Small and medium-sized law firms are looking to external investment to counter growing concerns about the impact of alternative business structures (ABSs), new research has found, even though they are recovering well from the effects of recession.
Though the vast majority of firms surveyed – whose turnover ranged from £5m to £35m – reported that they had not noticed any detrimental impact from ABSs in the past year, 36% expected to lose business to ABSs over the next 12 months.
The annual benchmarking survey by accountants HW Fisher & Company found that more than a third (36%) of the 75 firms it polled in London and the south-east are now themselves looking for external investment to keep pace – compared to just 11% two years ago.
“This could be through private equity or, perhaps more likely, some form of tie in with non-legal businesses,” it said.
Merger and acquisition activity was also on the up. While last year only 11% expected to be involved in M&A, it actually turned out that 25% were, while a third expected to undertake M&A in the next year.
There was also greater interest in what the survey called ‘law firm aggregators’ (including publicly listed legal businesses) and franchise operators. Last year this had yet to really take off but now a quarter of firms said they had been approached by a consolidator, and of those that had not been, 36% said they would consider joining such a group.
An analysis of the firms’ accounts showed 4.5% growth overall, rising to 10% at the larger end of the survey’s spectrum. Profits too rose – with the best performers recording a 17% rise on the previous year, and margins ranging from 31% to 17%. Turnover per employee grew 11% to over £100,000. Another positive sign was that most firms planned to recruit more fee-earners over the next 12 months.
The most impressive turnover growth came from the £20-35m firms – up 25% over the last two years, higher than the average of the top 50 – and the survey said this was fuelled by two trends: “the continuing incidence of larger buyers of legal services instructing smaller firms to reduce costs… and the larger SME firms also attracting an increasing pool of talent with lateral hires”.
While the amount of corporate and property work continued to slide, litigation came to the fore, and two-thirds expected to see further growth coming from their litigation work in the next year. To the surprise of the survey’s authors, a similar number anticipated an increase corporate work, possibly indicating a more bullish attitude about the recovery.
The survey highlighted that seven out of firms have seen an increase in the amount of fixed-fee work over the past year, with the average fee structure for SME firms now 59% hourly/time-based, 32% fixed-fee and 9% by results. It said: “A third of fees being fixed would have been unheard of 10 years ago and shows just how price-competitive the legal services market has become.”
The general message was that while most of those surveyed have recovered well from the effects of recession, larger firms were faring better than smaller ones. While the former were “substantially” better off than they were when the country went into recession, the latter were “not yet back to the same levels of profitability as in pre-recessionary days”.
However, HW Fisher said there were some warning signs for all SME legal practices. “Turnover growth is slowing and remuneration per employee is growing – factors that have adverse impacts on profitability. Profitability per equity partner has held up well to date, but these issues need to be kept under constant review and control.
“There are also a large number of firms which are facing severe financial problems and need solutions fast. We expect to see a continuing trend of mergers and takeovers to assist in resolving these dilemmas.”