Practice management | Roundtable: the end of the zombie firms

If you were just taking a glance at the agenda items for this meeting at Baker Tilly’s central Manchester offices in early December 2012, you might deduce that the topics of discussion were going to get very grim indeed. “It seems many firms are back on a downward slope with revenue growth once again diminishing. Will this spell the end for those hanging on by their fingernails?” reads one.

Read between the lines though and there’s a prevailing optimism for the future round this table, but it has got to get worse before it gets better. The assembled representatives of the legal services market included, a former Law Society president, legal finance and strategy experts and two managing partners, whose own firms are living proof that not only is it possible to survive in today’s marketplace, it’s a reasonable expectation to flourish.

The meeting opened with a presentation from Mark Hovell, managing partner at George Davies, a mid-tier practice in Manchester. Hovell has been at the helm of a long-term change process for the past five years and, despite admitting to suffering an early ‘recession’ about ten years ago, was able to report 16 per cent growth in income for 2011/12.

Hovell isn’t the only one to have had a good year, “We’re doing significantly better than we did five years ago. Last year we were turning over about £800,000 and this year we’re turning over about £1.2m,” says Russell Conway, regular Solicitors Journal columnist and senior partner at Kensington-based firm Oliver Fisher.

What are Hovell and Conway doing that the rest of the market needs to do? The consensus among this panel is that they are demonstrating the leadership skills needed to run an effective business, rather than being held back by an archaic concept of what a law firm should be.

Despite resistance from partners who believed that it was neither cost-effective nor necessary at the time, Hovell and Conway both initiated successful office moves to modern premises. Hovell achieved a cost-neutral move to an open plan, hot-desking environment and by engaging clients and staff throughout the process and leading by example in terms of, for example, being the last to choose where he would sit in the new space, did so relatively painlessly. Conway’s move was less dramatic, but it was proved to be a good decision and by the end of this discussion, he was so convinced by Hovell’s experience that he was almost prepared to tear down the last remaining office partitions himself.

Premises are a strategic consideration, which the panel agree can be make or break for a struggling firm. “It is interesting that very few of the top 50 law firms now owns the building they work out of,” observes Robert Mowbray, accountant at Taylor Mowbray. “They’ve all come to the same conclusion, which is that it’s a huge funding issue. New partners can’t afford to buy in to the firm because the firm owns the building and there have been so many issues when the partners own the property and the firm wants to move but one of the partners has left and it’s caused chaos. If you’re going to invest in property, invest in any property on the planet apart from that one. Let’s not confuse property investment with running a law firm,” he adds.

At George Davies, the partners had considered purchasing the building but the landlord refused to sell. Looking back Hovell is relieved it didn’t go ahead: “I’m sure our pensions would be looking good, but we, as a firm, would still be there now and we wouldn’t be turning over what we’re doing now.”

Office moves though, are the tip of the iceberg. As Chris Marston points out, what has actually been demonstrated by Hovell at George Davies and by Conway at Oliver Fisher is strong leadership. It is that, the panel agrees, which the legal sector has been desperately lacking.

Roger Hill, a senior business development manager for Lloyds TSB Commercial in the north-west, agrees that strong leadership is vital to the success of firms. Drawing on experience of his own clients, he says he has seen niche private client practices and several high street firms doing extremely well, despite the recession.

“It’s because they acted decisively in 2009,” says Hill, adding “some of them didn’t lose any people, but they made changes and they made the business more robust. They have dynamically managed their practices to make sure that they are ready for the new world and the more I look back to the firms I’ve seen, and the ones I’ve taken on as new customers, it’s leadership that makes the biggest difference and a good knowledge of financial management.”

The same can’t be said for the many ‘zombie’ firms, which, consultant Andrew Hedley speculates may only have remained undead for this long due to the pressure on banks not to close failing businesses down. Many will have been encouraged to buy their own premises and borrow substantially, but have not in the meantime dealt with the underlying issue – that the business model doesn’t work.

Niche practices, says Hedley, are better equipped to survive because they can trade on having a unique proposition which is valuable to their target clients but, he explains “the firms that are really struggling are the general practice firms, whether they are in private client or business services, since they’ve got no point of differentiation. And when people see no meaningful difference between firms then they shop on price, and since most firms are wholly ill-equipped to compete on price, all that gets eroded is profit.”

It can be very difficult to turn a firm like that around if it gets into difficulty and remains under the misapprehension that the cause is entirely external. If the leaders are unprepared to accept that external changes, to the market as a whole, demand that they make internal changes, zombie firm status is the likely outcome.

“Generally when a firm needs to make some changes, it needs to lose some people and buy some IT and both of those things cost money in the short term. So, in our support area, we tend to lend more so that these changes can be made. We work with them very closely to help with them turnaround and sometimes that can be done in a year. It might take three or four years in a big firm, where you have to get collegiate agreement from an ownership group, particularly if they are, irrespective of their legal structure, partnership minded,” says Marston.

Questions over the partnership model are raised repeatedly throughout the day. Having too many partners with competing agendas, as Marston has highlighted, slows decision-making down. Succession is also an enormous issue, with fewer young lawyers interested in equity partnership and far less likely to see a job for life in one firm. Many lawyers are nearing retirement age with no prospect of an exit.

John Thomas, chief executive of LawNet has seen cases in which all the partners are reaching retirement age, the firm has been failing to make money for several years, and when several partners suddenly want to leave, no one can afford to pay them out. “Why didn’t they identify this years ago? There’s been no succession planning, there’s been no leadership, and there are two managing partners sharing the role, which is always a disaster,” he says.

One way out of the situation once a firm has got to that point is merger. They have been more frequent over recent years and some of the panel expect to see more in 2013, although the over-riding feeling is that zombie firms will be flushed out this year, finally overcome by years of failing to reassess their position in the market.

“I think there’s going to be more failures than mergers this year,” says Hovell, who believes there is inherent risk if taking on a business that has gone into administration, which are often the ones seeking to merge.

That said, he is curious about the growth strategy at Linder Myers, which has involved acquisition of failing firms. “I’m not criticising them at all, in a way I’m quite envious of their growth figures and how they’re just pushing on and doing things. They’ve got a plan, they want to be a certain size and they’re very strong at pushing it through,” he says. But for others, without a strategy, “there’s a lot of burying their head and that’s part of this change process we’re going through – there’s a lot more pain in the legal sector to come,” he says.

There is scepticism over whether ABS, and the opportunity to bring in non-lawyer owners, may resolve some of the succession issues – leaving the lawyers to law and the business people to run the business. Most of the panel believe the new model is still too much of an unknown quantity to judge the impact it will have in the long-term but they are dubious about the concept of non-lawyer partners stepping in and investing. “I can only see money coming into a legal firm if it has got a specific purpose, and for me I don’t think it’s going to be to pay somebody to leave,” says Hovell.

Marston agrees: “I think the role of internal equity is to achieve an upside that could not be achieved without that equity injection, either to find new markets or make an acquisition, or increase a new line of business or something like that, so as to increase the value of the firm.”

Looking ahead to 2013 Marston, Conway and Thomas were relatively optimistic it wouldn’t be a significantly worse year than it was in 2012. Hovell, Mowbray and Hill however, believe the stress that has been placed on the sector in the past few years will mean that many firms reach breaking point this year.

“I think it’s a tough market, there’s no real growth. I think we’re going to see a lot of failures this year. The zombie firms will start to flush out because nobody will take them over. It always comes in around January, you’ve got to pay your tax – I think you’re going to see a swathe of people desperate for mergers. I think the issue is law firms that are incredibly badly run and inefficient businesses will go,” said Hovell.

Since then of course, we’ve seen Cobbetts go into administration and subsequently merge with DWF – is this the kind of survival strategy that we’ll see filtering down into smaller firms over the next year?
If so, the suggestion from both Hovell and Hedley that it will be a “horrible” year for many firms may be true. It’s hard to be optimistic in the face of such predictions but remembering that this is a part of the change is important. For those that move with the market, such pain will be ?largely avoided.