How financial stability got to take centre stage

Until recently it was not that challenging for lawyers to make good money. Chargeable hours recovered the costs associated with inefficiency. Client ?deposits delivered free cash in the form of interest and work arrived at the doorstep every day without the cost of marketing, regulation or an expensive insurance premium.

This period was less than ten years ago, a time before central banks drove interest rates down to historic lows in an attempt to stimulate economic recovery. This was before the global banking crisis resulted in years of recession, and before users of legal services were willing to explore the market for competitive options. Back then, sound financial management didn't matter as much; now, for some, it has become a question of survival. Halfway through the first quarter of the 21st century, the economic challenges have already claimed several victims. They have included firms large enough that nobody believed they would fail or be allowed to fail. Cobbetts and Halliwells are the Woolworths and Borders of the legal services sector. Many expect that there will be more casualties among the top 100. The concept of financial stability has suddenly taken centre stage for all firms across Britain, and for the regulator.

HEALTHIER DIALOGUE

"Law is now a business, and the largest differential is the drop in interest rates" says Steve Billot, restructuring and recovery partner, at Baker Tilly. "High street firms would easily make £50,000 per equity partner a year from interest alone on clients' deposit accounts; now there is no more free income."

This is not pocket money but it's nothing compared with the quarter of a million pounds that Glynn Morris, partner at Higgs and Sons, says his firm used to earn just a few years ago. But Morris is keen to stress that the concerns over financial stability do not reflect the situation on the ground. "There is a lot of fear about financial stability and in many ways this is being stimulated by the regulator."

All around the table agree, it turns out, saying the doom and gloom headlines are, well, just headlines. The reality, they say, is much more positive. You ?would of course, expect lawyers who accept to take part in a round table on financial stability to take a more optimistic ?outlook, particularly as most of them are from the affluent south of England.

It's not that these senior lawyers are financial climate change deniers. They all agree that the past few years have been exceptionally tough and that the relationship with their financial business partners is different from before the recession. "There is a healthier dialogue with banks and indemnity insurers," says Hugh James' managing partner Alun Jones. "It has certainly resulted in a new relationship with insurers," he says.

Steve Arundale, head of professional services for commercial banking at NatWest, confirms the general impression that the sector has, on the whole, remained comparatively stable in terms of distressed firms. "In business terms the legal services sector has become static compared with other ?professions such as accountancy, which is currently evidencing more signs of stress. Over the last six months, for example, we have seen more accountancy firms experiencing issues than legal firms - but of course that it just our experience. Depletion of capital is a serious issue but overall the sector has remained strong, with many firms reporting revenue growth and improved profitability," he says.

CULTURAL REVOLUTION

Backstage, austerity and the end of easy money have brought about not just a new type of relationship with funders but ?also a more business-like approach to management.

"Margins are lower, costs are up, and firms have had to develop a better understanding of which teams are doing well," says Chris Hart, managing partner of 13-partner firm Wollen Michelmore, in South Devon. His response was to instigate a more open culture where everybody knows what is expected of them. This includes quarterly P&Ls for all fee earners.

Further up the coast in East Sussex, Rix and Kay's managing partner Bruce Hayter is taking the same approach. "We've had management accountants in the business for the past eight years. Our head of finance has ?brought people into the real world," he says. Now, key performance indicators (KPIs) are in place across the whole firm and the board focuses on margins and profitably rather than just revenue.

"Risk is not a new issue for law firms, but it is true that banks ?and insurers are now stakeholders with an interest in the way firms are managed," he says. But much more challenging, Hayter adds, is "the negativity and frenzy" surrounding ?financial stability, with staff reading horror stories about law firms, which the partners then have to manage. "So our policy is one of complete transparency, so everybody in the firm can be confident about what we do and convey this to clients."

Central London Hodge Jones and Allen also introduced a new performance matrix ten years ago. The firm employs four accountants in house, and uses KPIs and rankings for ?fee earners. It has also become tougher on lock-up periods, with fee earners incentivised to ?reduce time between instruction and completion.

"Fee earners tend to focus on what they do for their clients ?and which court they need to be in the next day, so getting ?them to think commercially ?can be a challenge," says managing partner and ?co-founder Patrick Allen.

Hugh James has had a financial risk management framework for the past decade too, says managing partner Alun Jones, and it has encountered the same challenges. "Every lawyer has a dashboard in the morning, with weekly and monthly analysis. It's good practice but it can be alien to some fee earners at first; and we also don't want to chase out the lawyer in them," says Jones.

Hugh James has also introduced peer supervision once a quarter, which allows the firm to keep an eye on complaints, which have dropped to near insignificance as a result. Now financial management is so much part of the culture that fee earners can officially claim two 'financial management days' every month to work on figures.

Communication is also improving, with all participants saying financial information is circulated. Most business-minded firms are already doing this, but one realisation in the context of the recession is that the right information needs to be collated and then communicated. Sometimes, this means less rather than more. At Wollen Michelmore, for instance, inch-thick financial reports that nobody actually read have been replaced with a short weekly list of key points circulated by email.

Another major change in management culture has been the way work in progress is treated and debt collected.

"We have seen a number of firms who are wanting to work with us more closely in the general running and development of their business," says Steve Arundale. "Creating a healthy relationship with a funder which encourages confidence is vital - involve ?banks in your strategic ?thinking right through to ?funding implementation."

WIP AND DEBTOR DAYS

Payment on account is standard practice in most firms but the recession has made firms fine-tune their WIP, billing and debt collection processes. It starts with giving shorter payment terms - 14 days rather than 30 at Hugh James, at the end of which the credit control department takes over unless there are explicit instructions otherwise agreed via a billing board. Another simple but effective ?trick, according to Alun Jones, is to bill before the end of the month so that your bill gets into your client's end-of-month cheque run.

The position is similar at ?Wollen Michelmore: "it's about educating fee earners," says ?Chris Hart as he comments that lawyers should not be afraid of asking for payment as soon as the work is done.

Over at Bishop and Sewell, senior partner Stephen Bishop says, it has become standard practice to charge clients interest for late payment - and, astonishingly, clients pay both bills and interest with little fuss.

"Partners are getting, and have had to get, smarter about the way they run their firms as a business and are looking at billing structures and processes which benefit them - rather than the more traditional knee-jerk reaction to raise fees," Steve Arundale comments. "As the economy and work levels ?pick up, firms will need to consider the impact of increased lock-up on cashflow. Is the overdraft big enough?"

Another perennial gripe also emerges: the regulator's tendency to interfere.

INTERFERENCE AND INTEGRITY

The law, says Tony Guise, founder of two-partner firm Guise Solicitors, has not suffered from the downturn any more than other sectors. The profession's predicament is that risk is part of what lawyers do, even more so as regulatory rules require them to act with integrity. The latest version of the solicitors' handbook, he says, is "oppressive". When it comes to outcomes-focused regulation, he continues, "things are not as they seem. Past the new first part on OFR, the rest is mostly cut-and-paste from the old handbook."

Any dents to the principle in practice, such as the demise of Cobbetts and Halliwells, affects trust in the profession, says Steve Billot. "We're still feeling the ripples of these failures, and there will be more on the way," he says.

"Integrity," Glynn Morris ?agrees, "is at the heart of the profession and should apply to ?all in the sector". His main frustration however, is that the SRA is sometimes "?masquerading as your friend" when it is your regulator, and this flaws the dialogue firms can have with them.

Separate business rules is another example Tony Guise gives of the inflexibility of regulation as an impediment to innovation in business. He reflects on a firm he knows of that developed immigration software, initially for its own internal purposes, and was thinking about licensing to other firms. "Is that a separate business, and will that mean additional costs," ?he asks.

CAUTIOUS CONFIDENCE

All this, unsurprisingly, has affected the relationship between firms and their lenders. Most banks still see law firms as comparatively safe clients but the situation is more subtle.

"There is still an element of honorability with the legal profession," says Steve Arundale. "But it doesn't mean there aren't any challenges. Banks recognise the need to work more closely with legal firms to understand the strategic direction of the business. For instance, we look at a firm's IT systems, business make up, client exposure, marketing plan, business objectives - and its management capability. Debt levels were always an important factor, but the changes to legal aid and costs reforms are changing the way we look at it; for example, how CFAs are operated and managed post-Jackson and the potential effect on a firm's cash flow and f?inancial circumstances."

Changes to legal aid have forced firms like Hodge Jones and Allen to gradually move into a different direction. This has had an effect on funding requirements. "For instance, we're negotiating a sale and leaseback of our office," says Patrick Allen. The firm has also brought in "specialists in spreadsheets", who are able to keep their fingers on the firm's financial pulse - "You have to tackle it in this way if you want to secure funding from ?your lender."

Perhaps the most telling comment about the new financial relationships in the sector came from Higgs and Sons' Glynn Morris: "you have to have a bank manager who understands your business, it's essential to give you the confidence that they will support you."