Eight out of 10 City law firms report fall in PEP

Owen: Increase in lock-up worrying

Profits per equity partner (PEP) are tumbling at City law firms despite increases in revenue, new research has found.

Eight in 10 City firms reported a decline in PEP this year, by an average of 21% to £513,660. Regional firms fared better, with 62% seeing PEP fall by an average of 10% to £283,047.

The picture was very different when it came to revenue, with only 22% of all law firms reporting a fall, and 28% saying their revenue had increased by more than 10%.

The smallest firms (those with an annual revenue of less than £10m) were much more likely to report a fall in revenue than those with turnovers of over £50m – 42% compared to only 8%.

However, firms with turnovers of £20m-£50m were least likely to report revenue increases of over 10%, with smaller firms turning over £10m-£20m the most likely – 9% compared to 44%.

Accountancy firm Crowe based its law firm benchmarking survey, compiled in association with the Institute of Legal Finance and Management, on responses from 50 City and regional law firms.

City law firms were slightly more likely to report a decrease in their profit pools (52% v 48%). Researchers said: “Although fee income has increased for most firms, this has not translated into surging profits, with profit pools dented by increases in people numbers and higher baseline expenses, which – driven by the challenging economic backdrop – have risen to pre-pandemic levels (or beyond).”

They went on: “A key challenge for firms is to actively manage outgoings in the face of persistent inflationary pressures and salary costs that continue to rise.”

Three quarters of law firms increased their headcounts, with City firms more likely to increase partner numbers as opposed to other staff.

City firms increased partner numbers by 5.4%, compared to 2.3% for regional firms. Regional firms grew fee-earner numbers by 9.6%, more than double the figure for City firms. Regional firms increased their total headcount by 8.4%, compared to 5.1% for City firms.

This also pushed personnel costs as a percentage of fee income up to over 40% for City firms and 47% for regional firms. The average increase in personnel costs for all firms was 13%.

When it came to lock-up days, regional firms managed to reduce their average annual figure slightly from 129 days to 122, while the figure increased in the City from 138 to 142.

Crowe commented: “With ongoing growth plans, stubborn inflation and some emerging signs of economic turbulence, working capital may well come under pressure in the near future.”

Generally, the report said, law firms showed “buoyant expectations for the year ahead”, with 70% expecting fee-earner number to increase by up to 10% and 77% looking forward to improved financial performance.

Nicky Owen, head of professional practices at Crowe, commented: “After a strong 2022, the legal sector has seen more muted growth across most financial metrics this year, with City firms in particular battling to keep rising costs under control.

“If inflationary pressures and the battle for talent continue to intensify, the year ahead could see firms passing on the cost to clients through fee increases.

“One worrying trend for City firms is that lock-up days have increased. Cash is king and firms will want to ensure money is coming into the business promptly to sustain their growth projections, particularly if costs continue to soar.”

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