Is my legal practice viable?

In an earlier article we considered benchmarking, and the important role it plays in determining the performance of your legal practice.

The decision to open a legal practice is accompanied by excitement, anxiety, ambition and determination.

Similarly, deciding to close a legal practice can be fraught with emotion, especially when unforeseen circumstances present themselves (ie death, terminal illness, change of life circumstances or incapacity) necessitating an immediate closure.

Sometimes there can be a realisation that the practice is not performing as planned – you could be struggling financially, or tired of the juggling act required of a principal in a small practice. How do you decide when to cease practice?

Benchmarking data can inform your decision about the viability of your practice.

The decision around the personal viability of your practice is a personal decision. However, talking to a trusted colleague or professional can assist you to make the right decision for your circumstances.

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There are several metrics that can provide an indication on the viability of a practice. Some of the most significant metrics to track include:

• Profit margin: This is the percentage of revenue remaining after all expenses have been paid. A low profit margin suggests the practice may not be generating enough profit to sustain itself. The latest Small Business Commissioner’s report indicates the professional services small businesses average of 19 per cent growth since 2019 is well above average after a strong 2022-23 financial year.¹ However operating profit has only increased 4% over that same time.²
• Revenue per lawyer: Calculated by dividing the total revenue generated by the practice by the number of lawyers, a low revenue per lawyer may indicate insufficient profitability.
• Billable hours: The number of hours lawyers spend on billable work. A low number of billable hours may signal that the practice is not generating enough revenue to cover its costs.
• Debtor management: The number of days that receivables remain outstanding before they are collected reflects the effectiveness of your credit and collection efforts. A monthly review of aged debtors in terms of days overdue – up to seven days, seven to 15 days, 16-30 days etc – can give a clear indication of the effectiveness of your debtor management. Through the effective use of your legal practice trust account and clear terms of trade, most micro – small firms can improve their cash flow and reduce bad debts.
• Client satisfaction: Measuring client satisfaction serves as a litmus test for the long-term health of the practice. A low satisfaction score can lead to a loss of business, especially for firms relying on reputation, social media, and word of mouth referrals.
• New client acquisition: The number of new clients acquired in a given period of time. A low number of new clients can indicate a practice is not attracting enough new business to be sustainable. It is very common when launching an SEO campaign to mistake client inquiries (which should be tracked) with client acquisition or conversion. The aim of the campaign is to increase client awareness and inquiries. The SEO campaign is not working effectively if it drives the wrong type of inquiries, or the wrong client demographic to your practice.

In addition to these metrics, there are several other factors that may indicate a legal practice is not viable, such as:

• High operating costs: Excessive operating costs can erode profits posing a threat to the practice’s sustainability.
• High debt: A high level of debt, and increasing interest rates, without the cash flow to support it, can make it difficult for a practice to service its debt obligations and can quickly lead to financial hardship.
• Poor cash-flow management: Inadequate cash-flow management can lead to liquidity problems and can make it difficult for a practice to pay its bills when due.
• Lack of succession planning: A lack of succession planning can make it difficult for a practice to continue operating after the retirement or departure of key personnel.

Closing your practice does not absolve you of discharging your professional obligations. This includes making adequate provisions for the ongoing storage of safe custody and archived files.

Fiduciary duties to existing clients should be addressed and all clients should be notified of the impending closure with sufficient time for them to make arrangements for alternate legal representation.

The annual practising certificate renewals period in May is not the time to make the decision to close your practice by end of financial year; that decision should be made at least six to 12 months before to enable you to properly plan for the transition.

If you are concerned about the viability of your legal practice, it is important to seek professional advice.

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A qualified accountant or business advisor can help you to assess your practice’s financial performance and to develop strategies to improve its viability. The ATO has released a business viability tool available here: https://smallbusiness.taxsuperandyou.gov.au/considering-your-small-business-viability/the-ato-business-viability-assessment-tool

The QLS Practice Advisory Service can act as a confidential sounding board as you work your way through the decision-making process. They can also offer referrals to the QLS Business Advisory panel of accountants and business advisors for further guidance. The QLS Practice Advisory Service has a useful Checklist for closing a law practice.

Footnotes
¹ Queensland Small Business Commissioner, Queensland Small Business Outlook: Beyond the Pandemic (Report, September 2023).
² Ibid.