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Law firms feeling the draft

When legal information company Sweet & Maxwell surveyed the top 100 UK law firms in 2011, it found more than half of their finance departments saw continued downward pressure on fees as a high risk to profitability.

Less corporate work and more competition added to their woes, and a small but significant number of respondents, 13 per cent, cited the consequences of the Legal Services Act as a serious threat to their income. As of January 2012, this Act allows lawyers to extend partnerships to non-lawyers in alternative business structures (ABSs) while companies other than law firms can offer legal services. The latter provision has given the Act the memorable, if rather misleading moniker, Tesco Law.

While this deregulation did not figure as the number-one concern among finance directors, it has the potential to eat into the wider concerns around fees. Will the arrival of ABSs see an intensification of City competition? Alasdair Douglas, chairman of the City of London Law Society, views the immediate impact of the Act for his members as being limited. “I think City firms are unlikely to be looking for outside money as cash is not a problem for them,” he says. “If they want to boost cash flow they can always withhold payments to partners.”

Investors will expect to see sound financial management, and that means opening up a firm to greater scrutiny

Where Mr Douglas, a former senior partner at Travers Smith, believes the changes will strike hard is on the high street. “There will be a lot of consolidation as law firms outside London face competition from new entrants. Remember that big retailers have the financial firepower to market their services if they decide to expand into the law.”

So while WH Smith is beginning to offer legal services with a large consortium of solicitors, this should not create tremors among the top tier of commercial law firms. And Mr Douglas points out that seeking outside capital will dilute both share control and possibly profits for the firms and their partners. But the new entrants may not be content with remaining on the high street in the longer term. Justice Secretary Ken Clarke thinks existing firms should look to the changes as an opportunity to fund expansion overseas.

Irwin Mitchell, one of the largest UK law firms, has stuck its head over the parapet and appointed Espirito Santo Investment Bank as its financial adviser with a view to restructuring as an ABS and seeking external capital. Irwin Mitchell has one aim in mind - a strategic growth plan. But when it achieves ABS standing it may wait a while for company.

Chris Marston, head of professional practices at Lloyds TSB Commercial, claims a majority of the UK’s 10,000 law firms, many of which are sole practictioners, as a client. He rejects suggestions that a credit squeeze may drive law firms to seek ABS status. “Our lending to the legal sector has risen by 12 per cent over the past year,” says Mr Marston. He thinks that a period of careful evolution among law firms, rather than a dramatic shift of ownership, is due. “When you look at the top end of the market, the only big firm to announce anything is Irwin Mitchell,” says Mr Marston, noting that external capital investment is normally triggered by the prospect of rapid growth and many law firms will struggle to make that promise.

Stephen Rosser is chief executive at Clarke Willmott, a national law firm with a £35-million turnover and broad interests. He points out that many lawyers may not take the added scrutiny of external investors in their stride. “Investors will expect to see sound financial management, and that means opening up a firm to greater scrutiny, demonstrating efficiencies and ensuring that the right systems are in place across different disciplines.” He believes the traditional financing route, whereby partners raise their own funds, will continue, but that firms with a need to invest in specific areas, such as a personal injury practice, may turn to new arrangements.

The most immediate brake on potential expansion via the Act is, of course, the regulatory regime around it. The Solicitors Regulation Authority (SRA) has just been empowered to grant licences for any firm wanting to broaden its partnership basis or seeking external investment, thus becoming an ABS. And the kind of assessment the SRA will be undertaking is what Mr Rosser has in mind when he explains that leaping into the legal field is not an easy option. “It would be naive to think that it is easy to set up and run a new law firm,” he says. “There is more to it than meets the eye.” Ultimately he views the Act as “creating a bit more latitude, giving us all a useful tool that may lead to more efficiency”.