Law firm capital and the financial crisis

I don’t normally link to articles in National, the magazine I edit — this blog is my personal project and doesn’t necessarily represent my employer’s views, and so I try to keep Law21 and CBA in watertight compartments. But I’m making an exception for our September 2008 cover story “Who owns the firm?“, which looks at non-lawyer investment in and ownership of law firms, something that’s already underway in Australia and that’s coming to the UK within the next few years.

I provide the link partly because I think it’s a pretty good article — but mostly because it’s turned out to be awfully timely as well, in two respects. For one thing, the UK reform process is accelerating. The Solicitors Regulation Authority is fast-tracking plans to allow up to 25% non-lawyer partnership in UK law firms. “The timetable,” LegalWeek reports, “would put the SRA ahead of schedule, allowing it to fast-track applications when the regulations come into force, which is anticipated in March 2009.”

(The article is a little unclear on an important point. It refers to the SRA accepting applications for new Legal Disciplinary Partnerships (LDPs) — these are operations that comprise solicitors, barristers, licensed conveyancers and other legal professionals who up till now have not been permitted to form partnerships in the UK. But the proposal to allow non-lawyers to practise law in partnership with lawyers, a far more radical notion, envisions something called Alternative Business Structures (ABS). This article in Managing Partner magazine explains the difference very well.)

So the UK reform process is gathering speed. But the other reason why National‘s cover story is timely lies in the front pages of your newspaper over the past week — the financial crisis besetting the US (and increasingly, the world) economy. I won’t recap what’s going on — you already know about it, and the news is changing by the minute. Suffice to say it’s serious and it will directly affect lawyers (consider these comments by veteran Canadian corporate lawyers in today’s Globe & Mail).

Why should lawyers and law firms care about the financial crisis? The reason has little to do with the Dow Jones, the TSX, or any other stock market index that’s fluctuating wildly right now. The reason lies in the  more important indices in the credit markets. Credit is freezing up around the  world — the cost of borrowing is climbing higher by the hour, as banks grow far less trusting of other banks and of borrowers generally. Financial analysts are paying a lot more attention to the credit markets than the stock markets. Lawyers should, too.

Credit markets matter to Main Street, as opposed to Wall Street, because a lot of modern businesses rely on the liquidity of credit to keep their operations going. More than a few companies need access to credit just in order to meet their payrolls. And I would submit that few modern enterprises are as heavily dependent on credit as law firms.

Law firms have always been odd business structures. They pay out all their profits at the end of every fiscal year, and rarely commit any serious funds to long-term investments or anything more than the most essential capital or infrastructure needs. They’re also notoriously bad at cash flow — many lawyers don’t bill quickly or frequently enough, and they let outstanding receivables gather dust without forcing the collections issue. When your coffers empty every December and it takes you three months to get paid for a service rendered, you’re living an unnecessarily precarious financial life. Law firms are walking a very thin tightrope, and right now, the financial crisis is producing gusting winds.

In that context, the concept of stable outside funding is going to seem a lot more attractive in the years, and maybe even the months, to come. Many law firm leaders have so far shrugged off the idea of floating shares in the firm or taking on outside investment, on the grounds that what do firms need with deep capital reserves? That’s an attitude borne of an era of cheap and easy credit, an era that’s gone and might not be back for quite a while. The premise, and the promise, of outside investment in law firms could become a priority consideration a lot sooner than anyone expected.

Related post: Credit crisis: you ain’t seen nothin’ yet.


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