit per equity partner up 17%

Smaller law firms continue to see merger, rather than external investment or bringing in non-lawyer owners, as the more likely path to growth, Law Society research has found.

It also found that the majority of practices polled are now recording net profits ahead of where they were before the recession, while only 8% of firms saw partners’ total drawings exceed profits, compared to 21% the previous year.

The 15th annual law management section financial benchmarking survey said that a third of those surveyed thought a merger likely in the next two years – although only one in five were actually in talks at the moment.

Some 13% expected to seek external finance for expansion, while 17% thought they would bring in non-lawyer owners, both figures down from 20% last year.

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The number of firms that considered it likely they would sell to a third party continued to fall when compared to previous surveys, down to 10%.

There was also less interest in joining networks, with just 5% of respondents – half the number of last year – saying such a move was likely.

The survey, conducted by accountants Hazlewoods, covered 159 firms, mainly between two and 25 partners in size. The average fee income across the sample was £4.5m.

More broadly it painted a positive picture of law firms’ financial stability, with a “dramatic rise” in the percentage of practices operating profitability and within their overdraft limit during 2014.

It said that “for many, the key finding will be the fact that the median net profit per equity partner (before notional salary) has increased again, up from £123,621 in 2013 to £144,567 this year – a rise of 16.9%”. This followed increases of 3.6% in both 2012 and 2013.

When adjusted to include a cost for equity partners and notional interest on partner capital, the median ‘super-profit’ for the year was £72,077, compared to £46,017 in 2013. Super-profit as a percentage of total income also went up, up from 7.8% in 2013 to 11.7%, while the median return on capital employed (super-profits as a percentage of partner capital) rose to 40.8% from 26%.

Median practice fee income increased by 8.7%, with residential and commercial convenyancing the booming practice areas, growing fee income by 21% and 13% respectively. All other work types saw increases, except for criminal law and personal injury, even though personal injury practice recorded the highest fee income per equity partner – around £530,000. Wills was the worst field, at around £90,000.

The median fee income per fee-earner was £116,641, but almost 90% of this was eaten up by the costs associated with them, including support staff costs and non-salary overheads.

“Looking at it another way, if a practice has a 31 December year end, on average it takes until 21 November for a fee-earner to earn sufficient fees to cover his or her total costs for the year.”

Financial stability was on the up, the survey concluded. As well as the fall in the number of firms where the partners withdrew more than was earned in profit, one in eight practices were regularly operating near their overdraft facility limit, compared to one in five practices in 2013. Borrowings exceeded current assets for just 4% of participants, and exceeded equity partner capital for only 1%, compared to 20% last time.

Other key findings were that:

  • Median equity partner capital (combined total of capital account, current account and tax reserves) increased by 8% to £172,570;
  • Median fee income per equity partner was £601,924, up 8.5%;
  • Median interest receivable increased by 6%, following a 24% increase last year;
  • Total year-end lock-up days (WIP and debtors together) fell by nine days to 153 days;
  • The median cost of an employed fee earner, including fixed-share partners and notional salaries for equity partners, was £45,945 per fee earner, down slightly on the 2013, which the survey attributed to firms increasing their fee-earner numbers with lower-earning people:
  • The ratio of fee earners to partners has increased slightly, from 4.7:1 to 5:1;
  • The number of secretaries per fee earner fell very slightly, to 0.61 to 1. The number of all other support
  • staff per fee earner increased slightly, at 0.39 to 1;
  • Participants predicted a median fee income growth of 3.3% for 2015, with the most optimistic forecasting 9.4%.

Andrew Harris, director of Hazlewoods, said: “We were pleased to be able to report improvements in all of the key measures of financial performance. The results for many are finally back to where they were six or seven years ago.

“It was also very encouraging to see that practices seem to have taken on board the whole issue of financial stability, and are paying much closer attention to issues such as cashflow, lock-up and working capital.”

Paul McCluskey, head of professional practices at Lloyds Bank Commercial Banking, which sponsors the survey, added that he was plead to see “a change in attitude”, with the reduction in the number of firms where partners’ drawings exceed profits.

2 Responses to “SME law firms eye mergers as good times return”

  1. This, to me, is a counsel of despair. We all know that most mergers fail to deliver the benefits intended. We all also know they are expensive to engineer and waste a lot of senior time.

    Yes, the numbers quoted aren’t great. The gross profits available to law firms are such that no partner should be satisifed with £120k per year. The lock-up figure quotes is also capable of a lot of improvement (assuming not a PI/Clin neg workload).

    Why the mania for merger?

    I think one reason it is because firms don’t realise that it is cheaper and easier it is to grow and grow more profitable organically. Their experience tells them it is hard, of course, because they haven’t done it in the past.

    And why? – because they have used the same failed methods over and over.

    On growth.. the irony is that they’ll talk to several dozen marketing firms, who will almost all tell them that they’ll do the same things as the others, but better. Find the one that does something different!

    The problem as I see it is twofold:
    1.People have been trained in methods that are constantly ‘behind the curve’ and the discussions that take place are more appropriate for practising conditions a few years ago. One example is the use of mobile sites. When we built these (and they really worked) 4 years ago, not-one was talking about them. Now lots of people are, but the essential point has moved: now it is about making them cheap and highly targeted…first mover advantage is lost (the same is true of SEO and, increasingly, social).

    2. Selling to law firms is expensive as traditionally done. if you invest £2k in each pitch, and win only 1 in 4, then to make a return, someone has to pay the £8k…and that someone is the client they get. Accordingly, many firms tell people about what is best for the firm winning the pitch, not necessarily the client…and the easy way to do this is to talk about what the client understands…which, given the lag between best practice and general awareness, means supplying yesterday’s solution.

    Mergers exemplify the issue in a different way. Instead of doing something different, firms trust that effectively doing the same thing in a bigger unit will somehow produce a better solution.

    If I were a partner in a firm producing figures like those quoted above, I’d start INSIDE my firm, because clearly there’s a big improvement to make there…and once that is sorted out, you may well find that merging with the firm across the road seems a much less good idea.

    If what you are doing isn’t working, the answer isn’t to do more of what you are doing that isn’t working, it is to do something different.


  2. Joe Reevy on April 8th, 2015 at 8:22 am
  3. Mergers are not easy projects to achieve often because partners approach the project from an incorrect start. The most important matter for consideration from the start is compatibility. The business side comes next and I stress business.
    Have a free no obligation chat with me.

  4. Eric Golding on April 8th, 2015 at 3:12 pm

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