Will caution inhibit law firm growth in 2024?

13 March 2024

As uncertainty continues to loom over the economy, it might be time for firms to take some calculated risks to remain competitive, says Maurice MacSweeney, director of legal finance and sales planning at Harbour, a litigation funder and provider of lending and credit facilities to law firms.

Of all the things law firm leaders are worrying about in 2024, it seems continuing economic uncertainty is high on that list — 50% of law firm leaders say they think it’s the most significant barrier to growth, and just 5% say they do not anticipate their law firm facing any growth challenges in the next 12 months. It’s clear that obstacles loom ahead.

These results come from the Harbour Whitepaper 2024, for which we commissioned independent researchers to speak with 100 managing partners and other law firm leaders working in the top 200 UK law firms, to learn more about how they are gearing up for the year.

The results of the whitepaper show us that the law is full of savvy, creative and dedicated professionals who are embracing market challenges. However, a combination of simultaneous headwinds is making law firm management more challenging.

As firms deal with inflation, rising costs and required investment in areas such as technology, clients are taking longer to pay and want more flexibility in fee arrangements. Reduced operating profit and cashflow risk do not create a growth environment — so how will law firms stay ahead of the competition?

Financial predictions
Last year appeared to be a good 12 months for law firms we surveyed. More than 8 in 10 report their firm’s billings either increased or stayed the same. And it’s a slightly improved outlook for 2024: only 3% fear a drop in turnover – while the overwhelming majority expect an increase (56%) or for it to stay the same (41%).

Interestingly, there is some confidence for future profits, despite rising costs — six in 10 firms forecast some kind of increase, 37% predict a year of marking time and, again, just 3% expect a fall. Perhaps recent falls in inflation have improved confidence a little, although we note respondents seem more optimistic for their own firms than for the wider market: 43% agree (and only 16% strongly) that 2024 will be a strong year for law firm growth. Either way, inflationary pressures seem to be felt around the industry.

Where are the barriers to growth?
Indeed, despite confidence in their own firm, respondents did mention both continuing economic uncertainty and inflationary pressures as potential barriers to growth. Other factors include lack of access to capital, partner resistance to change, market consolidation, and talent attraction and retention.

One very specific issue that law firms structured as LLPs/ partnerships face in the coming year is basis period reform, which will see partners being taxed on the profits in the actual year they have been accrued rather than the tax year as chosen by the law firm itself.

Firms say they may fund accelerated tax bills through changing their tax year or, less appealingly, from cash reserves or issuing cash calls to partners. Others suggest external finance may be a way to deal with this while protecting those all-important cash reserves at an uncertain time.

Partner resistance
Two-fifths of respondents cite persuading partners to make further investments, or to seek external investment, as the third principal barrier to growth — unsurprising when one considers the various financial headwinds coalescing and gathering strength.

It is understandable that partners are cautious with their own capital and may be reluctant to invest — particularly if they’ve already been taxed on that income, as they are in partnerships, as opposed to firms structured as limited companies, where there may be more tax benefits to re-investing rather than simply distributing profits. This is especially so when partners might depart before the benefit of that investment is realised.

Taking external finance, such as a credit facility, may make sense for some firms as it places the risk on the business rather than the partners themselves. It might also help solve the perennial problem of improving lockup and debtor days by realising the value of WIP sooner rather than later. Could a 3rd party capital solution encourage cautious partners to vote for growth programmes suggested by their firm’s leadership?

Just 2% of the firms we talked to finance themselves entirely from operating income, with other forms of funding — partner/shareholder investment, private equity, bank overdraft and litigation funding — all used by significant minorities of firms. A third of respondents said their firms were actively considering credit facilities from a litigation funder.

Among the firms we spoke to, the majority will be looking at existing and new client development to drive growth. Perhaps the question for the 46% of firms that did not list this in their top three priorities is: Why not? Recruitment, M&A and acquiring a complementary non-legal business were the other most highly-rated answers, with around 40% naming each.

This is not the easiest of times for legal businesses — but well-run, ambitious firms continue to prosper. Though it will be a challenge to balance cash flow, investment and profit distribution in the current economic climate, there is a pressing need to invest and modernise, especially in areas like technology. Throw in concerns about succession, especially at smaller firms, and the picture becomes more complicated still. But partner caution and traditional structures should not be allowed to inhibit growth at a time when commercial opportunities must be seized.

Throwing caution to the wind is never advisable, but it seems a good time for law firm leaders to not be shy of taking some calculated risks.

You can read the White Paper here.

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