Surge in income but not profits for smaller law firms

Rourke: Generally positive results

The average fee income per equity partner at law firms with up to seven partners rose by 29% last year despite the pandemic, research has found.

However, accountants Armstrong Watson also found that net profit per equity partner at these firms was static, with overall net profit tumbling from 32% to 24%.

One reason could be that some of the very small firms had taken on “unprofitable work in a bid to drive their fee income up during the pandemic” and could struggle to recover fees “due to their predominant client types”.

There had also been a trend during the pandemic towards “more senior staff, and potentially equity partners, doing more of the fee-earning work”.

The report found that there was a 5% fall in fee income per equity partner at firms with eight or more equity partners, but a sharp rise in net profit, from an average of £142,400 to £187,400.

The net profit of these firms jumped from 25% to 32%.

Researchers said that at firms with larger numbers of equity partners, it “may be the case that some higher-level employed staff have been furloughed, thereby saving costs, while the fee earning has been done by the partners themselves”, driving the increase in net profits per partner.

The report was based on more than 100 law firms advised by Armstrong Watson, which were divided into two groups of firms with up to seven equity partners and those with more.

Since the firms’ accounting years finished at different times in 2020, it said the “full effect of the pandemic” had not been captured.

Rosy Rourke, legal services director at Armstrong Watson, said the results were “generally positive”.

“The increased profitability has appeared to continue, although how much that is being masked by government support remains to be seen.

“However, despite this increased profitability, cash still appears to be tight as lock up has slightly increased and drawings have fallen behind profits, resulting in large increases in average partner capital accounts, which may cause succession problems in the future.”

Firms of all sizes increased their charge-out rates in 2019/20, with the average for an equity partner rising from £241 to £267. The average for a salaried partner rose even more steeply, from £184 to £247.

Rates for associates rose from £177 to £202, for assistants from £129 to £161 and trainees from £110 to £124. The average number of chargeable hours per fee-earner hardly changed.

Researchers said this suggested that much of the increase in fee income reported by law firms was driven by higher charge-out rates, although “under recording of time in some practices remains an issue, particularly in smaller firms”.

The average number of fee-earners per partner rose for all firms from 3.5 to 4.6 and the number of staff per equity partner from 6.2 to 8.4.

However, the increase in the number of support staff per fee-earner was much smaller, from 0.8 to 0.9, and staff costs as a percentage of fee income grew only two percentage points to almost 42%.

Armstrong Watson said the increase in support staff may be driven by “smaller firms increasing their head count in ancillary areas such as IT” but could reverse in future years following the pandemic “as remote working forces fee-earners to become more self-sufficient”.

Overheads for law firms grew in all areas apart from bank charges and negligence claims. The biggest rises were in rent and rates, rising from 4.1% to 4.5%; indemnity insurance, 2.9% to 3.2%; and marketing, 2.1% to 2.4%.

Smaller firms by turnover had driven the increase in rent and rates: “It will be interesting to see how this measure is impacted in the years following the pandemic and what decisions firms make regarding office space if there is a move towards increased homeworking.”

The average time taken to bill work in progress for all firms rose from 61 to 67 days, while total lock-up in days grew from 123 to 125 days.

The average value of partners’ capital accounts increased by 61% from almost £170,000 to just under £273,000.

The report said this could be explained by factors such as “retention of reserves needed for working capital or refinancing of the practice” or “nervousness (and restriction of drawings) due to Covid-19”.

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