Over the past few years, a number of law firms have found themselves in financial difficulties. Some have been able to adapt; others have been less fortunate. Failures, mergers, acquisitions and closures have all contributed to a changing market for firms operating in the legal profession, and 2014 is going to be no different. January’s headlines have already highlighted a significant number of firms in the process of closure. This is driven in part by the inability to secure professional indemnity insurance, but in reality there will be a number of underlying contributing factors. Early engagement and advice is essential if this trend is to be stemmed.
Firms are facing many issues, and some are in a zombie like state, unsure how to move forwards. There is increased competition for dwindling business levels, making it a buyers market – clients are demanding more for less.
Some of the common issues include:
- Over leveraged
- Unable to provide lenders with adequate security
- Strained lender relationships
- Liquidity problems (cashflow is often very lumpy)
- Increasing difficulties raising periodic finance for vat, PI, partner tax etc
- Inadequate corporate governance
- Dominant partners
- HMRC arrears
- Aggresive drawings compared to profits
- Changes in legislation, and more stringent compliance demands
- Fear of intervention if take advice, and
- Poor management teams and lack of financial information and controls.
In addition, tough times have been compounded further, due to recent legislative changes which have opened the market to Alternative Business Structures (ABS) increasing already fierce competition from new players such as the AA, who already have vast consumer bases and strong financial footings from which to sell their own legal services. As certain areas of law become increasingly commoditized, so the pressure will increase on firms that can’t deliver the economies of scale and efficiencies, formidable new entrants have to offer.
The over riding problem we see time and time again is that firms are simply not used to dealing with financial difficulties. They lack the expertise essential to survive tough periods, and as such often delay seeking advice, losing valuable time and often credibility. Often, financial management is not sufficient to enable the firm to see a looming cash crisis coming, putting them on the back foot when they urgently have to approach funders for additional support.
This in itself may not have been a huge problem in the past where there have been strong relationships, but the banking market has also had a tough ride, and they are now far more wary of such requests, with greater focus on security cover – not easy to provide for many firms, making these asks extremely difficult to accede to.
These situations are tough all round – in particular in partnerships without limited liability, the partners may face personal financial ruin if the business fails. The shock in itself of this can be a huge distraction and a further barrier to taking preventative action.
Solutions are not easy for legal practices for many reasons, for example, issues with retiring partners, successor practice rules, TUPE, mismatch in value expectations, funding restrictions etc.
However, solutions are possible, but early advice is essential to maximize future prospects for success. Solutions may include a combination of:
- A complete restructure (possible including a debt sale) and trade through
- Partial change in management team
- Mergers and acquisitions
- Venture capital / private equity backing
- Improving lender security
- Sale (possibly on an accelerated basis)