Survey highlights challenges faced by medium-sized firms during pandemic

Drop in average net profit margin blamed on increase in cost of PII cover and additional IT spend

An annual benchmarking survey has highlighted the impact of covid-19 on medium-sized law firms. Year-on-year growth is up, and practice fee income saw a small increase, but profits per equity partner (PPEP) dropped and projected profits are down. Staff costs also increased.

The 2021 report, sponsored by Lloyds Bank, was produced by Hazlewoods LLP for the Law Society’s Law Management Section. In its 20th year, respondents are unlikely to have seen a more turbulent year.  

Financial data relating to the last two financial years was collected from 145 firms across England and Wales, with a combined income of over £725m. The survey closed in October 2020.

Many firms performed well in early 2020; 60 per cent reported year-on-year growth in fee income, and a quarter saw growth of more than 10 per cent. 

However, practice fee income increased by only 1.6 per cent, the smallest increase for nine years. Fee income per equity partner increased by 3.7 per cent, from £775,515 in 2019 to £804,437 in 2020. 

Net profit margin dropped by 0.1 per cent, largely due to increased staff costs. Despite homeworking, overheads grew more quickly than fees. An increase in the cost of professional indemnity insurance and additional IT spend led to a increase in spend of 4.5 per cent on non-salary overheads per fee earner. 

The cost of a fee earner (including fixed share partners and notional salaries for equity partners) increased by around 1 per cent, up slightly at £57,838, compared to £57,076 in 2019. The hourly cost of a fee earner, based on 1,100 chargeable hours per year, was £112.69, while fees per hour were £126.07.

Numbers of support staff remained static, though the cost of such staff decreased slightly, from 17.5 per cent to 17.3 per cent of fee income.

Firms reported a drop in PPEP for the second year running, with a drop of 6.9 per cent (before notional salary) from £166,000 in 2019 to £155,000 in 2020.

However, ‘super profit’ per equity partner (adjusted net profit figure to include cost for equity partner and notional interest on partner capital), increased by 6.2 per cent on 2019 figures to £58,638. 

This was mainly due to the gap between the average notional salary per partner in the £2m to £10m brackets and the highest turnover bracket, with those in the £5m to £10m bracket seeing an overall increase in the net profits per equity partner.

83 per cent of participants had taken advantage of government support, which included the automatic VAT liability deferral from March to June 2020.

15 per cent had agreed time to pay arrangements with HMRC on PAYE/national insurance contributions, and several limited company firms had negotiated time to pay on corporation tax. Partners in half of partnership/LLP firms had deferred July 2020 tax payments until January 2021.

Three quarters of firms had furloughed fee earners for a time, with one in eight fee earners placed on furlough. A third of support staff had been furloughed, with a quarter of firms reporting more than half of support staff had been furloughed for a time.

A third of firms anticipated making fee earner redundancies; where redundancies were expected, it was predicted two fee earners would be laid off.   

The drop in forecast income for 2020/21 was 15 per cent, with a reduction in forecast profits of 24 per cent. The 2022 survey, launched later this year, will make for interesting reading. 

Paul Bennett, chair of the Law Management Section, said covid-19 had “amplified” the usual challenges faced by firms. He added: “However, the trends evidenced will help those reviewing the benchmarks to develop their own firm for the better in the medium to long term. 

“The increasing cost base of professional indemnity and IT will not surprise anyone but does highlight the importance of growing the income.” 

He advised, “Growth must be with a focus on profitability as we emerge from the pandemic. The strong year on year income growth of 60 per cent of the firms surveyed confirms there are opportunities for firms to increase market share and to thrive. 

“There are clear green shoots and opportunities to increase the long-term financial rewards, but this data is from the first wave of the pandemic challenges so we will no doubt see trends develop in next year’s survey.”