The times they are a-changing and firms must keep in step

THE cyclical impact of the current downturn for law firms in general is pronounced. Traditional revenue opportunities, such as mergers and acquisitions, corporate deals and real estate, have, for many firms, simply dried up or fallen sharply.

This has been offset, in part, for those firms with corporate restructuring teams and also for those with strong litigation offerings.

For many firms, 2008 (typically most firms report to an April period end) proved to be a record year in terms of revenue and profit performance – and consequently for the partners, record tax payments – the final instalments for an April 2008 year end due in January 2010.

The expectation for 2009 is that most firms will report lower results compared with 2008, as the effect of the downturn started to bite through the last quarter.

For some firms with greater exposure to the real estate sector, the fall in profitability is already significant and financial exposures in the funding of these firms are starting to manifest themselves.

Many firms, therefore, are taking steps to strengthen their balance sheets by ensuring that the firm has an appropriate level of funds available.

For the typical firm, its source of funds is threefold:

&149 working capital optimisation;

&149 new capital from the partners;

• and bank debt

The first option is about ensuring honesty in the ultimate recovery of unbilled client matters, and ensuring properly managed billing and cash collection disciplines. Making discretionary partner drawings contingent upon achieving cash collection targets is a key feature of those firms with the best working capital practices.

The second is often, in practice, a simpler option for many firms. This sees partners raise and introduce capital individually and/ or capitalise undrawn profits in the firm.

Bank debt, depending upon the performance of the firm, will be comparatively more difficult to raise, potentially more costly and, if raised recently, is likely to feature a number of financial and non-financial covenants to which the firm is required to adhere by the lender.

In certain situations, the bank will require the partners to introduce new capital as a pre-condition of their support.

The primary worry for managing partners is what the landscape in 2010 and 2011 will look like. Many commentators are suggesting that the market for legal services in the UK is unlikely to return to 2008 levels for a number of years. This means that the structural change arising in the traditional mix of services offered by law firms is likely to be sustained for some time.

At the same time, the effects of the downturn are being felt by the clients served by law firms. In turn, they will seek to intensify the pressure on pricing for routine legal services and weigh up the benefits of bringing more work in-house. More than ever, the market and buyers of legal services will be looking for greater clarity on firm differentiation.

So, not a great time to be managing partner perhaps – or is it? One thing is for sure: you might not be able to beat the market, but you can certainly beat the competition. There lies the opportunity for those managing partners who wish to take advantage of the current downturn by taking action now that will position their firm to win on differential, once markets regain momentum.

Taking stock of the firm's situation is vital, in terms of making candid assessments of the economy, markets served, how the firm is positioned and what its options are.

Only then can the firm start to develop coherent business responses around strengthening the firm's balance sheet, optimising performance, building confidence among its various stakeholders and, most importantly, positioning the firm for the future.

Many firms have been focused on locking down the necessary and often unpleasant near-term actions around headcount rationalisation and cost-reduction.

The firms that will succeed and prosper are those that are now turning their attention to developing winning strategies that position the ability and mindset of the firm as one of competing to win.

This will require action around identifying and securing those activities from which the medium-term sustainable growth will come for the firm – possibly very different from previous stalwarts – transforming the business model and manner in which legal services are delivered and capturing opportunity through acquiring or merging with other firms and/or strategic hires.

• Mike McGregor is associate partner and legal specialist at Deloitte in Scotland.

LAST QUARTER'S FEES TAKE A TUMBLE

ACCORDING to Deloitte's Quarterly Legal Sector Survey, the fee income at the UK's top 100 law firms decreased by 4.3 per cent in the quarter ended on 30 April 2009. The consultants found that the quarterly results had a notable negative impact on the full year results for many firms, with more bad news expected on fee income in the current quarter.

The number of chargeable hours recorded per fee earner in the top 100 firms declined 7.1 per cent in comparison to the same period last year. This drop was more marked among the top ten who suffered an average 11.5 per cent drop.

Despite an overall drop in chargeable hours over the full year, Deloitte did see an increase in fee income of 1.7 per cent. This was, however, due to the decline in sterling which had a great impact on international firms.

Mike McGregor says the dip in chargeable hours demonstrates how tough firms found it in the final quarter of the year: "Many firms will be hoping that they start to see an improvement in their results through an increase in new instructions as business confidence improves and – importantly – the full effect of recent cost control measures."