Traditionally, many professional service firms have operated as partnerships, or more recently as limited liability partnerships, and been financed by a mix of retained partner profits, bank loans and capital contributions from partners. The changes in the economic and business environment experienced over the last two years have increased the working capital requirements in many firms. However, growth consumes cash and firms that have a strategy to grow will have a need for cash to invest in new services and offices, as well as additional working capital. Add into that the cost of developing offices across the world and there are some serious demands and tensions on the traditional model.
A number of alternatives are being considered by firms and in some cases implemented. Accessing the public capital markets through a listing is one model, but in many cases for a traditional firm run as a partnership this would be a significant step and have a number of implications for changes to the culture and governance of the firm. However, it certainly could be considered by a firm as part of a medium term strategy.
The use of private equity to take a stake in the firm (say around 20%) is another way of accessing external investment and some firms have used this route. Again this means that partners are giving up some control and will mean that part of the future profits will be going to an external investor.
Another option which can work within a partnership model, with the partners retaining full control over the firm is to use a corporate partner (a limited company owned by the partners) to provide for future funding and working capital requirements. This still uses mainly retained profits to finance the firm, but in a corporate partner this is after applying tax at 28%, rather than taxes of up to 50% which many partners are likely to be paying in the future. Therefore, there is more finance available to deal with increased working capital in a more tax efficient model.
With many firms now considering their medium term strategy in the post recession business environment, alternative financing options should certainly form part of that thinking.