Financial stability, or lack of it to be precise, is the latest issue facing UK legal firms.It is tempting to think this is just an issue for small UK based firms, brought on by regulatory changes in certain areas of the law, particularly personal injury and legal aid work. You would be very wrong to think this.

Consider a few other factors:

• A difficult economic climate
• Clients taking longer to pay their bills
• Clients wanting more service for less money
• More competition causing pressure to reduce fee levels
• Funding large tax bills at certain points in the year
• Banks being less willing to lend
• Partners drawing all the cash out of the business

Are these really issues that only affect the UK? Unlikely. Dealing with these factors if you are just a UK based firm will be difficult enough.  If you are a global firm, then the issues are likely to be magnified across all the territories in which you operate. They may impact either consecutively or concurrently across locations, neither scenario makes management of finances an easy matter.

One in three UK firms at risk

There have been some high-profile collapses of major legal firms in the UK and more predicted to come in what is becoming known as this Autumn’s ‘perfect storm’ for legal firm insolvencies. Our concerns are supported by research from The Association of Business Recovery Professionals (R3) who predict that just over 30 per cent of UK law firms are at risk of failing over the next 12 months.  Some of those are likely to be firms with overseas operations. 

What is certain is that this level of financial failure will have a catastrophic impact on the reputation of the legal profession, and also for the partners personally.So if profits are booming, or even just standing still, does that mean your firm is financially stable? No it doesn’t. It is not only the loss making firms or those with declining profits which are at risk.

Lack of cash

The problem in one word is cash. Actually it is three words - lack of cash. If you dont have enough cash to pay the bills when they are due, then quite regardless of how profitable your firm is, it is at risk of failing.Let's just look at how this can happen:

Your teams are working hard, clocking up the hours and generating good profits. You pay the teams, including the partners, monthly. This is likely to be by far your largest regular expenditure.  You must pay your teams as otherwise they will leave (and probably sue you in the process!)

Added to these regular monthly outgoings, there will be certain months of the year when you will have huge spikes in the need for cash as the big bills arrive - rent and tax liabilities for example.

A drain on resources

But cash doesn't come in on a matching time frame.  Clients are often slow to pay, or worse still, fees are contingent on an outcome which may be many months or years after you have done (and paid for) the work .

Firms setting up overseas operations and supporting these in their early years can also find they have huge drains on their cash resource with no prospect of payback for a long period.The result can be that there simply isn't enough cash in the bank at the right time and creditors are not willing to wait.

Potential solutions

There are two potential solutions to see you through the difficult months: Firstly, use a bank overdraft. Problem - banks are starting to say ‘no’ rather more often than they did. Secondly, leave sufficient undrawn profit in the firm. Problem - partners don't like this. They want their profit share paid to them in full to meet their own personal commitments.

This is, as we say in the UK, a chicken and egg situation (work out which comes first if this is not a familiar expression for you).  The bank won't fund a practice if the partners won't leave some of their profits in there. Partners don't want to leave profits in there, and so the bank won't fund the practice! Financial failure has serious consequences for the firm and the clients, but there could also be serious financial consequences for the individual partners of those firms too. They probably don't realise that and they need to know.

Rowan Williams is Baker Tilly's Head of London and South Professional Practices Group.