Dealing with a downturn: How law firms can share risk and remain competitive

According to research from the Thomson Reuters Institute, profits at many of the largest international law firms are in decline. The reasons for this are two-fold: An increase in costs and a reduction in corporate work.

While billable hours were less affected, declining by less than one percent in the last quarter, payroll expenses rose by almost 11 percent and overheads by almost 13 percent according to Thomson Reuters Institute. And with more challenging debt markets, there has been a decline in large leveraged buyouts, effectively stagnating M&As and public offerings. Demand for M&A work for law firms fell almost 14 percent in the three months to the end of September 2022 compared to the same period in 2021.

While law firms might be tempted to bring expenses under control by cutting headcounts, as they did in the 2008 global financial crisis, there are other ways to offset the loss of transactional work. In a downturn law firms can look to their litigation practices as a potential hedge: The countercyclical nature of disputes means there will be no shortage of commercial claims.

But as companies struggle to manage soaring inflation and reduced capital availability, law firms are likely to see increasing pressure from their clients to provide discounts or alternative billing arrangements, putting further pressure on law firm profit margins.

There are a few ways that law firms can share litigation risk and remain competitive in a downturn using tools like legal finance.

Legal finance helps law firms serve clients without interruption

In the event that clients become unable or unwilling to pay their legal fees, legal finance can provide law firms with the ability to continue working on meritorious claims. In fact, Burford’s very first matter following its 2009 founding, in the wake of the global financial crisis, involved a large New York law firm with an hourly billing model that introduced Burford to a client that used legal finance capital to continue retaining and using the firm on an important affirmative claim when the client’s capacity to pay became constrained. By financing the fees and expenses of ongoing litigation, legal finance allows law firms to continue to represent clients with strong claims regardless of their ability to pay.

Then, and now, Burford allows even the biggest of law firms to differentiate themselves and serve key clients without interruption.

As clients demand price innovation, law firms will need to share risk

With client facing increased capital constraints, law firms are increasingly being asked to share risk through alternative fee or contingency arrangements. In a recent survey of GCs, a quarter (25%) said their panel firms did not present any cost or risk sharing options and that it would have aided company success had they done so.

However, taking on more contingent work creates an extraordinary risk of outright capital loss to a law firm whose clients, however meritorious their claims, may well lose. The financial risk that law firms assume in representing clients on a contingent basis will make legal finance an even more important weapon in the arsenal.

Legal finance in the form of a portfolio-based capital facility—in other words, a pool of capital tied to a pool of existing or future matters—means that law firms can take on a significantly greater number of contingent cases without increasing risk to the firm. Law firms that do not have a legal finance partner in place will be more limited—especially in a downturn—in their ability to compete for profitable new business and hedge against the client budget cuts to come.

To hit annual revenue targets, law firms can advance client receivables

Top law firms are all too aware of the importance of hitting end-of-year revenue targets. Annual revenue and its impact on rankings have a direct effect on recruiting, partner retention and compensation. Getting clients to make timely bill payments is a perennial challenge, but in the face of challenging market conditions this problem is exacerbated.

Offering discounts—the typical solution—leads to depressed realizations, and traditional financing products such as factoring and bank loans cannot be treated as revenue and therefore can’t be substituted in as fee income for partner distributions.

Instead, law firms can accelerate or “monetize” year-end receivables by selling sets of client receivables to a legal finance company, allowing the cash advance to be booked as revenue. In hourly fee matters, this generates revenue regardless of when clients ultimately pay bills and helps law firms to hit those important year-end targets.

In times of uncertainty, Burford is the institutional partner for legal finance

It is inevitable that law firms will have to adapt to better serve their clients in a recession. Law firms should consider legal finance—and indeed, 70% of lawyers said that their companies and law firms were likely to use finance to offset recession impacts. As an institutional-quality capital provider, trusted by Global 100 and AmLaw100 firms, Burford stands as a ready partner in good times and bad. With the industry’s best team and most professional process, Burford has the capital and expertise to help law firms of all sizes navigate the unprecedented business challenges ahead.