Optimism among SME UK law firms is at an “all time high” according to the Financial Benchmarking Report.
The annual report – now in its second year – looks at the financial performance of small and medium enterprise (SME) law firms operating outside of the UK top 100.
According to the survey, commissioned by NatWest and RBS’ commercial banking division, 92% of respondents believe their profits will grow or remain the same in 2014 with 48% of those predicting growth of up to 10%.
A second report from RBS - A perspective on the legal market (PDF 727KB) - looks at larger legal businesses in the corporate arena.
It finds that despite a backdrop of constrained demand for legal services and continuing overcapacity, more than 60% of firms expect to increase their fees over the next 12 months, and 50% expect to increase the number of chargeable hours. However historical levels of profitability are still some way off.
The 2014 Financial Benchmarking report includes financial results from over 380 firms (an increase of 12% compared to last year) as well as a survey of delegates from the banks’ 2013 Legal Conferences - attended by 400 legal professionals.
Steve Arundale, Head of Professionals at Natwest and RBS, said: “Last year was another challenging one for the legal sector however optimism seems at an all time high with some great performances recorded across the country.”
Results showed that, on average, firms reported a 7% increase in profits from last year. However, smaller firms (with less than £1.5m annual fees) reported an impressive 15% jump with larger firms (more than £1.5m annual fees) achieving just 3% profit growth.
Fees are also on the rise with an average 3% growth – roughly in line with inflation.
Arundale said: “The report allows firms to track their performance against their peers and measure their progress.
“Comparing a firm’s profit (per equity partner) and fee growth gives a great indication of their efficiency. For example, Scottish firms came out as the most efficient in the country, posting profits at an average of 27% despite fees remaining the same. This is compared to firms in London whose fees rose by 6% while profit dipped below Scotland at 22%. It was also good to see firms in the South West posting revenue growth of 2% against a flat performance in 2012.”
Firms in the South East and the North also rank in highly for efficiency growing profit by 11%% against a 3% fee rise.
“One of the key issues we find firms have is in understanding the relationship between profit and cash,” said Arundale. “For example, a firm is unlikely to improve its position if it concentrates solely on growing revenue and profit and fails to look at the finer points like improving efficiency and lock up days [the days you wait before billing for work undertaken or before collecting debts].
“As the largest and only free benchmarking report in this space, this report provides a truly representative picture. We hope firms will use it to help them interpret their performance compared to their peers and identify areas where they can improve future financial performance and security.”
One factor driving profitability in larger law firms is their increased reliance on paralegals and legal process outsourcing. This trend is set to continue with more than 30% of firms planning to grow their non-legally qualified fee earner population next year, reflecting a material long term shift in the shape of the law firm model.
Disaggregation of legal instructions – breaking them down into component parts and outsourcing part or all - has become a feature of the market as firms pursue greater efficiencies and value. Legal sector consolidation will also continue to drive growth in both domestic and international law firms. More than 70% of respondents to the RBS legal survey expect the rate of merger activity to accelerate in the next 12 months.
The report highlights that, for some time, the growth strategy of many firms has been founded on the recruitment of lateral partners. Whilst this looks set to accelerate both domestically and internationally in the year ahead, increasing the number of lateral hires is a risky strategy; they may have to be induced with offers of higher pay, it can take time for the integration and recruitment costs to be recouped and, ultimately, their clients may not come with them.
Despite the challenges of successful lateral partner hiring, in response to the quest for growth only 6% of firms surveyed expected fewer hires of this type next year.
James Tsolakis, Head of Legal Services, Corporate and Institutional Banking said: “The legal sector is currently confronted by many challenges, from being ‘over-lawyered’ to stressed demand dynamics. I remain optimistic however about the future of the legal profession in the UK and market participants are clearly demonstrating a willingness to confront and respond to these challenges with initiatives which will permanently change the shape of the profession and the manner in which legal services are delivered.”
As a banker to the legal profession for over 200 years, RBS has vast experience in helping law firms with their domestic and international banking and financial needs. Services and support include financing arrangements, financial risk management, optimal liquidity management and the maintenance of good cash management disciplines.
The absence of growth in the UK market has required firms to restructure their businesses, build through lateral hiring and increasingly expand abroad. Combined with economic uncertainties, this has resulted in a healthy appetite amongst firms for additional credit facilities and financial support. In response to these financial needs RBS currently supports the legal profession with lending and other credit commitments to an amount in excess of £2.7 billion.
Both the Financial Benchmarking Report and A perspective on the legal market (PDF 727KB) are available for downloading.