2010 – a defining year for law firms

Chris Marston, Head of Professional Practices at Lloyds TSB Commercial, assesses solicitors’ prospects in a year of change and transition. Lloyds TSB Commercial is a Legal Futures Associate

Key to success: there are many factors for law firms to consider this year

For SMEs in all business sectors, 2010 promises change and a degree of uncertainty. There are signs of economic improvement, but the depth of the recession in the UK has engendered a degree of caution among consumers and within the business community that may take time to fade. For solicitors’ practices, there are added challenges, and as many opportunities.

It seems clear that many law firms will end the year in a different shape than they entered it. Many will re-engineer their business in terms of structure, business mix, staffing levels, location or gearing between owners, other fee earners and support staff. Some firms will make acquisitions to widen their geographical coverage or to improve the business mix. Some law firm owners will sell up. A number will reduce the size of their business, restricting it to a smaller patch, a narrower range of services or a niche specialism. Some may cease trading. Few will have the luxury of remaining unchanged.

A lawyer might look at this list and feel negatively about some of these options. That is understandable, but in reality each of these options is perfectly worthy, as long as it is desired and planned. This year will give plenty of stimuli for law firm owners and managers to consider the right strategic direction for their business and decide which tactics during 2010 will secure for them the outcome they seek.

I see three major influences for law firms to understand and plan for in 2010, but only after proprietors have carefully considered the most important issue of all – what do they actually want from being law firm owners? Are they seeking to build value, or simply to make the best living they can? Do they enjoy business management, and if so are they equipped for it? Or would they prefer just to get on with practising the law?

Every business, and therefore every business owner, needs an exit plan. What is theirs, and is there real congruence between the personal goals of the owners and those of the organisation? If the intention is to merge, then with whom and when? Has the right merger partner been identified, and is there a clear plan to ensure that the merger brings optimal value?

Many solicitors tell me that they intend to sell their business, yet have no idea of who will purchase it and at what price, and they often fail to appreciate the limited value of a business that has been built around the personal brand of one or two individuals who will be departing.

Regulatory and competition changes

The Legal Services Board (LSB) is now up and running, and determined to implement its remit to stimulate greater competition, efficiencies and benefits to consumers of legal services. The LSB has eight regulatory objectives:

  • Protecting and promoting the public interest.
  • Supporting the constitutional principle of the rule of law.
  • Improving access to justice.
  • Protecting and promoting the interests of consumers.
  • Promoting competition in the provision of services in the legal sector.
  • Encouraging an independent, strong, diverse and effective legal profession.
  • Increasing public understanding of citizens’ legal rights and duties.
  • Promoting and maintaining adherence to the professional principles of independence and integrity; proper standards of work; observing the best interests of the client and the duty to the court; and maintaining client confidentiality.

Solicitors may have doubts over whether these objectives are likely to be achieved by the policies that are currently being followed, but nonetheless these changes are on the way. The Office for Legal Complaints will be fully functional by the end of 2010, and this year will be the last where ownership by non-solicitors is restricted to 25%.

The LSB has announced that ABS businesses will be permissible from October 2011. This will see new players enter the market and firms therefore need to make sure they are configured to remain viable in the new competitive landscape. And they can be, provided they establish a clear strategy regarding the markets they intend to serve, the structure they need in order to deliver profitability and the right balance of debt and equity so that they can be properly financed. Additionally, they will need to make a real commitment to invest in their people and to build value in the business.

Some firms may already have the focus, management strengths and innovation required, but if they don’t, they’ll need help. Specialist accountants are uniquely well positioned to advise fellow professionals on business issues, understanding as they do the partnership model, the professional ethos and what best practice looks like in terms of optimising professional practice performance. Specialist bankers can provide valuable input too.

The economic climate – the challenges of the upturn

Most economists now agree that an upturn has begun in the UK economy, and the consensus among economists points to growth in UK and other world economies. Lloyds TSB Corporate Markets published The UK Quarterly Economic Bulletin – Second Quarter 2010, the main observations of which included:

  • The volatility in recent economic data resulting from poor weather conditions, the reversal of last year’s VAT cut and the ending of the stamp duty holiday on low-cost house purchase have made it difficult to ascertain whether the economy built on the upwardly revised 0.4% quarterly gain it posted in the fourth quarter, or relapsed under the weight of a renewed housing/consumer- led downturn. Overall, our central estimate is that Q1 GDP continued to expand at much the same pace as it did in the prior quarter, driven largely by government spending and a slowdown in the pace of de-stocking. Fundamental drivers of growth, namely consumer spending, business investment and net trade, however, all appear to have remained relatively weak in Q1.
  • While the UK now appears on the road to recovery, the improvement is likely to be a slow and gradual one. The planned tightening in fiscal policy, the ongoing fragility of the labour market, the eventual reversal of quantitative easing and the persistence of credit constraints all pose formidable obstacles to strong and sustained UK growth. Indeed, based on our forecasts, we do not expect the level of UK GDP to return to its pre-crisis level until late 2012. Moreover, as a result of the structural shock, we estimate the UK economy has experienced a permanent loss in its supply capacity of around 5%.
  • The UK’s recovery from recession has been slower and the downturn deeper than that of the average of the G7 economies. UK economic growth fell for six consecutive quarters, from Q2 2008 to Q3 2009, whilst the average fall in the other G7 countries was four consecutive quarters. We have identified the high degree of leverage in the UK as one of the reasons for this, alongside a higher services share of the economy. Given that the downturn was exacerbated by a global financial crisis, one of the features of the recession of 2008/2009 is that services output has contracted more than any other sector. This makes this recession unique in recent UK economic history, and explains why the decline in the level of GDP has been so pronounced.
  • Looking ahead, we are cautiously optimistic that recovery will steadily take hold. Monetary conditions remain exceptionally loose, inventories are well below their historic norms, the labour market appears to be stabilising, and the fall in sterling should boost net external trade. Monthly economic data so far released suggest that the recovery will be uneven. Expansion at a similar pace to Q4 2009 is likely in Q1, but Q2 and Q3 could be more of a struggle, partly due to Budget and election uncertainty. In any event, the March Budget does not so far seem to have altered expectations about the path of the economy. Whether a later Budget has any impact remains to be seen. We look for UK economic growth of around 1% this year, with recovery to just above 2% growth in 2011.
  • The challenge for the UK is that a weak currency, which it currently has, is not enough: a focus on key fast-growing export markets is also required. Nevertheless, with a large negative output gap, price inflation will fall back later in 2010. Hence, we look for official interest rates to remain low at 0.5% into 2011. However, we expect longer-term money market rates to remain much more volatile.

Many solicitors have traditionally been dependent upon domestic conveyancing, so what news on the housing market? The March 2010 House Price Index from the Halifax presents a mixed picture. Prices were up 1.1% during the month, but during the first three months of 2010, they were only 0.6% higher than in the final quarter of 2009. This was smaller than the 3.6% rise between the third and fourth quarters of 2009, suggesting a slowdown in the trend rate of house price growth.

However, compared to the trough of April 2009, prices are up 9.1%. There are signs that an increase in the number of properties available for sale is beginning to reduce the imbalance between supply and demand. This should help to contain the upward pressure on house prices.

What about solicitors’ SME clients? The results of the latest Business in Britain Survey were published in December 2009. Conducted by Lloyds TSB Commercial, this bi-annual survey tracks the performance of 1,732 UK companies and their views on prospects for the coming year. The latest report shows British businesses are now more confident than at any point in the past two years, and are hopeful of a revival of fortunes during 2010.

The report reveals a rising confidence in prospects for sales, orders and profits, further signs that the recovery will gather pace in 2010 and that businesses remain cautious about investment and recruitment.

Firms wishing to make the most of economic recovery will need to be careful that they understand the working capital consequences of gearing up again. Many firms do not have the ability internally to forecast cashflow. Banks will wish to support them as they take on more work, but reliable financial forecasting will be a key requirement. Firms without an in-house accountant should seek external help in this respect.

The political landscape

We have just seen some unprecedented events on the political landscape, with the formation of the UK’s first coalition government for 65 years. This Conservative-led government is currently working on its programme and its priorities, and we have yet to see what the impacts will be upon the legal sector.

What were the Conservatives saying in the lead-up to the general election in relation to the legal sector? Are they any more ‘solicitor-friendly’? Here are a few quotes from leading opposition figures:

  • “We really should be concerned about the lasting damage that could be done if we’ve got this wrong. It could permanently damage the provision of criminal legal aid.” (Shadow justice secretary Dominic Grieve, speaking in June 2009 when he gave a commitment to halt the roll-out of best value tendering if elected, pending a full appraisal.)
  • “If we possibly can, we’re going to find ways of slowing down the process. We’re not going to reverse the Legal Services Act 2007 but we certainly won’t move it any further.” (Shadow justice minister Henry Bellingham proposing an evolutionary approach to alternative business structures, describing alternative business structures as “one more assault on the high street solicitor”.)
  • “If we win the next election, we will scrap HIPs [home information packs] as soon as possible after a consultation period – we expect to be around 100 days. We do not plan to replace HIPs with anything else.” (Shadow housing minister Grant Shapps)

These quotes were perhaps music to some solicitors’ ears, but Henry Bellingham’s suggestion a few months ago that solicitors’ client accounts should be centralised so that the interest can be used to help fund legal aid was considerably less attractive to the profession.

Now that the coalition is starting to take shape, we have seen Kenneth Clarke appointed as Lord Chancellor and Secretary of State for Justice, with Dominic Grieve and Henry Bellingham appointed elsewhere. However, the commitment to scrap HIPs has featured in the coalition agreement between the two parties.

In conclusion

The extraordinary combination of economic, regulatory, competitive and political forces at play will make 2010 will be a defining year for many law firms, and business owners will need to focus on their longer term strategy, be clear about where they are heading and make sure that their actions are conducive to their desired outcome. Successful firms will be those who plan ahead and are prepared to seek help from their professional advisers.

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