Firms with two to four partners 'grow profits fastest'

Two to four-partner law firms are growing their profits the fastest, a report by national accountancy network MHA has suggested.

The report, based over 100 of the association's law firm clients across the UK, showed that average PEP improved in firms with two to four partners by 27.1 per cent to £145,351 last year.

In contrast sole practitioners suffered a decline in their average profits by over 12 per cent to £76,456 per partner.

While average PEP grew only marginally at firms with between five to 25 partners, at larger firms it rose by 13.8 per cent to almost £136,700.

Harmy Gill, head of the legal services group at MHA MacIntyre Hudson in the City, said that across the country equity partner returns increased by 8.5 per cent last year "from a meagre 2011" to £114,145.

In line with their success in PEP, Gill said that the average net profit percentage of two to four-partner firms increased from 24 to 28 per cent, suggesting that only firms of this size were agile enough to "turn the increased fee income streams into increased bottom line profitability".

Gill said these firms were also the most successful at cutting employment costs as a percentage of fee income from 65 per cent to 60 per cent last year.

However, he said they had to bear the brunt of the indemnity savings made by larger firms last year.

The amount paid as a percentage of fee income for two to four partner firms increased from 2 to 3 per cent, while sole practitioners had to pay 5 per cent, the same as in 2011.

Sole practitioners paid a similar average percentage of their fee income in marketing fees. Two to four partner firms paid the lowest, one per cent, while larger firms paid 2 per cent.

The report showed that two to four-partner firms had the lowest percentage of employment costs, as compared to fee income.

This was 60 per cent last year, compared to 68 per cent for sole practitioners and firms with five to 10 partners.

However, when it came to control of 'lock-up', a combination of unbilled work in progress and unpaid debtors, MHA said the average number of days was 127, meaning that it took over four months from doing the work to converting it to cash.

The report suggested a reasonable target for lockup would be 110 days. Here the best performers were sole practitioners, with only 62 days, and the worst those with 11-25 equity partners, where the lockup totalled an average of 148 days.

Gill said that MHA believed the legal sector "will continue to remain at a distinct disadvantage due to the increased competition resulting from deregulation, added compliance burdens and sector specific issues (relating to legal aid, PI referral fees and a reduction in PII providers, amongst others)."

As a result, he said merger activity was likely to become more pronounced.

Gill concluded that looking for continued improvement in the management of lockup, employment costs and fee income growth at per partner level "must remain the focus for law firms".