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Shaping the face of a post pandemic legal sector

Post Pandemic Legal Sector | Pro-Tem Executive Connect - Blog

Most of the 10,400 legal practices in the UK had a good pandemic and dealt with the challenges by using the government support well.

Many firms were financially stronger in 2021 than they were going into lockdown in March 2020. Turnover was down but so were costs and coupled with furloughing and funding meant that firms had cash in the bank.

However, we cannot ignore the challenges facing the profession and the pandemic has speeded up the eventuality of consolidation.

Let’s explore how other professions have changed. The most obvious example are Opticians. Once there were independently owned practices in every town and  city but gradually these became unviable as the use of technology and the growth of Vision Express and Specsavers took hold and a more corporate structure with volume purchasing of lenses etc.  There are now very few independent Opticians left in the UK.

The Veterinary profession is on the same journey with Private Equity backed Corporates purchasing and consolidating the independent Vets practice. In fact the desire to build brand awareness has resulted in the growth of Vets being attached to pet supermarkets.

The race to scale these businesses has seen extraordinary premiums being paid to acquire the local Vets practices – The EBITDA of these practices rose to as high as 20 for a chain of Vets practices in multiple locations.

The Legal profession has just started on this journey with a few Private Equity houses supporting the consolidator firms providing the necessary capital to grow by acquiring other firms with specific disciplines. We have seen a growing number of floatation’s on the various stock markets and an appetite from institutions to support this trend, with many more planning this route. As we will explore in this chapter there are number of reasons why this trend will continue but the pandemic has simply brought this forward. We will see large numbers of firms question their future strategy and there are numerous acquirers willing to purchase most types of practices or at the very least their clients and books of business.

Back in 2007 the Law Society had been the representative body and regulator of the legal profession and many traditional aspects had remained the same for many years. For example a Solicitor’s practice had to be a Partnership or  a LLP, and it was only following the launch of the Solicitors Regulation Authority (SRA) in 2007 that we began to experience changing structures and  new initiatives. Some 14 years later we now have approximately 70% of legal firms operating as limited liability companies and increasingly being subject to Company Law. We have also seen the growth of the Alternative Business structure (ABS) which now allows non-Lawyers to own Solicitors practices. This is a double edge sword for the profession. On one side we have the growth and investment from private equity houses taking ownership of firms, giving  the law firms the cash they need for growth and acquisitions. On the other side it gives the opportunity to others to enter the profession such as Accountants, Insurance companies and IFA’s who can employ solicitors to deliver legal work without the cost of compliance and regulation.

In March 2020 we were facing an issue of aging owners and dwindling profits with more than 3000 firms still operating under traditional partnership or LLP models but all operating in a partnership way in other words drawing all the profits from the business and not retaining and profit in the business itself. As we return to some degree of normality these issues haven’t changed and we are beginning to see a significant growth in merger activity.
Many smaller firms are seeking merger partners, but sadly many of these are unattractive to potential buyers and their only solution seemed to be controlled closure. The cost of this would be devastating for the current owners who had spent 30 years building a business that no one wanted. A lifestyle choice that thirty years ago would have younger solicitors chomping at the bit to become a partner, but not anymore.

Succession Crisis
There is no doubt that we are facing a succession crisis within the legal profession with many firms have not given adequate time to plan their exit hence the drive towards mergers and acquisitions. There are numerous examples in firm that have thought by incorporating the associates and younger salaried partners would jump at the chance to become an owner in their profitable firm. Many of these have resulted in the offer of ownership being declined and the current owners usually in their sixties are still left with a dilemma. I recently visited a firm where the above had actually happened. Two equity Partners in their late fifties had incorporated from an LLP to a limited company in 2019 but the younger potential owners did not want the responsibility of ownership and the risk that it entails. This now leaves them with a serious issue on deciding the future – obviously they cannot keep going for ever so rather than being in a position of planning their exit through succession they are now considering selling the practice.

A healthy profitable business in a high net worth area should be attractive to a prospective acquirer but what they thought was a plan has now turned into something else. This type of scenario is happening all over the country with profitable business finding it difficult to plan their exit successfully.    

We have an average age of a law firm owner of 65 years and few have faced the succession issue hoping it will all just go away.

 Many Law firms, whatever their size or structure are utilising the skills of a non-exec as part of their management. With the interest from both private equity and the numbers of floated law firms and planned floatation’s it sometimes becomes an enforced necessity to have a non-exec director on the management board. With over 70% of Law firms now limited liability companies the role of the NED can be an invaluable asset to all law firms. The remaining 30% can still take advantage of a virtual NED to guide them through the change management process that all firms need.

The banks are looking very cynically at the way many professional practices are operated and traditional bank funding by overdraft and loans will change dramatically over the next decade. Most Partners/directors of law firms have grown up with this traditional bank lending and find it difficult to understand alternative funding in the future – the NED will understand how this works and guide the business along the right path

What will a NED give you?
We are all aware of the challenges facing the legal profession; legislative, fiscal and a succession crisis, by having a NED or virtual NED your vision becomes clearer. Decisions that are made by partners, often ill equipped or experienced in managing change can be challenged by someone who is not involved in the day to day running of a busy practice. Business skills can be brought into play making individual departments become more profitable, constantly reviewing working processes and finding new and unusual ways of running a law firm as a business.

Most NED’s or virtual NED’s will improve the law firm’s profitability considerably and help avoid many of the pitfalls that partners will find themselves.

The role will bring a different dimension to law firm management and those firms who have willingly embraced the role have found the advantages far outweigh the cost. The cost of the NED will vary depending on the size of the practice, the time required, and the disciplines involved but would not exceed the day rate of your normal hourly charge.

Many of the banks encourage a non-exec presence within law firm management recognising the value of a non-lawyer helping with the vision, strategy and someone with business acumen reviewing the management of a law firm with non-lawyer eyes. It’s easy to become isolated within a legal practice and the focus becomes very internal “working in the practice and not on it”.  A NED or virtual NED can also find ways of reviewing the working capital requirements of a practice. The banks are looking closely and law firm funding and traditional overdrafts and loans will become the exception rather than the norm. Finding the essential alternative, a type of invoice discounting will become more common place and the NED should be able to provide sufficient knowledge and guidance in the right circumstances.

Professional Indemnity Premiums For the past twenty years we have experienced a soft insurance market and some would argue that we have become complacent with new insurers wanting to buy premiums each year. However this is no longer the case with some insurers not taking on new business. We have seen a gradual and progressive rise in claims outweighing the size of premiums in the past few years and following disasters such as Grenfell and the cladding issues insurers are wary about mounting claims. The legal profession, just like other sectors, has been forced into home working and dependent on the robustness of their IT has left many insurers nervous about what the lack of supervision of staff could have on future claims.
The conveyancing market has been incredibly busy following the stamp duty holiday and without excellent IT home working could well exacerbate a rise in claims. This coupled with a hardening insurance market has seen professional indemnity premiums rise dramatically in the last two years. A 30% increase in an annual premium was affordable, particularly when CIBLS and BBLS were available to fund premiums 

If the conveyancing turnover of a Law firm is in excess of 25% of the turnover then the average premium has risen by 30% year on year. However this is subject to a good claims history. For those firms with multiple claims some insurers have simply refused to quote even with existing policy holders. There are exceptions and some firms have seen a premium increase quadruple over two years. With no Government funding will premiums be affordable in the coming years and will this drive more firms to look for a merger?

Conveyancing staff has been impossible to find throughout the pandemic and some firms have not only substantially increased the fees they charge but turned work away. Many Law firm owners have found the pressure to keep clients informed and happy and have worked impossible hours during the pandemic. Many are now saying they have gone as far as they can with their firm and are looking to merge or sell. Is this a catalyst for greater consolidation?

 

Even specialist conveyancers have found the insurance market difficult to navigate with several CLC regulated firms unable to obtain insurance. What has been the bedrock and solid cash generator for many practices, conveyancing has become a real challenge for those firms without the resources to deliver and could force a number of firms to stop offering conveyancing to their clients. Without affordable professional indemnity insurance how many firms will be forced into merger talks?

Market Disruption
We have discussed how the change in Regulator back in 2007 has impacted on the profession with the growth of new models to disrupt the traditional legal sector. Weak management and outdated operating models have been partially responsible for this well needed change and the death knell for the High street practice that is here to stay.

Although not new, the growth of the firms operating in the Solicitor consultant model has been meteoric through the pandemic with many individual Solicitors choosing to change the way they work.  Traditional firms without the investment in IT have forced Solicitors to come into an office to work and many have realised that a self-employed consultancy role suits their work life balance much better.

The model works on the “eat what you kill” premise so having a good number of existing clients is an essential ingredient to the individual Solicitors success. For those Solicitors that have been “fed” work by the marketing departments of their firm find it difficult to become a marketing machine and tend to be less successful.

However for an individual that has a good client following it can be very lucrative with income splits ranging from 60/40 to 80/20 with the law firm taking the majority of the risk. In some cases it may be an exit route for firms to become a virtual franchise with the firm paying the PI premium and the majority of the administration costs yet they still receive 70% of their income.

The growth of the firms offering this type of model has come at a price; the investment they have made in technology has been high and although somewhat prescriptive seems to satisfy both investors and insurers alike in the success of the model.

The pandemic has accelerated the need to become “officeless” and the investment in the infrastructure, reduced support staff and cost efficiency has given many of these firms a considerable benefit over the traditional practice. Consumers seem more comfortable in purchasing legal service remotely and this can only be seen as true market disruption.

This sets another challenge to the traditional law firm that without government financial support are reluctant to make significant investment by the owners into costs reduction and technology. This will mean that the “Squeezed middle” will be traditional firms, mainly regional, that will find it increasingly difficult to compete on price.

As discussed earlier many Solicitors do not want the responsibility of ownership and many will find it attractive to be part of a bigger firm as a consultant with a better work life balance, and possibly a better income.

Cost Efficiency
Many legal services are technology and process driven and the efficient firm will look towards investment in artificial intelligence (AI). Outsourcing and offshoring will become an effective way of driving down costs and improving efficiency.

Consumers are becoming more comfortable in purchasing legal services through apps and by using AI we will see a reduction in the full time job market for Solicitors. Anything that can be processed will be; from conveyancing to probate the world of legal services is changing beyond recognition. Bizarrely the pandemic has speeded the need to process and a significant investment in technology is s step to far for many firms.

We have seen a significant growth in firms prepared to become more efficient by outsourcing and off-shoring processed services. We have seen progressive firms reducing costs by around 40% by offshoring the file opening and post completion part of the conveyancing process. By utilising this type of service it has allowed the firms to develop and grow and focus on the more technical matters, in fact I have seen firms doubling in size by adopting this efficient cost effective part of the process.

This will mean that more and more firms will not be able to compete in a highly competitive market and we will see the growth of the factory type legal process centres already making a huge impact on the smaller and mid-sized practice.

Consumer Choice
The growth of the “Trip Advisor” type websites is moving consumers towards less local purchasing of legal services. These review websites give consumers the opportunity to choose based on other client experiences where they purchase legal services. Many practices have given poor client care over a number of years and these websites will encourage consumers to vote with their feet. This is another challenge to firms not prepared to change the way of working. Despite client loyalty we are seeing a trend towards websites to purchase legal documents and templates primarily due to price.

Fundamentally the firms that re not providing exceptional client care will find a reduction in their turnover and generally changing the culture of the practice is a slow and difficult process that takes both time and investment. I strongly suggest that many firms will gradually see their business diminish if this is not addressed.

The Consolidators
For the first time in my knowledge we currently have more acquirers of law firms than we have firms for sale. The demand to grow and acquire is currently outstripping the supply of firms for sale this is due to the fact that most firms still have cash and therefore not focused on their future direction. All the points highlighted in this chapter focus on the reasons why we will see consolidation and failures but the majority of firms are at the crossroads in their decision making and not yet come to the decision to merge.

Diminishing turnover and aging owners need a catalyst to help make their decisions for them and the acceptance that competition and all the other issues should make them think carefully about their strategy going forward

These conditions are unique but as the professional indemnity season gets into full swing we may have the catalyst for firms to look to merge. Certainly over the next few years we will see a large amount of mergers and potential failures.

The legal sector has always been fragmented and numerous small solicitor practices have built their reputation on word of mouth and local advertising. In many towns Solicitors had their offices on the same street making it virtually impossible to compare one firm to another – this sounds very similar to where Opticians were several years ago.

We are now just starting to see National brands emerging, the first of these was Quality Solicitors which operated as a type of franchise but had television advertising supporting the brand. Private Equity has taken a significant interest in legal services and has supported numerous firms on their growth strategy. We have seen a number of these practices float on the various stock markets with institutional investment and there are many more to come.

A very different story is emerging with smaller local firms unable to compete on volume processed services and therefore choosing to become more niche in their offering and dropping unprofitable or unviable lines of work. Others will join the merger mania and realise that they are unable to provide the services traditionally offered and need economies of scale to make their business profitable. Some will merge with local firms that eventually will be acquired by National corporate brands.

We have significant interest at all levels from private equity houses that see legal services as a lucrative space to be in. We have consolidators in the volume process arena such as conveyancing that have their own off shore captive that they process legal work through.

Other brands are emerging and we are seeing legal brands become more nationally prominent as they continue to merge and acquire profitable practices.

Perhaps, this perfect storm will be the catalyst for change – will we see national brands providing legal services? Possibly.

Will there always be a place for the independent niche Solicitor practice?  Probably.

In the post pandemic legal sector what we will see is significant change.

Viv Williams, January 2022

Viv Williams of Viv Williams Consulting www.vivwilliamsconsulting.co.uk.  (viv@vivwilliamsconsulting.co.uk).
Tel: 03332 423993