Financing Law Firms: Key Credit/Risk Metrics Presentation to The Claims Conference Sue Carter MBA UK Head of Professional Services Sector Clydesdale & Yorkshire Banks 12 March 2015 1

Why Banks have loved law firms (and still should) £29bn industry Gatekeepers to many deals Local network Client Account Balances Personal liability (for many) Low failure rate Regulated businesses 2

Financing Law Firms: Understanding the following is crucial: The Strategy of the Business Strategic and Operational Risk Performance and Accountability Governance and Decision Making 3

Overview - Key Credit / Risk Metrics Management Market Financial Performance Operational and Balance Sheet Gearing Partner Dynamics Regulation Cash Management 4

Management Reactive vs proactive. Do you avoid difficult decisions? Quality of banking relationship what do you truly value? Poor quality Management Information. Is there effective Resistant to change? No competitive advantage if you just do the same Can you identify your real competitors? Can you articulate your competitive advantage? Who is responsible for business development? 5

Market Historical reliance on interest from client monies Vanilla, commodity offering or niche offering? What do you sell, who do you sell it to, where and how do you sell it? (What or who do you say no to?) Competitive threat from new entrants with big brands to leverage Panel positions up for renewal 6

Financial Performance Declining Revenues - (may be for the right reasons!) Law Society (Aug 2014) expects 3.8% growth on fee income in 2014 and 4.9% in 2015 (pre - recession levels). Improvements in UK business sector and housing market are significant drivers of this growth. Gross margin pressure over capacity? Revenue and profit growth required Key measure PEP (Profit per Equity Partner) against competition/peers 6

Operational & Balance Sheet Gearing High Fixed Costs: Property / leases Salaried partners and employees Pensions Immediate cost reduction challenging Reliant on unsecured short term funding lines e.g. for VAT, partner tax Inability to sublet excess accommodation space Understand off balance sheet funding (e.g. Partnership Loans) 8

Partner Dynamics Succession plan? Age profile/skill mix of partners? Admission of partners standard. Has to be right for business, culture, clients and risk strategy. Consequence = chronically weakened ownership! Differing equity splits v - same roles/responsibilities High partner and key staff attrition rates? where is the balance of power? Historically drawings based on profit consequence often overdrawn partner current accounts/excessive partner drawings 9

Regulation Financial Management and Financial Stability are now embedded in Regulation Firms in England & Wales have regulatory obligations to report Mirrored in PII & Practising Certificate applications Mandatory roles of Compliance Officers for Legal Practice (COLPs) and for Finance and Administration (COFAs) are champions of risk management and compliance within a firm, and will have responsibility for the firm's systems and controls. They are responsible for ensuring processes are in place to enable the firm, its managers and employees and anyone who has any interest in the firm to comply with Handbook requirements on them Avoid SRA Intervention! (Rare and as last resort) 10

Examples of Poor Behaviours Drawings exceeding profits Increasing firm indebtedness by maintaining drawing levels Payments made to partners irrespective of cash at bank Partners out of touch with office account balances Heavy dependence on high overdraft borrowings 1,011 firms closed in 12m to October 14 (43% ceased trading, 29% changed status, 16% merged/amalgamated, 13% other). SRA interventions on 14 firms (less than 3% of those that ceased trading) 11

Cash Management S hort term cash flow forecast? Sufficient focus on cash collection KPI? High aged debtor balance having regard to various practice areas WIP not regularly reviewed understand it! What is off and on balance sheet? Creditor/HMRC arrears Who owns billings and collections process? Timeline warnings January & July Tax September PII October practising certificates 12

THANK - YOU ANY QUESTIONS? Financing Law Firms: Key Credit / Risk Metrics Mar 2015 13