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Major study lays bare finances of SME law firms: best have 40 times the PEP of the worst


Arundale: too few firms choose to employ financial indicators

Profits per equity partner (PEP) at the most successful small and medium-sized firms were more than 40 times those of the bottom-earning firms last year, a major study by NatWest has revealed.

It also found that while fees at the 337 firms polled were holding up well – the median level of fees per equity partner was £393,000 – “it could be observed that the average firm was making virtually no real profit”.

This conclusion was based on median PEP across all firms being £90,000 and fair remuneration for an equity partner at £80,000.

Median PEP of £118,000 at larger firms was exactly double that of smaller ones.

Overall, however, fees and profit performance were weathering the economic doldrums. Median profit as a percentage of fees was 23%, with performance from the lowest to highest groups between 15% and 33%. “This was in line with pre-recession surveys and showed the legal sector in good health,” the survey observed.

The benchmarking survey, commissioned by NatWest’s commercial banking division and written by chartered accountant Robert Mowbray, polled firms with fee income of up to £27m, and collectively of more than £1bn. It found huge disparities across the firms, with profit to fees varying between 5% and 54%, and PEP ranging from just £11,000 and £459,000.

Firms in the top 25% of performance for gearing, recovered rate per hour and margin, made a profit of around 10 times more PEP than firms in the bottom 25%.

“One of the key drivers of profitability was gearing: in small firms it was two, while in large firms it was four. Small firms need to think about the development of a larger fee-earner base,” the report said.

Total lock-up averaged 148 days among the lowest quarter of firms, compared to 69 days at the top. The survey advised firms to require “some up-front cash”, to bill on a monthly basis and to require bills to be settled on receipt, adding: “Solicitors also need to remember that whenever a client is asking for a discount on a fee, it is appropriate for the solicitor to ask for accelerated payment in return.”

The finances of firms were also healthy, with the median office bank balance at year end £17,000, meaning that funds could be borrowed for investment if required. The median firm could run on overdraft for about 40 days if fee income collapsed.

NatWest’s head of professional sectors and financial institutions, Steve Arundale, said the data was “robust” and firms surveyed were representative of the majority of the profession. Further, they “were clearly at the frontline in respect of the operational challenges associated with legal sector reform and the consequences of an economic slowdown that has clearly outstayed its welcome”.

He observed that firms were generally poor at using financial indicators to devise future strategies. “In our experience, too few firms choose to employ financial indicators to influence their pace or direction of strategic travel. Without such indicators, it is unlikely that the leaders of law firms will be in a position to change the behaviours of their people and influence future performance, given the lack of specific performance objectives.”

Download the full report here [2].