Legal firms are vulnerable during the upturn


In 2010, the number of law firms going into insolvency is estimated to increase, and reach an all time high. This article looks at a number of reasons why legal practices are closing and, more importantly, how to overcome these obstacles.


1. Poor working capital control


In an upturn, firms will be looking forward to an increase in new matters, with a resurrection for some departments like residential conveyancing, which were particularly badly hit by the recession. But of course the increase in work in progress must still be funded by the practice. Cash flow projections are an important tool in managing short-term working capital. It is vital that cash receipts into the practice are maximised while outgoings are tightly controlled. By setting projections and reviewing actual performance on a monthly basis, action can quickly be taken to stem any significant cash shortages. Regular client billing and proper credit control must be implemented. Expenditure should be kept under strict control, and partner drawings may have to remain at lower levels until bank balances are healthier.


2. Lack of long-term funding


With banks limiting who they lend to it is becoming increasingly difficult to obtain funding for short-term working capital or for expansion plans. To overcome this obstacle we have seen many partners and LLP members injecting more personal cash into their practices. Many practices have used the relatively cheap source of tax funding that HMRC have offered in their payment plans, which has allowed income tax, corporation tax and VAT liabilities to be spread over a number of months. However, HMRC are making this payment route more difficult to be accessed in the future. There are still in existence a number of finance firms who offer funding to professional practices to cover annual expenses like insurance and tax bills. Whilst these firms make it relatively easy for finance to be obtained, they tend to run with high interest rates, and are therefore a costly alternative.


Another source of finance is the Enterprise Finance Guarantee scheme which has been extended up until March 31, 2011. This is a Government initiative for small businesses with less than £25 million turnover and replaced the small firms loan guarantee refinancing of existing loans. However, as with any finance scheme, there are conditions and you should speak to your business advisor to ensure your practice is eligible.


3. Poor financial management


Keeping your financial records up-to-date is imperative, especially in difficult times. If you require bank funding you will almost certainly need to provide forecasts for the following 12 month period, looking at profitability and cash flow. Partners need to have access to up-to-date financial information in order to make informed decisions. Potential cash flow problems can be recognised sooner, and unexpected issues can be identified and dealt with earlier, if there is access to timely and accurate financial information.


4. Increased competition from new entrants


Retail operations such as Co-op and Tesco are entering the legal market, or are expected to do so in the coming years. The areas they tend to focus on are volume-based legal work such as residential conveyancing, wills, probate and personal injury law. Firms operating in these areas will see an increase in competition and may have their market share eroded. To remain competitive on price, practices will need to adapt their work procedures to streamline and make efficiencies where possible, using the most cost-effective staff to do the work. If firms are not planning to compete with new entrants to the market on price, then they will need to differentiate themselves or the services they supply. Specialist legal practices may already be able to do this, or at least build on their “brand”. Multi-disciplinary firms will need a strategy to plan for the potential threats to the future of their business, or indeed to take advantage of potential opportunities that may arise.


5. No insurance


At the last round of professional indemnity insurance renewals, more firms than ever found themselves to be short of any offer of insurance at all. The Law Society has reported that 2009 was the worst year for firms entering the assigned risks pool. A number of insurance providers indicated that they had “lost their appetite” for smaller practices, with less than four partners. For 2010, firms need to be ready to start looking for insurance quotes as early as possible. Financial information needs to be up-to-date, as there will likely be an increasing number of questions relating to the finances of the firm, or even a request for management accounts. Firms should try to find insurance brokers who are able to access the whole insurance market, thus covering more options from one source.


6. New work


Firms need to plan how they will generate new work. This may arise from new clients or from additional services offered to current clients. There must be some strategy in place for business development, however “unrefined” this may be. Gone are the days when law firms would advertise in the phone directory and then wait for clients to arrive at the front door. Some partners or senior fee earners may be natural “work winners” and it would be beneficial to involve them in business development work rather than full-time fee earning. Support staff could be utilised by reviewing will banks, say. If you are concerned about how the upturn may affect your practice, then please do get in touch. We would be happy to offer advice on strategic issues or perform a cash flow healthcheck to ensure any problems are identified sooner rather than later.


Karen Hain will be presenting a Solicitors’ Accounts Rules update at the Blackpool and Fylde Law Society on on 079483238177 or email him at March 25, 2010. If you would like to attend please contact Don O’Toole