Debt: Red lines

Debt can kill a firm but it can also fund ambition. Our first-ever market snapshot shows firms in the UK 200 getting into it in a big way

“Theorist Nicholas Nassim Taleb says that if you’re financed by debt you’d better be able to predict future revenues and future volatility,” says Peter Kalis, global managing partner at K&L Gates . “We have no crystal ball and thus stay out of debt. Personally, I’m not smart enough to have a banker at the table and have to keep it very simple. Serve clients, bill, collect, pay our people, eat, drink, sleep. Start over tomorrow. No bankers.”

But how much debt is too much debt? Or, to put it another way, is debt a good or a bad thing?

In this report we offer a snapshot of the debt position at a majority of the largest firms in the UK legal market, with data taken from a sample of LLP accounts filed for 2012/13. We highlight the level to which debt is generally increasing across the leading firms and ask whether this will be detrimental to the health of the market.

The Lawyer analysed 153 LLP accounts of firms in the UK 200 2013, taking the net debt figure listed in each firms’ cashflow statement. Note, there is a grey area here. Firms are not always consistent in terms of what the net debt figure includes. For example, ‘loans and other debts due to members’ is sometimes included but, quite legitimately, may not be. Its omission or inclusion can have a major impact on the level of debt shown at a firm (see ‘Lack of clarity in LLPs’, below).


Forty-four of the 153 had no net debt listed (for the full list, see below). Of those 44, five (BP Collins, Boodle Hatfield, Capsticks, Digby Brown and Furley Page) had debt the previous year but had cut it to zero during the prior 12 months. Of these five, personal injury-focused Digby Brown saw the biggest reduction, from £931,553 to zero.

On the flipside, just two firms (Trowers & Hamlins and Pinsent Masons) had no debt in 2012 but had borrowed in 2013. Both added about £5m in net debt over the 12-month period (Trowers added £5.197m, while Pinsents added £5.857m).

The firm with the highest level of debt in 2013 was Herbert Smith Freehills, with £124.984m.

Not one of the four magic circle firms – Clifford Chance, Allen & Overy (A&O), Freshfields Bruckhaus Deringer and Linklaters – had any debt at all.

Of our sample 153 firms, 64 saw their debt level increase in 2012/13, 49 saw it decrease and 40 saw it stay the same. In total, the net debt of these 153 in 2013 was £820m, a 2 per cent rise on the previous year’s £805m. Statistical data gathered by The Lawyer reinforces the anecdotal belief that across the market, the debt trend is upward.

A changing outlook

It is generally held that there is no right or wrong answer to the question ‘how much debt is too much debt’. The key is whether a firm can afford to borrow the money and what it wants to use it for.

If a firm can balance these, debt becomes merely another tool for securing growth and achieving strategic ambitions. It can transform a nowhere firm into a serious player.

However, debt is still a relatively new phenomenon for most law firms. Lawyers are generally risk-averse creatures. For years, it has been their habit to espouse the virtues of being debt-free. But the no-debt approach of K&L Gates’ Kalis, is countered by the growing number of firms embracing borrowing.

Last month Irwin Mitchell confirmed it had secured new borrowings of £90m from HSBC, Lloyds and RBS, with the firm’s chief financial officer Andrew Merrick saying the money would be used to fund work-in-progress (WIP) and support growth ambitions.

Banks are unlikely to lend such a large sum to any organisation they think would struggle to repay it, so in this case Irwin Mitchell’s ability to secure such significant funding has largely been seen as an indication of its financial robustness and strategic appetite for growth.

On the other hand, the SRA recently identified a large number of firms as being “in financial difficulty”. It introduced a traffic light system to help assess financial stability based on three metrics: drawings exceeding profits; borrowings exceeding net assets; and simply borrowing too much.

Under this system the SRA marks a firm as amber if one metric applies and red if two or more apply.

The number of SRA interventions last year hit a record, while the intervention budget rose by about 600 per cent from its original £1.3m.

“Financial stability has become a major concern for the supervision team at the SRA,” says Menzies partner Peter Noyce. “Often, firms end up in a self-fulfilling prophesy situation when financial difficulties are highlighted and drawings are curtailed. Key partners and their teams quickly assess their prospects and, in a highly portable labour market, look to move to a firm offering better prospects. This leaves firms unable to maintain their turnover targets and looking for additional capital.”

A 10,493% rise

The Lawyer’s analysis of the UK legal market debt position throws up some startling statistics, not least when the table is ordered by the increase in net debt between 2012 and 2013 (see tables 1 and 2). (As always with percentages, a note of caution is offered.) Both Trowers and Pinsents’ debt grew by 100 per cent, although that pales in comparison with the firm that heads the table.


By some way the leader is Lewis Silkin , where net debt between 2012 and 2013 grew by 10,493 per cent. But the sterling figure from which the proportionate growth started was particularly low. In 2012 Lewis Silkin had just £11,809 of net debt listed in its LLPs. Last year that had grown to £1.25m. To put this proportionate growth into perspective, Lewis Silkin’s net debt as a proportion of turnover last year was just 3 per cent, while net debt per member was £21,203.

Net debt at second-placed Browne Jacobson rose in a more meaningful way. Between 2012 to 2013 it grew from £1.258m to £8.399m (a 567.5 per cent increase), while fifth-placed Berwin Leighton Paisner (BLP )’s net debt rose by 134 per cent, from £14.784m to £34.594m. In contrast to Lewis Silkin, that represents 15 per cent of BLP’s £231.8m turnover.

Other firms that saw an increase in net debt north of 100 per cent between 2012 and 2013 are Ledingham Chalmers (396 per cent), Matthew Arnold & Baldwin (146 per cent), RPC (123 per cent) and Bindmans (107 per cent).

HSF – most indebted

According to The Lawyer’s research Herbert Smith Freehills (HSF), which last year reported net debt of £124.9m in its LLPs, has more debt than any other firm in the UK.

The firm’s global LLP accounts from which this figure is taken were based on a seven-month period between 1 October 2012, when the full equity merger between legacy Herbert Smith and Australia’s Freehills took place, and 30 April 2013. Consequently, the closing net debt, as of 30 April last year, of £124.984m is off a seven-month turnover of £469.4m, or 26.6 per cent of total revenue.

If, as stated above, one of the key questions concerning debt is what a firm uses it for, then HSF probably has a better answer than most. The firm appears to be using its borrowings to fund international expansion and achieve its strategy.

“HSF is investing and reshaping its business significantly on a truly enormous scale,” says one source familiar with the firm. “There are integration costs associated with that.”

Legacy Herbert Smith’s UK LLPs show a net debt of £81m, an increase of 48.3 per cent on the previous year’s £55m which, in turn, was 33 per cent up on the year before.

The Lawyer’s research reveals that there is a big gap in the table from HSF to second-placed Simmons & Simmons, which had £46.7m of net debt off a total turnover of £247.6m last year, a net debt to turnover ratio of 18.8 per cent. DAC Beachcroft takes third spot with £38.7m off £186.8m (20.7 per cent).

Simmons’ senior partner Colin Passmore highlights the complex nature of law firm financing when he clarifies the debt position at his firm: ”For over 10 years, the firm has financed its working capital requirements through a single loan facility instead of calling for individual capital contributions from partners, backed by partner capital loan arrangements. The loan facility is guaranteed by partners such that the economic effect is similar to the partner capital loan arrangements that other firms use.  When comparing the firm’s debt position with other firms, it is worth noting that £47.8m of the net debt as at 30 April 2013 is represented by the working capital loan facility and these should be ignored for comparison purposes: hence on a like-for-like basis, the firm had positive net cash balances of £1.0m as at that date. In addition to this facility, the firm has normal loan and overdraft facilities of up to £25m available.”

Three places below Simmons in this ranking comes BLP. This firm is remarkable not just for its high placing here but also for its high position in the table showing increase in net debt between 2012 and 2013 – net debt rose by 134 per cent, from £14.784m to £34.594m.

Debt as % of partner capital

At the other end of the scale 44 out of the 153 firms, or 28.1 per cent, have no debt, according to their LLP accounts.

The largest in this group include all four magic circle firms. None of these have any firmwide debt listed in their LLPs, although all have considerable sums invested – and generally therefore borrowed – via individual partner capital contributions (the LLPs do not state whether these funds are borrowed from the bank of wealthy partners’ private capital).

Clifford Chance has no debt, but a total of £173m in members’ capital (the highest among all of the 153 firms, giving it the strongest debt to members’ capital ratio); A&O has £108.4m members’ capital; Freshfields has £91.9m; while Linklaters has £75.5m.

On a capital per member basis the order of these four changes slightly, with Clifford Chance continuing to lead the pack with £364,211 per member; Freshfields leapfrogging A&O with £276,807, immediately adjacent in the table to Linklaters with £259,619; and A&O with £206,476 per member.

Two firms stand out when data is ranked by debt as a percentage of partner capital: HSF and Simmons, though neither tops this particular chart – that honour goes to Northampton personal injury-focused firm Tollers at which, with members’ capital of £133,194 against firm net debt of £2,033,144, the debt to capital ratio is 1,526 per cent. None of the other top 10 in this ranking except HSF and Simmons is a UK Top 100 firm.

Of the top 20, the only other UK Top 100 firms to feature are Penningtons Manches and HowardKennedyFsi, in 14th and 17th places (posting debt to capital ratios of 268 per cent and 260 per cent respectively).

HSF’s ratio is 422.5 per cent (£29.57m members’ capital against £124.98m debt) while Simmons’ is 390 per cent (£11.99m against £46.77m).

Debt per partner

The ranking changes again when it is ordered by net debt as a proportion of turnover.

The top firm here is personal injury-focused Colemans CTTS, a Manchester firm that last year had net debt amounting to 67 per cent of its £15.2m turnover.

Personal injury and insurance-related work dominates the practice mix of many of the firms near the top of this table, although the largest full-service firm is the newly merged Penningtons Manches (see ‘The impact of debt’, below).

A more personal metric that might affect partners, whatever their firm’s service line mix, appears when the table is ordered by net debt per LLP member.

Once again the top two are personal injury firms. Fentons (now part of Slater & Gordon ) heads the table with £1,042,939 of net debt per each of its 10 LLP members. Colemans comes second, posting a net debt per member of £789,192.

This pair are the only two firms in the rankings to have a net debt per member in excess of £500,000.

“There’s then a trickledown that you’d expect to see,” comments Baker Tilly professional practices group chair George Bull. “There’s no such thing as a KPI across the legal sector as a whole – no right or wrong figure. It depends on the service lines a firm has and their blend within the organisation.”

Below these outliers the net debt per member metric does, as Bull says, trickle down steadily until you reach Charles Russell where members on average owe just £3,302.

Quick ratio

Interest rates have been at 0.5 per cent for five years now, the lowest since the Bank of England was founded in 1694. It is therefore not surprising that many firms have extended their credit lines.

But many remain conservative when it comes to borrowing money.

“People used to talk about ‘gearing’ as if it was always a bad thing but, frankly, having debt isn’t necessarily bad,” says Noyce. “What matters is whether you have an amount of debt that matches your firm’s needs and what the money is used for, that is not matching long-term debt against short-term working capital requirements or partner drawings. The other key point is obviously whether it is serviceable – not just the interest, but scheduled capital repayments.”

In other words, can you afford it and what are you using it for? These are the two questions any bank will ask a firm looking to increase its borrowing requirement.

With HM Revenue & Customs’ (HMRC) changes to the tax treatment of LLP members leading to a significant rise in new loan applications, this is particularly pertinent.

One useful accountancy technique known as the ‘quick ratio’ measures the ability of a business to use its ready cash or assets to pay off its current liabilities. A 1:1 ratio means assets, if converted, would pay off all the firm’s liabilities. The higher the ratio, the less likely a firm is to find itself in financial difficulty. The lower it is, the more problematic it could be. Anything below 1 indicates liquid assets are less than a firm’s liabilities.

The Lawyer asked partners at a leading firm of accountants, who preferred to remain anonymous, to cast their professional eyes over a selection of the LLPs included in our debt research.

They found that at HSF and BLP the quick ratios last year were 1.30 and 1.33 respectively. At Irwin Mitchell the quick ratio on its 2013 LLPs was 0.96.

But as with all this analysis, a word of caution is required. The LLP accounts alone will never reveal the whole picture about a firm’s funding requirements.

Some firms, including HSF, appear on the face of their balance sheet to have no members’ capital. In fact, the firm has a different way of funding this. HSF has a facility whereby instead of the bank lending money to the member as a partner capital loan (PCL) and that individual then lending it in to the firm as capital, the bank lends the aggregate capital amount to the firm directly. There are then agreements between the firm and the individual members that set out the proportion of this facility that is that individual’s personal liability. This essentially reverses the ‘paper flow’ for this capital funding.

“This is something a lot of firms have looked at as it makes co-ordinating the capital a lot simpler for the firm and the bank and can lead to better rates,” says Peter Gamson, head of professional practices at Grant Thornton . “However, it does mean this aggregate capital amount is shown as bank borrowings on the balance sheet and also that there is no members’ capital. Essentially, it shifts the full value of the liability for this amount from the bottom to the top half of the balance sheet and therefore reduces ‘net assets attributable to members’ on the balance sheet enough to make it a non-starter for most firms, even though it could be commercially beneficial.”

Gamson adds that while commercially the overall position for the firm and its members is the same as if they used the more traditional PCL approach, the financial ratio analysis will make it appear as if the firm is more heavily geared as it is bringing the off-balance sheet PCL on to the balance sheet.

“This is one of the reasons why ratio analysis alone cannot be relied on,” adds Gamson.

The bottom line

In 2012 the total net debt of the LLP firms analysed by The Lawyer was £805m. That rose to £820m in 2013 – a 2 per cent increase in a group that as a whole generates a turnover in excess of £14.2bn.

“For this group net debt as a percentage of turnover is 5.8 per cent,” says Mark O’Sullivan, head of working capital at Grant Thornton. “In a corporate context that wouldn’t be viewed as too problematic. Yes, there is distress in the sector, but it doesn’t feel like the sector as a whole needs to stress about net debt.”

However, as The Lawyer’s research reveals, there are some cash-rich firms at one end of the spectrum with no debt and others that are highly leveraged.

In the red on the up

64 firms saw their debt levels increase between 2012/13

49 firms saw their debt levels decrease between 2012/13

40 firms saw their debt levels stay the same between 2012/13

Owe levels

£5.365m The average debt across the 153 firms in 2013, up 2 per cent on 2012’s figure £5.266m

£820m The total net debt of the 153 firms in 2013, a 2 per cent rise on 2012 figure £805m

Herbert Smith Freehills The firm with the highest level of debt in 2013 at £124.984m

BLP The firm that has increased its debt the most between 2012 and 2013: its borrowings grew by £19.810m

Norton Rose Fulbright The firm that has reduced its debt most between 2012 and 2013: it cut borrowings by £18.623m

Lewis Silkin The firm that has increased its debt the most proportionately between 2012 and 2013: it increased borrowings by 10,493.27 per cent, from £11,809 to £1.25m

Digby Brown The firm that has reduced its debt the most proportionately between 2012 and 2013: it cut borrowings by 100 per cent from £931,553 (Boodle Hatfield, Capsticks and Furley Page also eradicated their total debt, but in all three cases the original debt was lower)

Caveats: lack of clarity in LLPs

In a 2010 report analysing the transition of firms from private partnerships to the scrutiny of LLPs and published accounts, Grant Thornton found that the legal sector remained well behind the corporate world in terms of the maturity of its financial reporting.

In short, there was often a lack of clarity in firms’ LLP accounts, making it difficult to make comparisons or draw accurate conclusions about the health of a business.

In 2010 Grant Thornton said it found “far too many instances of lazily drafted accounting policies, of disclosures omitted as it is felt that they are ‘sensitive’, and a disturbing number of areas where, if we were being kind we would say that ‘interpretation stretch’ had occurred but where the cynic may claim that firms don’t understand accounting standards or even that ‘deliberate errors’ had been made”.

Four years later, Grant Thornton partner Peter Gamson says: “depressingly, very little has changed”.

Menzies partner Mark Crosson echoes this when he says: “LLP accounts are not consistent with how cashflow statements are prepared. For example, some include within net debt ‘loans and other debts due to members’, as stated in the LLP Sorp [statement of recommended practice], but a number do not. It is therefore difficult to compare net debt based on figures from cashflow.”

Halliwells, Cobbetts, Manches: dragged down by borrowings


When Halliwells went bust it later emerged – via its administrators BDO – that it owed its creditors a total of £200m, roughly three times the value of its final reported annual turnover.

The debt is understood to be so high partly because it took into account the remainder of the term of all of the failed firm’s leases, some of which had as much as 20 years left on them.

The rent-related totals were £176,499,347 owed to landlords and £5,679,582 to lease creditors. In addition, RBS was owed £17.7m, while HMRC was owed £4.3m in tax and £1.2m in VAT.

The administrators clawed back some revenue via sales to rivals including £1.4m to Hill Dickinson, £197,000 to Kennedys , £1.25m to Barlow Lyde & Gilbert (now Clyde & Co ) and £1.5m to Gateley Wareing. As The Lawyer reported, an additional £200,000 was generated by “selling company cars”.


Cobbetts owed creditors about £41m when it cratered in January 2013. According to a statement by its buyers, DWF , Cobbetts had, “built an infrastructure reflecting the buoyant economy of the mid-2000s and had put in place plans to cut costs. However, poorer than expected trading in November and December last year caused the firm to review its financial position and subsequently obtain an interim statutory moratorium to enable a sale of the business and its assets.”

Cobbetts’ administrators KPMG confirmed the root cause of its demise was a downturn in trading performance from 2009, which saw its turnover shrink in two years from £60m to £44m.

Real estate expansion which piled on debt – specifically expensive new leases taken out in 2006 and 2007 – was once again a major culprit. And despite a variety of plans aimed at staving off extinction, by Christmas 2012 Cobbetts’ partners could not afford to pay wages, rent, VAT or a £2.4m partners’ tax bill.

Enter DWF, exit Cobbetts. For £3.8m the larger firm acquired Cobbetts’ debts and WIP in a pre-pack administration. The debt recovery subsidiary Incasso was later acquired by Redditch-based HL Legal Solicitors, while Walker Morris acquired the finance litigation practice.


The writing was on the wall for £26.3m turnover