Weaver: Strong resilience across the industry
Four in 10 law firms would actively consider third-party investment, according to research that also warned some firms would go bust without client account interest.
NatWest’s annual legal report showed too how almost all firms are now using AI, from just half a year ago.
Authored by Andrew Allen, a partner and head of accountants PKF Francis Clark’s national legal sector team, the report drew on the detailed analysis of 112 law firms’ finances, with turnover ranging from £1m to £250m and a median of £23m.
Some 40% of firms reported that they would actively consider some form of third-party investment in their firm, up from 29% when asked two years ago.
While the majority said it would be to help their growth plans, a range of other reasons were cited, including succession management, technology investment and “opportunistic windfall realisation”.
A third of respondents reported that competition for talent was the most significant challenge of private equity-backed firms in the market. A further 24% cited increased business investment costs to keep up with them.
The report explained: “Many firms are being pushed to accelerate investment in infrastructure to enhance both the employee and client experience, enabling them to compete with externally funded firms which often have the budgets to invest quickly and boldly in these areas.
“At the same time many externally funded firms, for a mix of reasons including the medium-term exit of their investors, are seeking to rapidly gain market share which in turn places pressures on work pricing.”
The survey found that law firms’ exposure to interest income has reduced in 2026 compared with the last three years but remained significant for many firms.
Interest profits represented a median of 3.7% of firms’ earned income (5.6% last year); this converted to 14% of profits per equity partner (PEP), down from 21%.
In 2022, before the base rate rises, less than 1% of PEP would have come from interest income.
Mr Allen wrote: “We must of course be careful in reporting these types of financial performance statistics and remind ourselves that clients do, in accordance with the SRA accounts rules, receive the interest they would have earned if they had held client funds themselves.
“We should also be mindful that inflation in legal service fees/rates over the last five years have usually fallen behind general inflation.
“Based on the current profit model in law firms, which like the position pre-2008, is supported by interest income it is important to consider that if law firms no longer retained excess interest, then this would lead to both significant inflation in their fees and most probably the demise of notable volumes of law firms with the associated pressures and challenges that would bring to the SRA intervention team.”
Asked about the Ministry of Justice’s proposals to divert client interest to its coffers, 29% of firms suggested inflation in legal prices would be the main consequence, 24% said increased pressure on margins, 22% the administrative burden and 11% the financial failure of law firms.
In other findings, Natwest reported:
- “Solid” optimism in the sector, with 90% of firms optimistic about the future and 27% very optimistic;
- Median fee income growth in 2026 of 7% (12% in 2025), with growth stronger in larger firms;
- Private client was the strongest fee growth area, with family law the least;
- Margin improvement has “stalled”, largely due to the impact of the increase in employers’ National Insurance and managing AI;
- Median PEP was up just 2% (2025: 23%), with small firms performing better
- The trend of reducing lock-up in the last couple of years “appears to have halted and we have evidence of increases in the level of lock-up”. While there was no evidence to show law firms relying on increasing debt levels, “anecdotal evidence points to reducing cash reserves”; and
- For every £1 of members’ funds/net assets in the business, the median level of debt was 13p, lower than in 2025 because firms were “taking longer to pay out prior year profits (current accounts) to members and there is evidence that cash balances have been reducing”.
The survey found a dramatic increase in AI use – whereas in 2025 half of firms were not using the technology, a year later the figure was just 5%.
Streamlining administrative processes was the most significant benefit – only 10% in each case cited client delivery, cost savings and service accuracy/quality.
Uncertainty about which AI tools to use was the biggest challenge for 34% of firms, while a further 18% identified concerns around their ability to recover the investment costs associated with them.
The minority of firms who have looked at recouping these costs were mainly reviewing pricing and service options, while a small minority have sought to reduce headcount.
David Weaver, head of business and professional services at NatWest, said: “While the latest results indicate ongoing challenges affecting the sector, leading to more subdued top-line growth and continued pressure on margins, it is encouraging to see strong resilience across the industry, with most firms remaining optimistic about the future.”
We will be discussing the future of client account, and interest from it, at our Regulation & Compliance Conference on 3 December in London.
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