The legal sector was historically regarded as being low-risk and high-value, and was therefore an extremely attractive lending proposition for bankers. However, this has not been the case for five years now – and in a number of cases, firms have been slow to realise the implications.
As lending to law firms is no longer seen as low-risk and high-return, firms need to make sure that they have resources of their own and that they are no longer reliant on significant amounts of borrowed money relative to the firm’s equity.
This means both making sure that there is capital subscribed by the partners, and that the partnership has considered the possibility of external investment – even if the decision is ultimately not to change the ownership structure.
The long-term culture of profit extraction that still characterises the profession means many firms lack a buffer for a rainy day, but they also do not have the resources available to fund expansion. In an intensely competitive market, with new entrants and changing management and funding structures emerging, having those resources on hand for investments that will reduce costs and improve the client experience will be an important characteristic of the firms that will survive and maintain their independence (or attract investment).
Focus on Cash Flow
Firms must develop an absolutely relentless focus on cash flow and cash generation, to create sufficient balance sheet strength to fund growth. This is not a good time to be relying largely on debt to fund the future.
The first action should be to ensure that all partners are aware of the cash flow imperative, and to make sure that partner and fee earner standards include measures that will improve cash flow.
Those standards should not be limited to chargeable hours, but should also include aged WIP and debtors, and rewards should be linked to the level of lockup by fee-earner, department and, ultimately, across the firm.
Strengthening the Balance Sheet
Cash flow can be greatly improved in a short period of time through such a dedicated lockup reduction programme, and this will strengthen the balance sheet – an important factor in any potential investment decision.
It should also be recognised that different work types have different cash flow profiles – Personal Injury and Clinical Negligence will take much longer from instruction to cash than Conveyancing or Company Commercial work.
Billing processes and standards should reflect cash flow profiles, so that upfront billing and interim billing are used where appropriate, but ultimately the firm must be absolutely sure that it can fund its work, through a healthy mix of debt and equity.