Size matters when you take on civil legal aid work, if you want to make a profit

Economy and scale: It is possible for a firm to take on high volumes of civil legal aid work and make a decent profit – but size matters

There is much comment in the public domain at the moment about legal aid funding. The company – I do mean ‘company’ – I work for, Duncan Lewis, has had its share of publicity and not necessarily for reasons it would have wished.

We think much of the adverse publicity we have attracted is directly linked to the publication in May of figures on the amount of public funding paid to the country’s largest legal aid providers, which showed Duncan Lewis as the law firm paid most from the civil legal aid budget. Being successful does not always pay off in PR terms.

There are plenty of people in the legal aid world who are pleased that the ‘Subway of legal aid’ is getting roughed up a bit in the press. This isn’t the whole story, though. People looking to expand their legal aid practices also contact me regularly to discuss how we took a practice of three people in 1998 and turned it into a multi-site legal aid firm with more than 350 fee-earners within 11 years.

There are people out there who want to continue to provide legal aid services. Why? And how should they do it?

Why do legal aid?
In purely business terms, it is possible to make a reasonable return on investment from providing legal aid services. Returns are commensurate with the associated business risks.

We target a profit margin of around 10%. This is a far cry from the ‘rule of thirds’, where staff costs, other overheads and profit are neatly divided into three equal parts to represent the ideal type of a legal business. However, as a sustainable level of return, 10% is perfectly adequate.

Sustainability is achievable when you accept that the business risks of doing legal aid are relatively low. There are three reasons why this is true:

• the legal aid market is large, and growing more so as other suppliers are failing (because they are using inappropriate business models);
• the market is not particularly vulnerable to swings of fortune in the macroeconomic environment. The recession may have ‘helped’ legal aid firms, but an economic recovery is unlikely to do any major harm to the supply of work; and
• the rates of pay are unattractive, but the relative certainty of having income set out in a defined contract underwritten by the government is a luxury most businesses do not have.

These factors all resonate positively with the bank manager when trying to raise finance to help with cashflow and, to a lesser extent, facilitate growth.

The limitations on the availability of debt finance for growth is a subject to which I will return. For now though it suffices to say that there is a business case for undertaking legal aid work. So, provided you have a commitment to the provision of social welfare law that will tolerate the relatively poor rates of pay, the next question is how to make it work.

It is now time to do some mathematics. Beforehand, I need to state clearly the basis of my modelling. The figures I use are not absolute, and I won’t pretend that each individual figure below is unarguable. But I will vehemently contend that the picture they paint is that of the genuine ‘coalface’ reality of providing publicly funded legal services.

I make no apology for basing most of my examples on the lowest-paid fixed-fee work, because it is that work which is arguably most important to those people wrapped up in the justice system. And it follows that it is in the areas of law that other providers are ditching most quickly where it is most important to establish quickly a model that ensures continuity of supply. The alternative is allowing, by inaction, a failure of provision of social welfare legal services to the most vulnerable members of society.

Working days
We need to start with the top line. How much income can an individual fee-earner generate doing legal aid?

You should start by assuming there are 225 working days in a year (I have a heart, so this includes the possibility of the odd day off for illness and training). You then set a benchmark of six chargeable hours a day – this equates to 1,350 chargeable hours a year. Assuming an average charge rate of £45, this gives you a total time recorded value – £60,750 a year. These figures are shown in table 1.

Once we stop reflecting ruefully on the fact that the total possible income generated by one person is around two-thirds of the salary for a newly qualified lawyer at a big US firm, we need to plug this top-line figure into the Legal Services Commission’s fixed-fee regime.

If we take the figure of £167 as representing the fixed fee in connection with providing welfare benefits advice under the Legal Help scheme, and if you want to realise your time value of £60,750, you have to open 364 fixed-fee files in a year to achieve this. This is similarly true of other fixed-fee advice areas. Table 2 shows the breakdown of how many fixed-fee files you would need to open altogether, and each month, to achieve the £60,750 time value.

Table 2 slightly exaggerates reality. Many areas of law operate the fixed-fee escape mechanism for billing ‘exceptional’ files by reference to the time ledger as opposed to the fixed fee. Other areas lend themselves to public funding under a full certificate. Duncan Lewis demonstrates its commitment to social welfare by taking on all qualifying clients and not ‘cherry picking’ those who are likely to generate larger fees.

You therefore have to kiss an awful lot of fixed-fee ‘frogs’ to find a nice publicly funded ‘prince’.

But no one really wants to do all the following unaided:

• taking on more than one client a day;
• managing a case load; and
• most importantly, managing the relationship with the LSC, to include: file reviewing; preparing tender documentation for the next contract application; responding to audits; learning the latest billing rules; managing the bulk upload, and so on.

The latter list could go on and on. There has to be some capacity in the system somewhere for someone to take on the non-fee-earning elements of running a legal aid (or indeed any) practice. This costs money.

Because of the low absolute amounts paid for fixed-fee work, and the low margins achievable on those fixed fees, you need a lot of matter starts to make this work. In other words, if you make £20 per file in notional profit, you have to generate a lot of work to pay someone competent to take some of the administrative burden away.

So we arrive, inevitably, at the rather underwhelming conclusion that, to make this legal aid gig work, you have got to be big. Assuming you agree and resolve that big is best, there are two further questions that arise. First, what should the structure of your big firm look like? And second, how do you expand your firm to get sufficiently big?

How to structure a legal aid firm
No single model can capture the nuances of Duncan Lewis’s model or that of any other legal business, but a model can help explain why and how it is intended to work. Tables 3 and 4 show two suggested models for which members of staff in a firm take on legal aid work, both of which, theoretically, would generate the same total billed value for the firm, but which would give a firm a very different profit margin.

Table 3 outlines the model Duncan Lewis pursues – to leverage the knowledge of fully qualified and accredited senior staff by asking them to supervise the work of less-qualified junior members of staff. In this simplified version, three fee-earning staff bill 364 welfare benefits Legal Help files a year, at a trainee solicitor salary of around £18,000 a year. In reality, some of these salaries could be lower for first-year trainees and paralegal staff. Either way, these three fee-earning staff are supervised by an accredited supervisor who, for neat mathematical purposes, and probably in reality, earns twice as much.

The ratio of salaries to turnover in the table 3 model is that the salaries represent 49% of the top-line billing figure.

The alternative model (table 4) is to have qualified solicitors do the work. In that model, to get the same billed value for comparative purposes, I have used three solicitors accredited to supervisor level.
You could argue that I have exaggerated the average salaries in the table 4 model, by having three supervisor-level solicitors. But the reality is that, as soon as you start to use less-qualified solicitors, you lose some capacity in terms of billing performance, which would offset this. In any event, the salary figures are no more inflated than the figures that I have used for the unqualified staff in the first model.

The ratio of salaries to turnover in the second model is that the salaries represent 59% of the top-line billing figure – a much higher percentage.

In my opinion, the choice of model two over model one would mean two things: the death of Duncan Lewis; and the death of legal aid.

The difference in the models between the cost of salaries as a percentage of turnover would wipe out the 10% profit margin that we target. A traditional legal business based on model two is not sustainable.

However, there is an alternative innovation in the provision of legal aid, which is not dissimilar to model two, and which could be more viable. The model of engaging ‘self-employed’ consultants who work for a high percentage of their fees is very attractive. This is made possible for a firm by having a predominantly ‘virtual’ infrastructure.

The serious limitation of this model is the entry criterion – you are already a three-year post-qualified experience (PQE) solicitor. A solicitor obviously needs to have trained somewhere to become three-years-PQE and, to work effectively to provide legal aid in such firms, those solicitors must have received some of their experience in other firms that take high volumes of legal aid work, giving them a detailed knowledge of relevant social welfare law and a commitment to continuing such work themselves. These solicitors cannot be trained by firms that are not financially viable, nor by innovative firms which rely solely on experienced staff to operate effectively.

The leveraged business model in model one is not only sustainable in business terms, but it also underpins the future provision of social welfare services, not only for firms working under this third model, but for the UK in general.

However, adopting model one is not easy. There has to be a genuine commitment from experienced staff to be the ‘schoolmasters’ of a fast-running stream of new, mostly paralegal recruits. These recruits are invariably hardworking and intelligent, but inevitably they are also ‘green’. At Duncan Lewis, recruits are motivated to attain one of the company’s 68 training contracts. From my (admittedly unscientific) research on the issue, I reckon this to be roughly 10 times the number of places offered by any other civil legal aid firm.

Our model throws up new challenges all the time. The latest is that one becomes an easy target for those who want to beat you with the ‘quality’ stick. For the most part, this debate is conducted by the ill-informed. But such challenges mean that PR work must be added to the list of non-legal disciplines that must be performed by the company, because it cannot be ignored.

Legal aid firm of the future
So, the model works, but how do you get big? In theory, you need a clear vision that incorporates a desire for the business to grow. Add to this access to capital, to facilitate the implementation of growth plans. I know many people who clear the first hurdle, but I have not really been able to help those that ask for the magic solution to the second problem.

The very existence of the Legal Services Act 2007 is an acknowledgement of the need to bring external capital into legal businesses. But key provisions to enable this will still not be in force for a couple of years.

The contract structure of legal aid provides security for an overdraft to support your business. It categorically does not underwrite a blank cheque from banks to facilitate a firm’s growth – particularly at a time when their attitude to credit has, allegedly, been stunningly unsupportive of even successful businesses.

The LSC’s structure of payments is not usurious – standard monthly payments for controlled work and ‘claim 4s’ for certificated work do provide some cashflow. However, it is still payment in arrears; it is paying the firm that you were, and not the firm that you want to become.

The only thing that is directly in the control of firm managers is the ability to cut costs, and I mean really cut costs. This can be done through aggressive procurement, tight controls on administration costs and the strategic outsourcing of virtually anything that does not require legal expertise. Law firm managers are not universally loved when a firm is in this phase of its operations. A thick skin and an absolute belief in the fact that you are doing the ‘right thing’ are required as an absolute minimum.

What next?
If the above represents my views as to where we are today, I am not alone in being concerned that there is no coherent vision about where we are going tomorrow with legal aid.

I would like to see the LSC do more to support those businesses that demonstrate a clear commitment to a sustainable business model for providing social welfare legal services. Whether the commission does this or not, however, legal aid provision will increasingly be concentrated in the hands of fewer, larger legal businesses.

A franchise model is far from out of the question. At Duncan Lewis, I already see the emergence of a clear separation of roles between those who provide the legal services infrastructure and those who deliver legal services to the public. The fact that smaller legal aid businesses are not economically viable begs questions regarding the provision of legal aid where population density is low. Surely it would not be tolerable to have significant swathes of the landscape devoid of legal aid provision? That the genesis of legal aid was in Bevan’s post-second world war government in the form of the Legal Aid and Advice Act 1949 reminds us that legal aid is a fundamental part of our welfare state.

If there are not to be legal aid deserts, larger legal aid providers will surely have more bargaining power with regard to the prices charged for providing legal aid in these areas. There is already some evidence of this happening by allowances built into the fixed-fee regime – the system has been designed to cut out the cost to the fund of travel and waiting, but there are additional travel payments claimable for certain out-of-town detention centres and mental health hospitals.

To point out how ‘joined up’ provision could really be if we tried hard to achieve it, consider the following. Train franchises are (some would say similarly, in light of the above) a fragmented but national service contracted by the government to a few large suppliers. The ‘price’ to the legal aid firm, and ultimately to the LSC, of using the travel network – that is, firm staff using the train to travel for work – is significantly higher than the marginal ‘cost’ to the rail companies of ‘public service workers’ using the transport network (particularly at off-peak times). Perhaps properly joined-up environmental, transport and legal social welfare policies would seek to integrate some relevant contractual provisions? Police officers use some public transport for free – why can’t we?

But that’s a long way from where we are now. I wish all legal aid suppliers well in doing their important work. But, for those that succeed in creating sustainable, growing, leveraged businesses, I raise the spectre of an increasingly politicised future. Central contracting with the LSC may just be one part of the contractual nexus at national level, with which we humble legal service providers may become concerned. And as there become ever fewer of us, perhaps government will hear our advice more clearly.

Adam Makepeace is practice manager at Duncan Lewis & Co Solicitors