THE lack of deals being carried out by their clients may be behind continued slim pickings for many of Scotland's corporate lawyers, but it is an M&A deal within its own ranks which has proved to be the big talking point of 2012

THE lack of deals being carried out by their clients may be behind continued slim pickings for many of Scotland's corporate lawyers, but it is an M&A deal within its own ranks which has proved to be the big talking point of 2012.

After much speculation and rumour about potential mergers, the tie-up announced by McGrigors and English-based Pinsent Masons has sparked a fresh round of fevered discussion about which firm could be next. Further consolidation is thought to be inevitable in a fragmented sector which is still re-adjusting to life following the financial crisis.

Insider's latest research of the sector shows total fee income at the top ten corporate firms in Scotland edged up to £354.3m from £344.2m the previous year. But excluding the impact of the combination of McGrigors and Pinsent Masons, the total number of fee earners across the ten largest firms has dropped.

Research by accountancy firm PKF found half of Scotland's top 30 firms saw equity partners leave the business during 2011. a quarter reduced at least one equity partner's interest in the firm, while nearly a fifth demoted partners from equity to non-equity status.

"The dependence upon conveyancing for large tranches of the legal sector and the decline in banking activity and corporate deals in the commercial market has meant that too many firms have been chasing too small an income for some years," points out charles Barnett, professional services partner with PKF.

According to James Tsolakis, head of law firm banking for Royal Bank of Scotland, the legal profession is still over-resourced in the face of a "permanent structural change in market forces in the UK". "We would see a good case to take out five per cent of fee earners to put the profession on more stable levels of profitability."

While the law Society of Scotland's figures show that profits across Scotland's law firms rose in 2011 - the first increase since the financial crisis - their survey revealed that the smallest and largest practices were still finding life very tough. average profit per equity partner across firms rose to £71,000 in 2011 from £64,000 in 2010, although still significantly below the £104,000 achieved in 2008.

Lorna Jack, chief executive of the Law Society of Scotland, says the survey highlighted "very mixed fortunes" and predicted that the economic conditions will continue to prove difficult for solicitors throughout 2012. "The legal services sector will remain highly competitive with clients continually pushing to get more for less, particularly in the current economic climate," she says.

While many firms have already taken steps to cut costs, outsource non-core activities and, in some cases, reduce staffing levels, consolidation in the sector is seen as something of an inevitability.

The merger of McGrigors and Pinsent Masons may also prompt others to look at their futures with more urgency than before. McGrigors had been linked with a number of potential suitors in recent years but it is thought the close fit with Pinsent Masons was the clinching factor that won the vote from partners at both firms.

The Scottish firm has been at pains to stress that the merger was to take advantage of strategic opportunity rather than out of necessity to build scale in the face of tough times. The last set of figures to be published ahead of the merger supported that, with McGrigors' revenue in the year to September 30, 2011, up eight per cent from £65.6m to just under £72m, while profits jumped 20 per cent from £17.17m to £26m.

Although the merger will lead to the disappearance of one of Scotland's oldest legal names, Kirk Murdoch, who has become chairman for Scotland and Northern Ireland of Pinsent Masons, said the deal was a positive one for staffand clients. "I suppose inevitably people will be a little sad to see the name disappear, but it's all part of our evolution and the feedback from clients about what we are doing has been overwhelmingly positive.

"What really excites us about this deal - and what makes it different from some in the market - is the potential we see for growth. We all recognised that there was space in what is an already crowded legal market for a firm of our combined scale and reach that would be compelling to clients from both firms. By combining our two firms we'll have the ability to provide an even greater level of service in a broader range of areas - both domestically and internationally. What we are creating is an international law firm, with significant headcount in Scotland, which can play a pivotal role in helping Scottish businesses grow abroad."

While Jennifer Young, recently appointed chairman of Aberdeen-based Ledingham Chalmers, says there has been a certain degree of consolidation "frenzy" in the middle market, she doesn't see the McGrigors deal as necessarily opening the floodgates for similar deals. "That merger was for particular reasons, in a particular market and to achieve certain ends," says Young, who says her own firm has had a number of discussions and continues to be open to talks with other firms.

"I think there are a lot of conversations going on right now but consolidation has to be for something more than just scale; there has to be a vision. My suspicion is that is why we are not seeing a rash of deals happening. You also have to remember that many of these firms have strong foundations and histories and that can't be given up or changed overnight."

Chris Smylie, chief executive of Maclay Murray & Spens, believes there will be "good consolidation and bad consolidation" ahead. "Undoubtedly there will be firms who see it as a means to advancing their business and will have a clear strategy they want to pursue. But in other cases it will be a port of last resort where people have run out of other means of taking things forward."

He also agrees that merger for the sake of scale without a strategic plan will "just add to your problems".

Philip Rodney, chairman of Burness, thinks the McGrigors' move signals a major shiftis under way and believes similar mergers are likely. "I think the so-called 'Big Four' firms have adopted a strategy of no longer wanting to be Scottish firms but wanting to be UK firms, which I think is a natural next step. This is a major shiftand we will see segmentation; some firms will be UK national firms with offices in Scotland and others will be Scottish indigenous firms. The best firms in both these categories will prosper but their business models will be quite different."

Murdoch says he believes the Pinsent Masons deal will give "pause for thought" about the nature of the legal services market in Scotland. "There is really no such thing as a 'Scottish Big Four' anymore because so much of the work is national and international."

Bill Drummond, managing partner of Brodies, believes other long-established Scottish legal names could disappear due to what he calls a "preoccupation with scale and place". He believes merger activity will be led by the larger, more profitable UK or international firms that have a capital base "adequate to absorb the additional overheads and the financial and HR restructuring of the new entity".

"Such mergers, or perhaps more accurately takeovers, have to make sense of course and just won't happen unless the business case stacks up. So what is perceived by some to be an overcrowded Scottish market seems likely to be a hurdle for firms with large Scottish overheads seeking a merger partner. We shall see."

Although Young believes there may not be a tidal wave of consolidation, she believes there will be "fewer of certain types of law firms in the future". "I would be very surprised if there isn't middle market consolidation in the central belt. I think a lot of firms there are trying to differentiate themselves."

She believes many small firms are also like to disappear. "There are a lot of smaller firms who have very good client relationships but are perhaps reaching a natural end due to generational issues and the economic climate may have accelerated the process of them looking to move on and do some kind of deal."

Smaller deals already this year have included the acquisition by Edinburgh-based Tods Murray of two-partner private client specialist Fyfe Ireland. Glasgow-based insurance specialist Andersons Solicitors is also being taken over by larger London rival DAC Beachcroft.

Alan Thomson, chairman of McClure Naismith, also predicts more mergers in Scotland but believes more cross-border deals are unlikely. "Mergers are a consequence of the times but whether they will necessarily be a good thing for clients remains to be seen. Success is more assured where the rationale is strategic rather than the uncertain benefits of scale. Over the years M&A among legal firms has had mixed outcomes," he points out.

While exploratory talks continue over long-term futures at many practices, firms are also having to focus on the day-to-day challenges of running businesses in a climate which continues to be difficult.

But the sector does appear to be in better shape now than it was three years ago. PKF's annual review of the top 30 legal practices in Scotland in 2011 identified a "significant improvement", with half of those surveyed reporting that their financial performance was broadly on budget or exceeded their expectations.

PKF's Barnett says it is important for firms to recognise that there is unlikely to be a return to the "good old days" and to develop strategies for growth in the new economic environment as well as recognise the legal sector as it is rather than as they would want it to be.

Although Burness itself has had its best ever year in terms of turnover and profit, chairman Rodney argues: "There are still too many lawyers chasing too little work."

He believes that will inevitably lead to polarisation. "Those firms that are well organised and have a clear strategy will continue to prosper; those who don't will continue to see their business eroded," he predicts.

"The successful firms of the future won't be all things to all people, they will focus on doing a number of things very well," he adds.

According to Alison Newton of HBJ Gateley, the "softness" has very much gone out of the whole sector. "Even if you have a particular team which is doing very well there's certainly no complacency out there."

She argues that the lack of transparency on the pipeline of work is a key issue for many firms. "It's not hand to mouth but things do take longer to come together now. That's not so much about lack of confidence but just that there are much more stringent hoops that people go through now on transactions than there were, say, four year ago. We advised on a building transaction recently where the due diligence which had been done in 2006 - which had been perfectly adequate at the time - didn't even start to answer the questions we were asking now."

Newton argues that the current climate very much requires "partners to concentrate on the clients and management to concentrate on managing the business". "It is also very much about supporting and driving the parts of the business that have the current pipeline of work."

MMS' Smylie argues that while the overall market is tough, there are also opportunities out there. "Recession is not necessarily the roadblock which some think it is. There have now been four to five years of tough times and that causes any business to have a really good, long, hard look at their business and where it is going. As well as throwing up challenges that also throws up opportunities but in order to take advantage you really have to have a very clear idea of where you are going and the kind of business you want to be."

Smylie says while the mainstream corporate market is still tough, in some areas such as the oil and gas sector, business is relatively buoyant. "We've seen a good deal of deal activity in our Aberdeen office which we haven't been seeing in the mainstream M&A market."

Scott Allan, managing partner at Paull & Williamsons in Aberdeen, believes the recent announcement in the Budget on measures to support investment in smaller fields and deepwater developments should further benefit the North Sea oil and gas industry and, in turn, the legal sector. "We expect this will encourage companies to allocate capital to the UK offshore industry that may otherwise have been spent elsewhere. Market conditions in other sectors have been slower to improve but are showing signs of strengthening which will result in further opportunities for growth."

McClure Naismith's Thomson says whilst deals have remained subdued, his firm has diversified into new service areas such as regulatory work and increased business in fields such as tax driven property work, dispute resolution and debt and asset recovery.

Brodies, which opened a new office in Aberdeen just over a year ago, also launched a Brussels office in response to both policy direction and demand from clients for advice on EU regulation, competition and public law.

While the impact of the economic downturn has been felt across the sector, it is perhaps those looking to start their legal career in recent years who have been hardest hit. Latest figures show the number of trainee solicitors taken on by Scottish legal firms and organisations was 10 per cent lower in 2011 than in 2010. A total of 484 training contracts commenced last year, compared to the peak of 629 reached in 2007.

Catriona Headley, president of the Scottish Young Lawyers Association (SYLA) which represents students, trainees and lawyers up to 10 years qualified, says there are fears of a "lost generation" of hopeful lawyers who had been unable to embark on a legal career after finishing their studies. "Those that waited until things had picked up found that by the time they had, the market had moved on and there was a fresh round of graduates salso looking for places."

For those who do manage to secure a foot on the ladder, many trainee lawyers are having to work harder and longer hours, particularly in smaller firms.

Headley says the fierce competition for fewer jobs was highlighted by a recent recruitment exercise for a practice. "One of the first questions being asked of the applicants was what they could bring in terms of business development which would never have been expected of a trainee in the past."

In response, the SYLA - recently named Legal Training Provider of the Year in Scotland – is looking to put on an event to help ensure prospective trainees are as prepared as possible to meet the challenges of an ever-more competitive environment for young lawyers.

According to Ledingham Chalmers' Young, whose firm is currently recruiting for a number of posts, the biggest competition is not from other law firms but from in-house positions. "Certainly at the trainee level there are some very attractive packages on offer for inhouse positions but I think that is just a cyclical issue reflecting a time when organisations have been taking more legal services in house."

Hbj Gateley's Newton, whose firm expects to recruit for a record number of newly qualified posts this year, says it is important for firms not to lose sight of the need to bring on young talent. "The sector has changed but there will always be the need for clever people. But more than ever it is about firms being able to apply that talent smartly."

Despite the upheaval he predicts in the sector, RBS' Tsolakis is "immensely optimistic about the future of the legal profession in the UK". "I see evidence of firms adopting new visions of their future, goals that respond to the changing environment and initiatives that are crafted to deliver immediate tactical success," he says.

"Those firms that challenge convention and think creatively about their business model, are nimble and agile in the execution of their plans, and who quickly organise themselves to deliver superior service, value and results to their clients will enjoy success."