A year ago Tollers’ debt position put it on the brink. A year later things are looking much better. Managing partner Duncan Nicholson reveals how.
This week’s cover feature, which focused on debt, included data on Northampton personal injury-focused firm Tollers. We said that according to the firm’s LLP accounts to 31 March 2013 it had members’ capital of £133,194 against net debt of £2,033,144, giving it a debt to capital ratio of 1,526 per cent.
That was the situation over a year ago. It’s not now.
Tollers has just been through a period of intense change following a change of management. These days, not only is the debt position significantly better, it’s no longer even accurate to describe it as a PI-focused firm. Even the firm’s locations have changed.
We quizzed managing partner Duncan Nicholson, an insolvency specialist who took over as head of the firm in 2012, on exactly what has happened at Tollers. His candid recounting of his efforts at bringing Tollers back from the brink is an object lesson in dealing with debt.
“The position I inherited when I took over as managing partner was net debt of £2,008,894; members capital of £26,271; debt as a percentage of capital an alarming 7,646 per cent,” recalls Nicholson. “The firm was seriously under-capitalised. By the end of 2012, six months after my appointment, our turnover was £8.4m with profit at £965,000, or 11.5 per cent (the previous year profit was as low as £735,000 on a similar turnover). Profitability was therefore a major issue. In summary, debt was increasing and profits had been falling. I was appointed with the task to address those issues.”
Why the firm had reached that position?
“There were two main factors,” says Nicholson, “the firm’s policy on retiring partners and tax provision. Tollers had five or six equity retirements in a short period of time. I was the only ‘new’ equity partner appointed at this time while the retiring partners withdrew their capital. The policy adopted at the time was that the capital withdrawn by retiring partners would be treated as a debit to the remaining partners’ accounts. This was as opposed to the injection of new capital to replace the capital being withdrawn by retired partners.”
Due to the number of retirements over a short period of time at Tollers, significant capital was withdrawn and never replaced, in accordance with the policy adopted by the firm.
“With regard to taxation, for several years the firm did not make adequate provision for taxation,” admits Nicholson, “and as a consequence the partners were over drawing, causing deficits in their balances. The other factor was the reliance on PI referrals and the cost of these.”
In other words, on top of the firm’s policy towards capital and the lack of provision for paying tax, its service line mix was also contributing to its perilous financial position. In fact Tollers had an over reliance on PI work being acquired from claims management companies (CMCs).
“It was a major contributor to the increase in the firm’s debt position,” says Nicholson. “The funding of referrals was obtained through bank debt, specifically overdraft. At the time of my appointment personal injury made up 50 per cent of the firm’s turnover but was becoming more marginal in terms of profitability. It caused the firm’s debt to increase through the funding of referral fees for PI cases. The lock up in PI was also a significant issue.”
A perfect storm of the Jackson reforms hitting Tollers’ core business and its chronic under-capitalisation added up to a dearth of investment in the business.
“We had no working capital to invest at a time when there were (and still are) significant changes in the legal sector,” admits Nicholson. “A law firm more than ever needs to be agile and needs to have the working capital available in order to invest with the aim of being a ‘fit for purpose’ legal practice in the current decade. Tollers needed to invest in change. The over reliance on PI and the looming Jackson reforms, which were going to hit profitability, were such that the firm recognised we needed to reshape our business. Without working capital that was not going to be possible.”
Cue Nicholson and his appointment as managing partner. The lawyer has worked in insolvency and turnaround throughout his career. In 2012 when he became managing partner Nicholson put together a short-term strategy to address the firm’s profitability. The previous year to 2011 had produced profit of £735,000 at 8.8 per cent. The following year was £965,000 at 11.5 per cent.
“Investment from partners, old or new, to address the capital position would not be forthcoming in a business that was failing to produce acceptable returns,” recognises Nicholson. “A full strategic review was carried out and the necessary efficiencies were made. That produced a small improvement in 2012 but it was not until 2013 that the full benefit was felt by the firm. Profit to March 2013 was increased to £1.62m at 18.8 per cent (on a turnover of £8.62m). For the year just ended to March 2014 profit is estimated to be between £1.7m and £1.8m at around 19 per cent (on a turnover of £9.02m). The benefit of the improved profitability has allowed for investment and enabled us to address the under capitalisation.”
Recapitalisation has been achieved in two ways, says Nicholson. Firstly by retaining profits from equity members – “the improved profitability has given us the scope to do this” – and secondly, with the business being more attractive to both equity investors (and crucially the bank), the equity members have each injected capital to replace the shortfall brought about by the retirements.
As a result Tollers now has working capital, meaning it can invest and put into practice its strategy.
“Previously our hands were tied,” says Nicholson. “The debt burden on the firm has vastly improved. Partners’ current accounts were significantly overdrawn in 2012. All partner current account debt has now been repaid and as at 4 April 2014 current accounts collectively had a positive balance of £195,000. The members’ capital (as defined in the financial accounts) will now stand at £1,000,000.
“The debt position is vastly improved. The current position is that the firm’s net debt now stands at £1.166m (compared to £2.009m reported in The Lawyer’s article). Members’ capital is at £1m (as opposed to £0.133m as reported). Debt as a proportion of capital will now stand at 116.6 per cent (as opposed to 1,526.45 per cent as reported). As mentioned above, members also have positive current account balances of £195,000 and the firm’s profitability is running at around 19 per cent on an increasing turnover of £9.02m.”
Nicholson is convinced that this healthier financial position will allow his firm to make some strategically significant moves. In particular it should give Tollers the room to invest and reshape its business in the light of the changing legal landscape.
“[The Lawyer’s article] described us as ‘personal injury-focused firm Tollers’,” says Nicholson. “Personal injury was making up 50 per cent of our turnover in 2012. The cost of PI leads and the length of time it takes to run a case and therefore get a return on investment was a major contributing factor in the firms spiralling debt position. Jackson was on the horizon and we knew of the impact that this was going to have on fees and profitability. We have a strong reputation for PI and didn’t want to ‘throw the baby out with the bath water’, but we also knew that we needed a more balanced business. We therefore wanted to invest in other areas so that we reduced our reliance on PI and became a more balanced business.”
In practice that has meant investing heavily in commercial areas with some key appointments and team additions, including a new private client team Hilliers HRW headed by partner Fiona Nash in Kempston and Stevenage.
“We’ve also diversified our geography from Northamptonshire and Milton Keynes and are opening in Stevenage [as a consequence of the Hilliers bolt on],” adds Nicholson. “We’ll open other services in the new office and are just in the process of recruiting conveyancing into Stevenage as this is complimentary. We’re also undergoing a rebrand to change the look and feel of the business both internally and externally. We’re investing in premises and infrastructure, including a completely new case management system (Proclaim by Eclipse).
“Our strategy now is to create a more balanced business fit for purpose in the current legal environment. Crucially for Tollers, this means that while PI will remain a significant part of our business we want a reduction in reliance on it for the firm and a reduction in PI’s reliance on CMCs for PI cases. PI will remain an important part of the business but the firm will no longer be ‘PI focused’ but a balanced modern law firm.”
Tollers is now targeting a turnover of £10m by the end of the financial year in 2016, a total it hopes to achieve while at the same time its PI turnover reduces.
“By 2016 we aim for a turnover of £10m with PI producing £2.6m (26 per cent),” reveals Nicholson. “This compares to £8.4m with PI producing £4.2m (50 per cent) back in 2012. So the net growth of Tollers’ business outside of our PI practice will need to be £3.2m by 2016 from the position in 2012.”
Nicholson insists the firm has made progress with its strategy for a more balanced business already.
“The year to March 2014 saw Tollers turn over £9.02m with PI contributing £3.4m (37.7 per cent) and the non PI practice turning over £5.62m (a growth of £1.42m on 2012),” says Nicholson. “Looking ahead, the investments we have been able to make as a consequence of the improved financial position are such that we’re budgeting for non PI business to grow to £6.7m for the year to March 2015. The implementation of this strategy could not have been achieved without the fundamental steps on profitability and capitalisation being taken.”