Failure to Fund: Law Firm Insolvencies Continue to Rise
May 13, 2019
2 min read
What's going on here?
An increasing number of law firms are becoming insolvent due to tighter funding options.
What does this mean?
The number of law firms becoming insolvent increased from 23 in 2017 to 39 in 2018, with the trend expected to continue. The main victims are smaller law firms which are being badly affected by fewer funding options.
Steve Din from Doorway Capital (a leading fund that invests in the legal market) says that the “explosion of online lending” has been increasing within law firms. This has resulted in firms relying on “loan stacking”. Loan stacking is when businesses take out several loans at the same time from multiple lenders. This practice is particularly used by small firms with few equity partners who are more willing to give personal guarantees. While it has been traditional for partners to fund firms, in recent times firms are more likely to be funded by loans which can be challenging to manage for smaller firms.
What's the big picture effect?
Developing a growing firm and maintaining a competitive advantage in the legal market today generally comes through investment. Investing in new technologies and people requires money. Therefore, a more structured approach to debt is vital.
The way banks are acting is also not helping the situation which law firms are finding themselves in. It is expected that in 2020, high street banks will be limiting credit and overdraft facilities only to the strongest firms. This has led firms to embrace a more corporate mindset, moving away from short term loans, in favour of long term borrowing solutions.
An uncertain future of funding may lead to more insolvencies and personal bankruptcy for partners. It will also lead to more consolidation and acquisitions as failing firms are bought by more wealthy organisations. To illustrate this, Doorway Capital has recently acquired Leeds’ Simpson Millar and plans to invest £50 million to grow the firm.
However, law firms aren’t blaming funding worries alone for them shutting their doors. Data from Hazelwoods (accountants for the Solicitors Regulation Authority) show that only 10% of firms closed over financial struggles. As Hazelwoods has said, this highlights the “resilience” of some players in the legal sector. In periods of economic uncertainty, while there may be fewer new deals, there will be increased work for firms which engage in financial service regulation and restructuring (which tend to be larger firms). For smaller firms, the impact of legal aid cuts and civil justice reforms have clearly taken their toll. Having a diverse range of work is clearly important for the stability of law firms to weather periods of economic or political uncertainty.
Sometimes small firms just can’t diversify well enough.
Report written by Elizabeth M
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