Law firms must bulk up their capital reserves if they want investors to consider them as serious acquisition targets, experts said at the Claims Standards Council’s annual conference last week.

Royal Bank of Scotland relationship manager Sara Hutton told delegates that firms should retain up to 35% of fee income as capital, if their aim is to entice investors to take equity stakes once reforms allow.

However, Paul Hinchliffe, managing director of legal process outsourcer Judicata, said that law firms, especially personal injury firms, would probably not be able to supply the 35% capital margin suggested by Hutton.

‘I see a lot of your balance sheets, and they are not good,’ Hutton said. ‘In most cases, you do not have enough spare cash. If you want to negotiate with venture capitalists from any position of strength, you are going to have to make sure you have enough of your own cash in the business, because venture capitalists are excellent negotiators when it comes to corporate finance.’

Firms will have to convert into limited companies so that they can be acquired as subsidiaries, she said. ‘But it’s not just about being a limited company, it’s about acting like one. It’s not your piggy bank any more, and venture capitalists will notice if you treat it like one.’

Hutton said that venture capitalists will want a 20-30% return on their investment, a large stake in the firm, and an exit within three to five years, either by flotation or management buyout. ‘You could end up with a much smaller stake in a much larger and more profitable business, and with new management skills and access to new markets,’ she said. ‘But it would not be for the faint hearted.’