Small and mid-sized law firms need to accept that lower levels of profitability are becoming the “new normal”, it was claimed yesterday.
Their income is also falling, with firms of 11-25 partners recording the biggest drop last year – 11% – compared to only 1% for sole practitioners.
However, sole practitioners’ profitability plummeted by 40%, leaving them with average annual profits of only £41,000, according to national accountancy network MHA.
Karen Hain, head of MHA’s professional practices sector, said law firms in the past aimed to achieve net profits of 33%, but it had become clear that the “new normal” was closer to 25%.
She linked the drops in income and profitability to changes in the personal injury and conveyancing sectors, with personal injury cases “running off and not being replaced with matters generating the same fee levels”.
Ms Hain went on: “New types of litigation work, such as holiday claims, have been stopped in their tracks by government legislation. Other new work types, like pension mis-selling, are still in progress and had not yet generated significant fees in 2017.
“Smaller practices have seen even more competition from online sources. This has been prevalent in residential conveyancing matters, with traditional high street practices suffering from a fall in new matter openings.”
MHA found, in its annual legal benchmarking report, that there was a drop in income “across the board”, with firms of between two and 10 partners, and over 25 partners seeing a fall of 5%.
Profitability also fell, particularly for sole practitioners – to a level nearly 60% lower than the “heady heights” of 2015, when it was £100,000. Profit percentages fell to 12% for sole practices and 15% for those with two to four partners.
“This level of profits is the lowest since we started our benchmarking statistics five years ago,” the report said.
“The smaller firms are now starting to struggle in a market where the trend seems to be leading to larger firms dominating the market place.”
Profit per equity partner fell for all sizes of firm, by 13% for firms with 11-25 partners and 8% for those with more than 25.
Researchers said this was driven not only by falling income, but by a shift in the ownership of firms, with “larger fee-earners remaining as salaried partners rather than moving into equity positions” and a “cultural change” in favour of higher salaries without the financial risks of equity ownership.
The report found a “worrying increase” in lock-up across law firms of all sizes in the past two years, apart from those with 11-25 partners. Increasing lock-up at a time of reduced turnover for firms put extra pressure on funding.
Smaller practices billed more regularly but took longer to collect the debts, while larger firms took longer to bill but had better credit control.
“The key is to get the balance right. Our survey also suggests that attention was focused on managing lock-up after the last recession (cash is king), but that this focus may have slipped in the last two years.”
Ms Hain added that as fixed fees also became part of the “new normal”, firms would need the “financial data at their fingertips” to accurately price up work with profits built in.
“Efficiency will need to be a key planning theme for 2018, so that all work completed is done following the quickest and most accurate procedures, by the lowest costing individual. This will help bolster profits, which have taken a negative hit in 2017.”
MHA, a UK-wide association of accountancy and advisory firms, based its report on data from 113 law firms.