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"Thinly Capitalized Workers' Cooperatives"

06.04.2010

Back in November of last year, we wrote that the upturn would present significant difficulties for overstretched firms, in terms of working capital and funding requirements (see The Growth Imperative). As far back as May 2009, we commented that surviving the downturn would require a re-prioritisation of cash flow above profits and other traditional measures of success within the sector (see Cash is King in Recession).

So we may perhaps be forgiven for feeling a little smug on reading this piece in the Times a couple of weeks ago, which describes the huge increases in borrowing right at the top end of the market. It seems that even the top firms in the country are still shying away from tough conversations with the partners about the level of capital they have invested in the business – and that, for now, the banks are still prepared to fund firms playing at this level.

Two of the banks have been repeatedly telling us that their lending to the legal profession has increased over the last year – and we have taken that to start with a much greater use of facilities by the good risks.

What is not clear to us is whether this uptake at the top of the market potentially squeezes the amount available to others – or whether there is still plenty of lending capacity for ordinary firms.

An Alternative Approach

For many firms going back to the bank manager for yet more overdraft funding is simply not an option today. As the Times article suggests, firms in this category will find it difficult to fund growth in the recovery, and (perhaps even more pertinently) will be a wholly unattractive prospect to investors when external capital enters the market in the next couple of years. There has to be an alternative approach for the “Thinly Capitalized Workers’ Cooperatives” that make up the majority of the profession.

There is really only one viable alternative approach: become a better managed, financially stronger business.

  • As we have written before, since the balance sheet must balance, reducing lock-up will reduce correspondingly the level of debt (or equity) required to fund the firm’s assets. This is no longer just a desirable approach; it is an essential one for any firm hoping to succeed in the next couple of years.
  • Partners must learn to recognise that they are business owners – and must behave accordingly. Decisions must be taken by the firm’s management, in the interests of the firm as a whole. The days of partners running their own personal fiefdoms, with ‘their’ clients and ‘their’ staff, are gone in any serious business.
  • Business development should be accorded the priority it deserves. Steady income streams will not come from haphazard initiatives, and staff must be given the requisite training to ensure they can manage a sustainable pipeline of regular instructions.

Taking Responsibility

This approach does not remove the necessity for increased contributions from the partners. A well-managed, financially successful business is one in which the owners (i.e. the partners) have a significant stake, and for which they take responsibility. This means that prosperous law firms can no longer afford such thin capital ratios, especially in an increasingly competitive market. It’s high time for tough conversations – as well as a tough approach to financial management and business development.

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