A Case Study in Law Firm Gross Margin and Lockup

Roll On Friday broke the news on DWF putting 100 roles at risk of redundancy a couple of weeks ago and some of the commentary since has been a somewhat snarky 'see, this is what PE really means for law firms'

But the truth is the issues at DWF were well publicised and known prior to the delisting in July '23 - and needed to be addressed regardless of ownership

The April '23 financial results for DWF as a listed group highlighted two key issues:

• A gross margin of 50%, down 1.3pp on 2022 and materially lower than the 60+% sector benchmarking would suggest

  
  

• 196 days of lockup, up 17 days (9%) on the prior year and 40-50 days higher than for firms of this size

Reading between the lines of the annual report, the gross margin issue was likely caused by two factors (i) lack of pricing power and (ii) decreasing fee earner utilisation. DWF has been public about not rebasing salaries alongside the wider market in the post-pandemic flurry and so it's reasonable to assume that wage inflation wasn't a major factor in the margin erosion

Left unchecked, that margin erosion and increasing lockup was always going to put the firm under pressure and, indeed, you can see that from 2022 to 2023 with debt and gearing increasing on the balance sheet and interest expenses ballooning 45% in the P&L

Perhaps those fundamental issues have been addressed over the past couple of years and with these latest redundancies?

I don't think so

Or at least, we can see that they weren't resolved in the 2024 financial statements of the acquiring company - Aquila Topco - which showed GM flat at 50% and lockup increasing even further to 210 days (albeit skewed upwards by increasing revenue)

Based on all of the above, I question whether this round of redundancies is going to make a real difference or if it's part of a wider transformation

Back of a napkin, I estimate they're looking at just ~£4m of savings on 100 redundancies before redundancy costs are factored in (i.e. <1% of a £400m+ turnover firm) and contrast this with the £9m in expected losses on the 2024 trade receivables 😐 

Subject to the 2025 results which will be published later this year, my view remains as it did in 2023 - the business has a gross margin and lockup problem, the latter in particular acting as a drag on top line revenue growth as someone ultimately needs to fund the 6+ months of lockup on that increasing revenue

It's akin to driving up a mountain with the handbrake on

It was not the PE owners that applied the handbrake