Posted by Ian Vicary, a partner at Legal Futures Associate Weightmans LLP
Staffordshire legal practice Hacking Ashton LLP, which was one of the first 100 firms to register as an alternative business structure (ABS), recently closed its doors in the first high-profile demise of any SRA-regulated firm operating under the new business model.
The first failure of an ABS may cause those currently seeking a licence to ask whether it remains commercially viable. The novelty value of an ABS ought not to disguise the fact that any structure must be based on a sound and viable business model, yet the failure of Hacking Ashton leaves us asking if liberalisation will be the panacea to the current ills of the industry or simply a damaging distraction.
The expected deluge of ABS applications has not transpired. Part of the reason for this has been the slow application process, and although this has now been streamlined, it has meant further delays for applications already underway. Assuming that the uptake rises by the end of 2013, this still represents a much lower engagement than expected and it cannot all be blamed on the process itself.
In reality the flood of private equity funding into the legal market hasn’t materialised. This is partly due to lack of funding (banks are unwilling to invest in tried and tested fields let alone speculative new markets), but is also a reflection of the realisation that the ABS model is no answer to the more pressing questions affecting the legal profession: are firms generally fit for purpose?
Recent research from Company Watch suggested that a third of law firms are under financial pressure and may require refinancing or an injection of capital. Certainly the SRA sees financial stability as its key concern, demonstrated by its recent circulation of a financial health questionnaire to law firms.
Funds will rarely be forthcoming where a practice isn’t financially robust. Whilst private equity investment may be available to allow firms to exploit new markets and introduce new systems to maximise profit, it will not be utilised to shore up a failing model.
Many investors hold nagging doubts as to whether employees can be adequately incentivised to commit to a firm that has a third-party investor onboard where career progression may be unclear, in contrast to the investor’s exit strategy which is likely to be tangible.
With this in mind, and in light of the cost (both financial and in management time) of an ABS application, it may be seen as an expensive distraction. The real issue for all law firms revolves around a fundamental analysis of whether the long-term business model is viable.
Time must be spent focusing on basic business questions: what are the firm’s lock-up days and debt recovery like? How well does the firm record work-in-progress? How well does the firm ascertain a client’s ability to pay before commencing work? How highly geared is the business?
The current landscape also demands that law firms must also concentrate on regulatory compliance. A non-compliant business is one that cannot continue to trade. Compliance is not an avoidable add-on, but a fundamental commercial imperative. Compliance encompasses not only the more obvious COLP and COFA, and money laundering/’know your client’ matters but also, for example, the client engagement process, which in turn has a direct bearing on the recoverability of debt.
There are also what many see as the more esoteric but equally valuable business sustainability issues to consider, namely process, data capture and innovation. Driving work down to the most basic process level is seen by many as the Holy Grail. Commoditised legal services are one of the first things a third-party investor will look at, hence why the process-driven personal injury market has been among the first targeted by investors.
Whichever area of the market they operate in, law firms must understand that financial health, regulatory compliance and efficient processes are the cornerstone not only of attracting investment, but also of survival. Unless firms converting to ABS status appreciate these underlying principles before deciding on the most commercially viable structure for their business, Hacking Ashton may not be the last newly formed ABS to fail.
Rather than rushing to negotiate the long and winding path of an ABS application, the majority of law firms ought to devote time and resource to a strategic review of their business model, identifying the key drivers of risk which are likely to raise concerns with both the SRA and the bank.
The need to run an efficient, financially robust and compliant business has never been more important to ensure survival. Whilst these fundamental hallmarks will not guarantee success, without them there will be a bleak and short-lived future.
Ian Vicary is a corporate partner in Weightmans LLP’s legal services team which provides legal advice and support to law firms