Survey provides insight into early impact of pandemic on medium-size law firms

In its 20^th year, the Law Management Section’s Financial Benchmarking report provides a vital insight into how medium-sized law firms have been hit by the unprecedented conditions brought about by the Covid-19 pandemic with profits projected to be down just shy of a quarter.

Looking back to early 2020, many firms were performing well, with 60% of participants reporting year-on-year growth in fee income in 2020 including one-quarter seeing growth of more than 10%.

Median practice fee income had increased by 1.6% (the smallest increase for nine years) whilst median fee income per equity partner increased by 3.7%, from £775,515 in 2019 to £804,437 in 2020.

Firms reported a drop in profits per equity partner for the second year running – with a median drop of 6.9% for participating firms. Despite increased fee income, overheads grew more quickly than fees, leading to this fall in profits.

In particular, the median spend on non-salary overheads per fee earner (i.e. everything except salary costs) was up 4.5%. Much of this was driven by rises in the cost of professional indemnity insurance cover and additional spend on IT.

Early impact of Covid-19

Up until the time the survey closed in October 2020, 83% of participants reported having taken advantage of the assistance provided by the government and HMRC to manage through the pandemic.

This included deferring VAT liability from March to June 2020, in line with expectations given that the deferral was automatic.

15% of firms had been able to agree a time to pay arrangement with HMRC on the PAYE/National Insurance contributions due on monthly salaries, and a small number of limited company firms were able to negotiate time to pay on their corporation tax bills.

Finally, partners in half of the partnership/LLP participant firms deferred their July 2020 tax payments until January 2021.

Three quarters of participating firms furloughed fee earning staff for a time, with a median of one in eight fee earners placed on furlough.

When it came to support staff, the furlough figures were much higher, at a median of one in three. A quarter of participants reported that they had furloughed more than half of their support staff for a time.

A third of participants anticipated making redundancies amongst their fee earning staff, and where redundancies were expected, the median was two fee earners.

Looking forward, we asked participants for details of the impact of COVID-19 on their financial projections for 2020/21. The median drop in forecast income was 15%, resulting in a median reduction in forecast profits of 24%.

We will see how accurate these figures are in the 2022 survey, which will be launched later this year.

Paul Bennett, Chair of the Law Society’s Law Management Section, said:

“The trends are reassuring to law firms as managing a law firm can be challenging at any time, but Covid amplified the challenges. 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.

“Growth must be with a focus on profitability as we emerge from the pandemic. The strong year on year income growth of 60% 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.”

Darren Cable, UK Head of Legal at Lloyds Bank, which sponsors the survey, added:

“We are proud to once again sponsor this invaluable survey, which provides vital benchmarking data for law firms. Our team of Lexcel-trained industry experts continue to work closely with businesses across the legal profession, providing the funding and tailored support to help them recover from the impact of the pandemic and look forward to a brighter future.”

Key findings from the report included:

Staff costs continue to increase – the median cost of a fee earner (including fixed share partners and notional salaries for equity partners) increased by around 1%. The number of support staff remained similar to 2019. The median cost of support staff – including secretaries, reception, HR and accounts decreased slightly, from 17.5% to 17.3% of fee income.
Median spend onnon-staff overheads per fee earner (i.e. everything except salary costs) increased by 4.5%. Much of this was driven by rises in the cost of professional indemnity insurance cover and additional spend on IT.
Thenet profit margin dropped slightly from a median of 20.8% to 20.7% – this is largely due to increasing staff costs. As a result, median net profit per equity partner (before notional salary) for participating practices, dropped for the second time since 2010 – from £166k in 2019 to £155k in 2020, a fall of 6.9%.
In addition, median ‘super profit’ per equity partner was £58,638 (adjusted net profit figure to include cost for equity partner and notional interest on partner capital), an increase of 6.2% on 2019 figures. This is largely due to a large gap between the average notional salary per partner in the £2 million to £10 million brackets and the highest turnover bracket, with those in the £5million to £10 million bracket seeing an overall increase in the net profits per equity partner.
Total year end lock up days (WIP and debtors combined) fell by one day to 128 days and median equity partner capital (combined total of capital account, current account and tax reserves) rose by 8.3% to £229,994.
The median hourly cost of a fee earner (based on 1,100 chargeable hours per year), was £112.69, median fees per hour were £126.07.
The median cost of a fee earner, including fixed share partners and notional salaries for equity partners, was £57,838, compared to £57,076 in 2019.