Finance and Funding for Law Firms
The most common reason law firms fail is poor cash flow. Losing sight of working capital requirements and adequately managing them can lead quickly to collapse.
Overall Funding Levels
Total funding per equity partner has continued its downward trend, decreasing significantly this year from £25,000 in the smallest firms to £139,000 in larger firms with more than 25 partners, compared with £42,000 to £228,000 last year. The majority of firms have also seen a significant decrease in their percentage of funding from external sources. The largest firms have seen a drop from 65% to 32%, with 11-25 partner firms seeing a drop from 26% to 18%. It is the percentage of external funding in comparison to equity partner funding that has seen the biggest drop again this year, with averages in all bar the 5–10 partner firms dropping significantly.
Down to the Partners?
Although the total funding per equity partner has decreased across all firms surveyed, the actual capital invested in the year has varied depending on the size of the firm, with both the largest firms and those with 5-10 partners seeing increased levels of capital being invested by their equity partners.
Equity capital as a percentage of fee income fluctuated greatly this year, rising significantly in firms with 2-4 partners and 11-25 partners, but decreasing by over 10 percentile points in the largest firms. The actual amounts of capital invested also saw fluctuations, with the largest firms and 5-10 partner firms seeing a decrease in absolute terms. All other firms showed a moderate increase in capital invested.
The range of external finance offering is wider than ever before. However, traditionally, law firms veer away from carrying too much debt. Financing becomes much more readily available if partners have invested themselves, showing a commitment to their own success and the firm.
This is supported by the level of borrowing per equity partner continuing to fall across all sizes of firms. The highest level of bank borrowing was seen in the larger firms at £95,000, compared to £112,000 last year and £228,000 in 2016. This drop is likely to have been driven in part by banks requiring firms to reduce their overall lending.
Financing the Future
Firms are having to review financing options. Traditionally, law firms have raised funding from partner capital injections, bank loans and finance leases. To replace the fall in bank funding, legal practices have had to look at alternative finance streams, including private equity investment, IPO’s (Initial Public Offering) for larger entities and in some cases litigation funding options. Purchases of new assets tend to come with a finance option, and more short-term finance companies are being utilised to fund the payment of large one-off expenses, such as Professional Indemnity Insurance (PII) renewals.
It is vital to plan and monitor cash flow and funding requirements accurately, both in the short term, with a rolling quarterly cash flow, and also with at least an annual projection of cash needs. The level of finance available to firms remains crucial as it is the available capital that still determines a firm’s viability and future success.
- Be aware of the importance of accurate and timely cash flow monitoring and forecasting.
- Review the level of capital in the firm, is it sufficient?
- Review the distribution policy – can the firm afford to pay out profits in full?
- Ensure the cost of succession is adequately
- investigated. Capital needs to be paid out to
- retiring partners, will the injections by new
- partners cover this?
This article featured in our 2019 Legal Benchmarking Report. Download the full report here: 2019 Legal Benchmarking Report
If you would like to discuss any of the issues raised in more detail or if you would like to speak with a member of our team, please contact Hannah Farmboroughor call on 0207 429 4147 to be put in contact with a member of our Professional Practices team.