Legal Business Blogs

More law firm insolvencies expected as funding options tighten for smaller firms

The number of law firm insolvencies is expected to increase after nearly doubling to 39 in 2018, as tightening margins, succession issues and more difficult access to funding put pressure on high street firms.

Statistics from the Insolvency Service show the number of solicitor firm insolvencies was up 70% in 2018, from 23 in 2017. The previous high was 34 in 2014, while as recently as 2010 there were no recorded law firm insolvencies.

Steve Din, the founder of Doorway Capital – which has advanced more than £65m to law firms and acquired law firm debts worth £50m since it began trading in late 2015 – claims the increase has been driven by the increase in law firms over-borrowing.

‘The explosion of online lending has already led to a phenomenon known as “loan stacking” – a practice we have seen increasing amongst law firms, which appears to have been aided by a willingness amongst equity partners at these firms to enter into personal guarantees,’ Din commented.

Loan stacking is described as taking out multiple business loans from various lenders at the same time, including from fin-tech, peer-to-peer platforms and other secondary lenders. Din said Doorway, which last year acquired Leeds-based Simpson Millar and invested £50m in a five-year growth plan, had seen the practice at some of the firms it has looked into.

‘The fin-tech and peer-to-peer lending platforms appear to appeal to those law firms for whom funding secured by personal guarantees amongst partners can be agreed very quickly. The implication of that must be that it is the smaller law firms with only a handful of partners that are more likely to gravitate to this source of funding,’ he told Legal Business. ‘We are starting to notice some contraction in bank credit, which may well lead to higher numbers of insolvencies in the future.’

Arden Partners head of business and support services John Llewellyn-Lloyd, an adviser on legal IPOs, said he expected more law firms, whether through voluntary or compulsory insolvencies, would withdraw from the market, particularly smaller scale, high street firms.

He said margin pressures across the industry, combined with increased costs – particularly in relation to wages – meant it was also inevitable there would be further consolidation.

‘It’s just a question of how long that takes to happen,’ he told Legal Business. ‘Law firms are always slightly closer to the brink than most firms because their operating model is effectively to pay out each year and reload. They’re reliant on the predictability of their cash flows and the maintenance of their margins.’

Data provided by the Solicitors Regulation Authority to accounting firm Hazelwoods, however, showed that of the 281 firms that closed in the year to 31 May 2018, just 29 cited financial reasons as the primary reason for closure.

Hazelwoods partner Andy Harris said the legal profession was mostly resilient with many UK law firms doing very well over the last couple of years. There was an overall feeling of positivity rather than doom and gloom, he said.

He told Legal Business: ‘A lot of high street-type firms and traditional firms are struggling a bit because of all sorts of issues: not just in terms of profits, but also succession. We’re seeing lots and lots of these firms in talks with each other or in talks with consolidator firms.’

He added: ‘Some firms are borrowing from all sorts of places, and a lot of that’s because some banks have recently tightened up on what they’re prepared to lend and so firms have no choice but to speak to others.’