UK: Profesional Practices News - Challenging Times: Law Firms Hold Their Nerve - Our 18th Annual Survey Of The Legal Sector

Last Updated: 7 December 2012
Article by Smith & Williamson

BEST FOOT FORWARD

By Giles Murphy

While everyone seemed to enjoy the Olympics and the related spending boost to the UK economy, many professional firms have reported that summer trading was quiet, in part due to the Jubilee celebrations as well. We will see whether this was just a temporary pause if and when trading improves in the autumn and winter months, but I believe that for many firms, trading conditions remain tough. Sporting triumphs and extended holidays will no doubt have boosted staff morale, but the fundamental issue is that there is currently insufficient demand for professional services in the market.

It is therefore more important than ever that firms operate efficient, effective models and this newsletter provides some insight into how this can be achieved. We also highlight the first of our 'expanding overseas' case studies by reviewing the opportunities of expanding into Singapore. In our next issue, we will look at Brazil – the venue, of course, of the 2016 Olympics.

ECONOMIC OUTLOOK

By Christopher Bates

Christopher Bates discusses the impact of the Olympic Games on the UK economy and where we go from here.

This summer's Olympic Games appear to have given the UK more than just gold medals to cheer about. The 1% rise in gross domestic product in the third quarter of this year exceeded expectations and helped lift the UK economy out of a technical recession - providing welcome relief for both the Government and the Bank of England. However, since most of the gain in output was attributable to temporary factors, it is still too early to know whether this marks the start of a decisive uptick in growth.

Employment v productivity

The Olympic Games boosted services, which, in turn, helped to push unemployment claims down to their lowest levels in more than a year. The number of people in employment rose to its highest levels since 1971, when records began. However, the sharp contrast between trends in employment growth and levels of economic output has puzzled economists and policymakers alike.

While employment rises, productivity has remained around 4% below pre-recession levels, limiting the economy's growth potential. Another source of bemusement is that despite the high levels of employment, tax revenues have fallen - a worrying trend for the Treasury, which is already struggling to meet this year's Budget deficit targets.

Where next?

When Chancellor George Osborne outlines the Office for Budget Responsibility forecasts in the Autumn Statement in December, he is likely to claim that public finances are in line with his 'plan A', although tough decisions will need to be made if tax revenues continue to decline. The question for the Monetary Policy Committee (MPC) is what to do next.

Minutes from the most recent MPC meeting show that the focus for discussion has shifted to whether further quantitative easing in its current form will help. Although inflation has fallen steadily and now lies just above the Bank of England's 2% target level, recently announced energy price increases will moderate the impact on disposable incomes.

Funding for Lending Scheme

Early reports suggest that the Funding for Lending Scheme, which was launched in June, is beginning to yield positive results in the mortgage market. In fact, both the Government and the Bank of England are pinning a great deal of hope on its success. However, the MPC may be forced to implement even more unconventional policy if it is to reach the wider economy.

UK equities

The UK equity market is highly skewed towards the mining and energy sectors, which have proved vulnerable to the continued global economic slowdown. Investors have been finding better value in companies further down the market-cap scale. Both mid-cap and small-cap shares have comfortably outperformed the FTSE 100 Index over the past three months, benefiting from the momentum gained during the summer.

CHALLENGING TIMES: LAW FIRMS HOLD THEIR NERVE

By Giles Murphy

Our 18th annual survey of the legal sector explores the latest issues and trends affecting law firms and the legal market. This year, 119 of the UK's top 250 law firms took part, including half of the top 40 and 54 of the top 100 firms.

Confidence slides

Confidence within the legal sector appears to have taken a downward turn, with only 61% of respondents upbeat about the business outlook for the next 12 months, compared to nearly three-quarters last year. This fall in optimism is reflected in an 11% rise, to 38%, in the proportion of respondents who are not confident about the year ahead.

These results are not altogether surprising given that the UK economy has not bounced back in the way many had hoped and coupled with continuing uncertainty in the eurozone.

Strength in numbers

The fragility of the UK economy, pressure on fees and maintaining profitability are the overriding areas of concern for both the sector as a whole and individual firms.

Fewer transactions, resulting in reduced demand for legal services and increased competition among practices, are inevitably a source of concern for many firms and continue to impact on their bottom-lines.

Merger activity

There has long been an expectation of high levels of merger activity and this year is no different. A resounding 84% of respondents anticipate an increase in mergers over the coming year - up 4% on last year. Cultural differences, integration and financial performance are considered the three areas of greatest potential difficulty in determining whether mergers get over the line.

Nearly three-quarters view the Legal Services Act as the catalyst for future consolidation, with the key drivers being to strengthen existing service lines, grow the client base and expand the size of the firm.

Dynamic businesses?

As it becomes increasingly difficult for firms to expand organically, there appears to be a growing appetite for acquiring new teams or service lines. In the last year, over three-quarters of respondents engaged in discussions about merger or acquiring a team. Around 25% of respondent firms took on one new team and an additional 13% acquired two or more teams. Interestingly, almost a third of the teams changing hands included 11 or more people, which suggests that law firms are prepared to invest in larger teams than they have been in the recent past.

A third of respondents are opening a new office or considering it, with another half launching a new service line or looking into it. This underlines the challenges of organic growth and the need to differentiate services in order to maintain profitability. Could this be a knee-jerk reaction to challenging market conditions and would firms be better off sticking to what they do well instead of potentially diluting existing service lines?

Business structures

Firms continue to review their business structures in part to enhance the level of cash received by partners. Just over half of respondents have introduced a service company or are in the process of doing so, while a fifth have this option under review. The service company route has clearly been well tried and tested and is now considered routine practice.

In contrast, only 13% of firms have introduced a corporate member or are in the process of doing so, with another quarter considering it. It would appear that a corporate member is generally viewed as an effective way to retain profits but complex to implement.

For those looking to open an overseas office, a corporate holding company is an important tax-planning vehicle. Yet only 13% of respondents are setting one up or considering doing so, compared to a significant 63% who said it was 'not applicable'. This suggests that there is either a lack of awareness about the structure or those firms with representation in overseas jurisdictions have already explored this option.

Following the proposed reduction in income tax to 45%, a significant 70% of respondents said that tax planning is part of the firm's strategy to lower the overall rate of tax for partners, but nearly 30% said that it is not. This suggests that some firms feel they have already put appropriate tax structures in place and the onus is on individual partners/members to manage their own personal tax affairs.

Managing the business

Firms continue to make important changes necessary to manage their business effectively - although not to the same extent as last year. 8% of respondents have closed offices or are planning to do so (last year, the equivalent figure was 17%) while half have re-organised their management structure or are considering it. By comparison, last year 38% of participating firms re-organised their management structure, with another 27% considering it. Perhaps the majority of firms have been through the worst but are continuing to keep a watching brief on these issues following the upheaval of the last couple of years.

The survey confirms a long-term trend that is gradually seeing the phasing out of the full distribution model, with firms adopting a more 'corporate' approach to bolstering their finances. For the second-year running, half of firms said they are looking to retain more funds within the business.

Against this backdrop, as seen last year, 45% of firms have de-equitised partners or are planning to do so. 10% of firms are organising capital calls on partners with another 12% keeping this option under review.

While many firms continue to use the traditional lockstep reward mechanism for partners, merit awards seem to be gaining ground. Two-thirds of firms still use lockstep, while just over half are also using some form of merit-based award. Nearly a quarter of respondents allocate more than 25% of their profit share on discretionary terms, while 10% of practices allocate more than 50%. Looking ahead, a quarter of respondents expect these figures to rise in the next few years, but a significant 69% believe they will stay broadly the same.

THE 2012 IBA CONFERENCE - A DELEGATE'S VIEWPOINT

By Simon Mabey

Simon Mabey shares his experiences of the 2012 IBA Conference in Dublin.

When the International Bar Association (IBA) comes to town it's a spectacular event. Over 5,000 lawyers from around the world descend on the city, fill its hotels and keep an army of taxi drivers happy.

This year the conference was held at the new Dublin Conference Centre, where the capital city was abuzz with legal talk. The tone was set with the quality of speakers at the opening ceremony. The keynote speaker was Professor Joseph Stiglitz, former chief economist and senior vice president of the World Bank, who gave an address on the world's economic difficulties with an emphasis on Europe. This was followed by an engaging speech by the Taoiseach (Prime Minister of Ireland), who formally opened the conference.

As well as a full conference programme with more than 200 different working sessions to attend, there was a separate - almost parallel - event. With so many lawyers from so many different jurisdictions at the conference, this provided an opportunity for numerous discreet meetings between law firms.

Law firm management

My focus for the working sessions was largely on law firm management. There was a session on whether, in these more difficult times, non-lawyers should manage law firms. This gave rise to interesting discussions about competence and status. There was also a discussion on multidisciplinary firms and it became apparent just how quickly the Big Four accounting firms are building up their legal practices again. Another interesting session was on how law firms can continue to make the same profits in more difficult times, with a focus on outsourcing and re-engineering legal processes.

Spaced out

The most confusing moment - and quite a surreal experience - was caused by the labelling of rooms for the breakout sessions. You had to focus closely on whether you were supposed to be in 'Liffey Hall 2', 'Liffey Conference Room 2' or 'Liffey Meeting Room 2'. Having slipped into a session that I expected to be on law firm management, I found myself taking part in an interactive session on space law, ranging from the legal consequences of damage caused by satellite debris to mining rights on asteroids! I quickly made my excuses and left.

Networking opportunities

The event provided opportunities to meet lawyers from different jurisdictions at the numerous social events around the conference and on a one-to-one basis. I was present for just over 3 days but still managed to attend 12 evening receptions. The highlights included the UK Trade & Investment reception at the British Embassy, The Law Society reception at the Guinness Storehouse and, of course, the Smith & Williamson reception at the Royal Hibernian Gallery. Our guests and Dublin colleagues, as well as our forensic accounting and professional practices teams appreciated the venue and a good time was had by all.

BUILDING A PARTNER PERFORMANCE MODEL

By Rachel Stone

As part of our series on taking a balanced approach to measuring partner performance, Rachel Stone discusses the importance of internal management measures.

So far we have looked at measures for financial performance and for assessing client satisfaction. This time we turn our gaze inwards to the successful management and development of people.

The reality of partner responsibilities

A few years ago, I met a client partner who boasted that he spent just one hour a week on internal management issues, usually on a Saturday morning! He perceived management as a necessary chore and one that should be reduced to as little effort as physically possible.

I am sure that there are many partners who agree with, and can relate to, my client. So this third quadrant looks at partner responsibilities for making the most of the time, money and effort they spend on managing their employees.

Measures to assess effective internal management

Failure to invest time and effort in managing and developing employees leads to increased pressure at the top and no pipeline for future succession.

It can be harder to identify key measures in this area in the same quantitative way as others, but it is still possible to develop a good set of key performance indicators that tell you whether you are building and maintaining a high-quality approach to managing staff.

Internal management measures

  • Recruitment of new hires - how successful are you at attracting the people you want for your firm?
  • Training and development of an existing team - is the overall competency and ability of your team growing over time?
  • Staff relationships - how well do your staff work together to create a good result for your clients?
  • Morale and motivation - how motivated are your employees to deliver their best every day?
  • Performance management - do you give regular feedback to staff as well as carry out more formal assessments during the year? How successful is your performance review process at focusing staff on the right behaviours and outcomes?
  • Retaining high-performing staff - how successful are you at keeping people you see as having high potential?
  • Developing your successor - are there individuals within the team who can cover for you when you are involved with other projects or who can lead the team when you move on?

Getting started

In most firms, there are some partners who are naturally better at managing people than others. But all partners have some core responsibilities, including how to get the best from expensive teams.

These measures also have value on a firmwide level. If you don't know how to measure morale, motivation or the quality of staff relationships, a simple staff survey may provide some baseline information to help get you started.

Next time, we examine business development measures, recognising that different partners achieve great results in quite different ways.

TIME FOR A REVIEW? TAX UPDATE

By Pamela Sayers

Pam Sayers highlights three key areas that could impact on the tax liability of partnerships, meriting a review of existing and future structures.

Proposed cap on income tax reliefs

A technical consultation was issued in July, proposing to cap relief at £50,000 or 25% of an individual's total income (depending on which is higher) on ten unlimited income tax reliefs from April 2013. These include:

  • trade and property loss relief against general income
  • early trade loss relief
  • post-cessation trade and property loss relief
  • qualifying loan interest relief.

If implemented, individuals with additional business activities may only be entitled to a restricted amount of relief, including overlap relief for retiring partners.

The potential restriction on qualifying loan interest is likely to affect those partners who borrow significant amounts for the partnership, where the combined results from all business activities mean the cap on relief applies. Partnerships previously using partner finance may need to increase borrowings from elsewhere. With draft legislation expected in December and limited time before implementation, it may be appropriate to review partnership structures and financing arrangements now.

Impact of transfer-pricing Requirements

Transfer pricing for UK transactions was originally introduced in 2004. It was intended to ensure that UK rules on transfer pricing applied both crossborder and within the UK to comply with fundamental EU freedoms. It is now thought that these freedoms might be met without applying transfer pricing to UK transactions and HMRC is considering the implications of any possible changes.

Transfer-pricing arrangements apply automatically to businesses which are not classified as SMEs (no more than 250 staff and either turnover or balance sheet total of less than £10m, although the latter can elect irrevocably for transfer-pricing arrangements to apply on all transactions). Where transfer-pricing arrangements do apply, transactions between connected parties must be on an arm's-length basis where one or both parties would otherwise obtain a potential UK tax advantage.

Some partnerships use a service company within their structure and this company recharges costs at a mark-up. If the transfer-pricing rules for UK transactions change, there could be implications concerning the effectiveness of partnerships operating under existing rules.

Discussions are still at an early stage, with the possibility of further consultation. This presents an ideal opportunity for businesses to review their related-party transactions.

HMRC taskforces tackle tax evasion, avoidance and fraud

HMRC recently issued a press release announcing the launch of new taskforces to tackle tax evasion, avoidance and fraud in a number of specific business sectors, including the London legal profession.

This is just one of several recent initiatives aimed at bringing the less compliant or more aggressive tax avoiders into line, including:

  • disclosure facilities for those previously evading ta
  • a proposed general anti-abuse rule
  • a proposed strengthening of various anti-avoidance provisions
  • some high-profile court successes against marketed tax-avoidance schemes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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