Regardless of their operating models or their approach to recruitment and retention, all law firms are sensitive to the state of the economy, with the outlook for 2024 not necessarily positive.
Last year we reported that many law firms had benefited from a Covid margin as a result of the pandemic. Lockdowns and social distancing measures had meant fewer overheads relating to travel and entertaining and more time available for working. Meanwhile, despite lockdowns and the restrictions on economic activity, demand for work was surprisingly strong throughout the pandemic, enabling firms to be very profitable.
With life returning to relative normality, the financial boost has petered out. Law firm overheads have returned to more normal levels. The return of face‑to‑face meetings and entertaining have meant an increase in the expenses relating to working with clients. The return to working from offices has meant more time spent commuting and less time available for Partners and Associates to work.
The overall outlook for the UK economy is not as positive. A recession may be avoided over the next 12 to 18 months but there is not much optimism when it comes to growth either.
Law firms are usually relatively recession-proof. The increase in demands for services relating to challenging economic conditions such as administrations, restructuring and consolidations can offset the lost business in other areas. However, several specific factors mean that this may not be as true during the next 12-18 months as it has been in the past.
A significant proportion of law firms focus on servicing the needs of Private Equity and other high-value, specialist work related to corporate transactions and deals. In particular, Pace Setter Firms have purposefully operated to serve this highly lucrative but demanding market. The amount of Private Equity ‘dry powder’ has meant that this market has long been a reliable source of work for any law firms able to tap into it.
Many law firms also benefited from the boom in corporate deals and PE activity that followed the pandemic. While deals came to a virtual standstill in the early days of the pandemic, markets were quick to compensate as conditions returned to normal.
While there is still plenty of ‘dry powder’ available for PE firms or houses to invest, high interest rates and tough trading conditions have made investing more challenging. PE investors are simply being more cautious. They are doing fewer deals and taking longer to complete the process as they try to gain assurances that their investments will perform in difficult conditions. This means less money for the Pace Setter Firms, obviously, but also for all other firms that are involved with private equity. If this top tier PE work continues to slow, will Pace Setter Firms begin to encroach into work currently more the purview of Mainstream Firms?
For many law firms, large infrastructure projects are a valuable source of work and revenue. It may not be as lucrative as corporate finance work, but these are large-scale and long-term projects that provide reliable income. This source of work can become more valuable when other areas of work drop off, for instance, due to a weak economy.
The current economic situation, the precarious state of government finances, and the current government’s policies have meant that there has not been the same investment in capital and infrastructure projects in recent years. For instance, the government has recently announced it is abandoning the HS2 project’s northern extension, undermining investment confidence and weakening the confidence of both home and international businesses in the economic viability of investment into the UK.
This has reduced the volume of infrastructure work available for law firms. Firms can no longer reliably depend on this source of income during economically challenging times as they might have done in the past.
A general election in 2024 may bring in a Labour government, traditionally more likely to invest in infrastructure. The question is whether the state of the government finances and the high cost of borrowing will allow any substantial increase in spending on infrastructure projects. Law firms may not be able to depend on this source of income in the medium-term at least. Despite the outlook for the next 12-18 months not being very positive, many of the law firm leaders we spoke to expressed confidence in their ability to survive and even thrive. There can be no doubt that some of this confidence rightly comes from their track record of effectively adapting and evolving to be successful, with law being a remarkably resilient business. Time will tell whether these leaders are right to feel as confident as they do. They may find that they must adapt and evolve to continue being successful.