This article was originally published in New Zealand in New Zealand Law Society's "LawTalk" in June 2018.
For quite some
years now there has been a lot of discussion about the viability of
small-medium legal practice…unfortunately, much of it quite negative.
For at
least the last thirty years various pundits have signaled the eventual
disappearance of the smaller, general, legal practice.
Commentators
more recently have argued that we are heading to a gross over-supply of private
practice lawyers, assuming that there will not be enough work to go around, and
that revenues and profitability will inevitably fall.
I have a
much more positive view of the future and have penned this article from that
perspective, looking back across the decades since my Admission in 1975, to
draw on a wide range of experiences in the trenches with small-medium
practices.
I freely
acknowledge that my thoughts on what is important to viability will not
necessarily align with what might be found in a textbook on the subject.
Preliminary points…
Law is a
Profession, with very special considerations applying, but for the big majority
of practices very similar considerations apply as to those for ‘normal’
businesses. Viability is important in both.
What
‘viable’ is understood to mean will differ widely, even wildly, from
practitioner to practitioner.
One dictionary
definition of ‘viable’ is, “Capable of living, developing, or germinating under
favourable conditions”.
Many readers
might consider that current conditions are somewhat less than favourable, but
as always, those participants in any marketplace who best understand the keys
to success and best react, getting the fundamentals right, will achieve the
best outcomes.
What size
delimits a ‘small-medium’ legal practice in New Zealand? Just for the purpose
of this article, I would set an arbitrary number of lawyers in total at 19, for
the upper limit of small-medium practices. Numerous statistics available to us
use different numbers. My reasoning is that above this level practices tend to
have genuinely experienced managers.
Around 97%
of New Zealand firms fit into this grouping, as at 1 February 2018.
Importantly,
although the range of numbers used to delineate ‘small’ or ‘medium’ can be a
bit rubbery, the principles of viability for practices are pretty much
standard.
In looking
into the definitions of ‘viability’ as my logicaI starting point I quickly came
across these, firstly from the New Zealand Inland Revenue website tools for
assessing the viability of your proposed business, and secondly, from the
Australian Tax Office.
IR…
“Your …venture will need to generate
profits each year to meet your requirements. Profits are needed to generate an
acceptable return on investment (ROI) and pay salaries or wages”.
ATO…
“Viability is defined as the ability to
survive. In a business sense, that ability to survive is ultimately linked to
financial performance and position.
A business is viable where either:
- it
is returning a profit that is sufficient to provide a return to the
business owner while also meeting its commitments to business creditors
- it
has sufficient cash resources to sustain itself through a period when it
is not returning a profit”.
Readers should
immediately discern therein an important difference between ‘surviving’ and
‘thriving’.
It is
difficult to discuss viability without examining carefully what is meant by ‘a
return to the business owner’. In my view that has to be clarified in terms of
implications in day-to-day operation of a legal practice.
If the
owner works in the business (as is the case in most small practices), the owner
has to, at least nominally, be allocated a salary commensurate with their
effort and market value of their work, plus normal benefits.
Why would
employees be provided with various benefits beyond base salary as a matter of legal
obligation, or market forces, and the owner working alongside them not?
Think
Annual Leave, Long Service Leave, Carer’s Leave, Superannuation etc…it’s quite
a long list when you really turn your mind to it.
In
determining a remuneration for the owner’s efforts in working in the business
alongside employees, it is important not to use a figure that is purely nominal
and unreasonably low. To do so is to risk real confusion about whether the
practice is properly profitable and viable.
It may
indeed be ‘surviving’, but at what hidden impact on the owner?
In this
regard I regularly see Principals paying (or notionally allocating) themselves
a salary that is considerably less than that being paid to some employed
lawyers in the firm. Where that scenario is actually appropriate, it should be
the exception rather than something quite common.
It should
also be noted that the mere ‘allocation’ of a reasonable salary to an owner who
works in the business, for the purpose of better assessing practice viability,
is not to be confused with issues of taxable income.
This basic
remuneration for working in the business is one part of an owner’s total return,
but it is not to be confused with ‘Return on Investment’.
After the
‘remuneration package’ of a working owner, what is considered a reasonable
return on investment? That could be the subject of a separate article or, indeed,
a book!
Practice
management guidance from lawyers’ Professional bodies seldom, if ever,
addresses what is considered to be a reasonable profit margin in percentage
terms, whether before or after Principals’ salaries.
Businesses
are valued every day including a calculation of the level of risk that
historical (last 2-3 years often) genuine profit is likely to be maintainable
for a reasonable period in the future.
The higher
the risk perceived to the maintainability of the historical profit, the greater
return an investor in the business should want to see, so they can recover
their investment more quickly before any big risk factors may kick in.
Simply put,
the higher the risk, the faster the investor should be wanting to get their
capital invested repaid. That said, it is reasonable that different owners will
be happy to live with different expectations about returns, but need to be
mindful that potential successors may well have different expectations, that
could well impact their perception of the value of the practice. (More on this
later).
Well-managed
small-medium legal practices are on average only moderately risky in my view,
and ROI sought might be expected to be 20-25% typically. Note the critical
qualification, ‘well-managed’!
Fundamentals…
It should
go without saying that responsiveness to enquiry, quality communication, and
doing the legal work well and promptly are givens.
At the
heart of viability are profitability and management of working capital.
Planning…
Planning is
essential, but it is important not to over-complicate planning at the expense
of continuous execution of a good basic plan.
Identify a
manageable group of key things you need to always do well to achieve reasonable
goals, and arrange to do them, regularly tracking performance.
Too many
firms invest a lot of effort in overly-elaborate plans, and begin to fail on
execution the moment the plans are completed. The plan is not the end goal,
only the preparation for the commencement of the next stage of the journey,
setting out what you were trying to do and how you will go about it.
Identify a
level of profitability that would be acceptable, and work out how you would
achieve that, generating sufficient revenue to cover expenses (including all
salary of owners discussed earlier), and creating an acceptable profit margin.
Identify
the types of work that you believe are available that you and your team have
strong skills in, and that generate acceptable fee levels.
Build into
all your planning a strong understanding that the big majority of all revenue
will go to expenses, including all salaries and associated outlays. It
is only after all that revenue is generated that additional revenue will create
your genuine margin. This is a key part of the reason not to take planning
lightly or to leave most things to chance.
If you
haven’t done this exercise before it would be wise to target a modest margin of
10-15% of revenues. This is where the vast majority of small-medium firms sit
anyway, and once achieved, provides a very sound platform for significant
improvement.
This
exercise will in effect give you a basic budget.
The
revenues in the main will come from the labour of your people applied to the
clients’ files. Doing some careful human resources planning will show you how
much of the available labour can be applied to client files if they are
available to be worked on, and how much labour needs to be allocated for
investment into what I term, ‘FirmTime’.
FirmTime
covers such things as Marketing, Technology, Training, Knowledge Management,
Supervision, Services Development, Premises and general firm administration.
In this
aspect of your planning, appreciate that the cost to you of each available hour
of labour is the same whether the investment is applied to ClientTime or
FirmTime. Plan both carefully, matching skill sets to whatever type of work
that you expect to need/want to get done in each planning period.
Cash Flow and Credit Control…
There will
be few lawyers who don’t deeply appreciate the very practical difference
between when a file gets worked on, when it can be invoiced in whole or part,
and when the fees may be paid (in whole or part)!
Only a
limited number of firms are well-enough organised to not need a cash flow
budget, simply because in most firms invoicing doesn’t immediately follow the
work being done, and in many firms, payment to you don’t immediately follow
invoicing.
Take into
account cash flow expected from Debtors carried forward from earlier planning
periods, and of course factor in the availability or otherwise of an overdraft
facility to assist in smoothing cash flows, and the need to expend funds on
capital items not included in your expenses.
There are
plenty of other items to plug into your cash flow, especially GST flows in and
out, and anticipated regular drawings over and above salary.
Credit
control has not historically been a strong point in a lot of legal practices,
and it is essential that you have clear reasonable terms for all types of work,
and do not slip into the error of honouring your terms more in the breach than
the observance.
Cash can
dry up very quickly, and as it starts to flow less regularly than it should,
pressure comes on owners first. That very pressure can impact owner performance
on legal work and running the practice, further impacting the financial health,
and general health, of the practice.
Marketing…
The fees
you can create through the work of your team, and invoice and collect, depend
on the availability of the right types and volumes of work, effective timely
attendance to the work, and sensible pricing of the work.
Despite
this critical ‘recipe’ few small-medium firms do much planning around the
required flow of new work needed to keep each person/team properly busy.
In my
experience this failure ties in to the deep dislike of marketing of many lawyers.
That is, they would prefer not to accept that the volume and type of work that
comes to the firm in the future is a direct result of the quality of
execution of the complete range of activities they undertake now.
Many tend
to believe that the work will ebb and flow naturally, and will come at
satisfactory levels in the future if they simply do a good job on the work they
already have.
The reality
is that even when the existing work is done well, there are many reasons why
new work can reduce to a level where the practice can no longer generate a
margin at all, let alone a reasonable one, and owners have to take less and
less from the firm, or worse, have to inject more of their own capital to keep
the firm going.
A firm needs
to view sensible marketing as fully consistent with being professional, in that
it helps existing clients, referrers, contacts and elements of the wider public
with information that is of use to them in navigating their lives and/or
businesses.
The length
constraints of this article do not allow us to canvas the ‘How’ of practical
marketing, but suffice to say that wide experience shows that it can be done
reasonably easily, at reasonable cost.
There are
many potential channels for information flow out from a practice, and it is not
particularly difficult to test some. Of course websites and social media may
have a place, as may seminars and newsletters and speaking engagements, to name
just a few. Sadly, one-size-fits all is not applicable.
An
effective contact database is an important tool to underpin many of these
efforts, and keep track of them and their relative success, and your return on
investment of time and money. Not all ‘off-the-shelf’ practice management
systems incorporate contact databases of sufficient power and flexibility for
this undertaking.
In
financially healthy businesses marketing and pricing are closely inter-linked.
All of us
recognise that when new work is pouring in we are usually more confident with
setting out our pricing and our payment terms, and then sticking to them. The
opposite is true when the possible piece of work we would like to be instructed
on is one of very few on the horizon.
Being
heavily tied up in work that cannot ever produce a decent margin is like a
large sea-anchor on a practice…very inhibiting, dispiriting, and almost
certainly preventing any clear thinking on the right way to get out of the
maze.
Aside from
the need for confidence when scoping and estimating fees for potential new
instructions, there is great scope for lawyers in small-medium firms to improve
their skills in pricing.
With all
the discussion over recent decades of the failure of lawyers to record their
time spent accurately, it is easy for lawyers to assume that if they do record
accurately, the time they will thus be able to charge will be both acceptable
to clients, and provide a good profit margin.
Neither of
those assumptions are necessarily correct.
Many
clients are looking for better value in the services they receive, and the
thoughtful lawyer will combine an improved level of skill in communicating
value to each particular client in each particular matter, with a wider range
of pricing options to meet the wide range of circumstances.
The
thoughtful lawyer will be aware that psychology plays an important role in
clients’ perception of value.
Again, the
vigorous debate over the inappropriateness of charging clients by time spent
regularly obscures the harsh reality that charging merely by time is often a very
poor outcome for the lawyer given the value the client is delivered.
Planning
for your team to be properly busy to planned levels involves knowing how much
new work that will entail from time to time, approximately what it should
produce in revenues, and how to go about ensuring you do in fact get it…through
sensible, cost-effective, marketing.
Having
enough work and charging properly for it will of course go a long way to
guaranteeing viability.
Technology…
Make your
technology choices based on a clear understanding of how they will considerably
improve your achievement of your particular goals, not because something seems
exciting or interesting, or because many competitors seem to be using it.
This
applies to time-saving, effectiveness, file velocity, quality control,
marketing, financial management, cash flow etc.
Technology
needs to be in your practice for a clear purpose, and the potential to assist
is undoubtedly huge.
However,
the relationship between technology and its perceived purpose is often not
managed by lawyers such that the benefits are highly tangible. All too often
the cost is incurred, but the training has not been undertaken properly to
ensure that at least the bulk of the benefits are actually delivered. Expensive
equipment and software sits largely unused.
As
professionals we are as blessed as others in business by the range and power of
the technology available to us, far greater than ever before in history. To
quite a degree technology has closed the capability gap between smaller firms
and large, but only if it is used smartly to help achieve clear goals.
Succession…
As with so
many other aspects of legal practise, what a particular owner hopes for by way
of succession will vary greatly from the hopes of others.
Some hope
for little more than a smooth transition for their remaining clients to a new
lawyer, while some others have inflated views of the value of what they
perceive they have built over many years of hard work.
The main
debate these days appears to be whether succession can reasonably be achieved
by a sale in which one or more purchasers pays an owner of a small-medium
practice for a share of the practice assets including goodwill.
Certainly
it is happening much less frequently than it used to.
In my view
the main reason for that is that the vast majority of such practices are hardly
profitable, and the key factor behind that situation is poor management over
considerable periods of time.
The fact
that practices of little value are not being purchased for significant sums is
hardly surprising!
On the
other hand, where practices can be demonstrated to be profitable beyond
principals’ salaries, financially stable and relatively low risk, with strong
client bases and excellent marketing, good sales are still being achieved.
In the real
world beyond ill-informed opinion and urban myth, goodwill still exists, and is
being bought and sold in profitable practices.
Summary…
Populations
are growing, families are continuing to change, business is continuing to
develop rapidly (both local and global), laws are continuing to become more
complex, and people will need quality legal assistance more than ever.
There is an
ever-increasing array of service offerings in the marketplace aimed at
different segments of the population. The internet is playing an increasingly
large role.
Nevertheless,
there is a very bright future for small-medium legal firms that are clear in
who they want to assist, with what services, and in what manner.
They do
need to plan and organise well, deliver excellent services that clients
perceive to be good value, charge sensibly, have quality credit management, be
good leaders and managers, good marketers, and good financial managers.
Beyond merely
being “viable” there remains great opportunity to thrive!
