Business and professional services (BPS) firms are grappling with the heightened uncertainty a global pandemic brings. As a result, they are drawing down on their revolving credit facilities and pausing investment in an effort to keep cash on hand for day-to-day operating expenses. Payroll and related workforce decisions are priorities, while business leaders rethink the achievability and timeline of longer-term investments. Firms with strong liquidity positions will eventually seek to reposition for growth and focus on embracing digital transformation. Firms pursuing greater mobility, flexibility and security will likely start by investing in information technology and cybersecurity programs. This outlook centers on two specific sectors within BPS, law firms and government contractors.

LAW FIRMS

Law firms big and small have seen a healthy run of revenue-per-partner growth over the last decade as they reacted to the effects of the Great Recession. However, as COVID-19 has brought forth a new series of challenges, law firm leaders must draw on what they learned about appropriate staffing levels, investment in innovation and strategic planning after the Great Recession and act swiftly to ensure their firms don’t lose the traction they’ve gained. Many firms must address the following challenges as they look to adjust strategies for new post-pandemic routines.

The legal industry is one built on relationships, and ensuring clients that firms are there to support them in their time of need is vital to maintaining healthy client relationships.

Liquidity, agility and uncertainty

Firms have been forced to make decisions on furloughs and layoffs, compensation and partner distribution cuts, as well as find other ways to reduce operating expenses. At the same time, they’ve had to adjust to new ways of growing top-line revenues while working remotely. A firm’s liquidity will enable them to continue to be agile as unpredictable results continue to roll in over the course of this summer. Firms should continue to look for ways to expand their current lines of credit, while capitalizing on federal financing alternatives (Paycheck Protection Program, employee retention credits, Main Street Lending Program options). Firms should also look at this time as an opportunity to circumvent the typical fourth quarter collection race most firms run to lessen the demands they place on their lines of credit throughout the rest of the year. Implementing quarterly collection discussions with clients will challenge the status quo, but it can lead to opportunities to invest in other parts of the firm.

Investing in employees from a distance

As much as firms are focused on monitoring all parts of their operations, the single most important aspect during this pandemic has been their human capital. Almost all firms have moved to remote work environments. That has heightened the challenges facing their workforce, as attorneys and staff have begun balancing the demands of being professionals, parents and caregivers. Firms must continue to support their attorneys and staff with enhanced benefits that show employees how they are valued as part of the firm’s culture now more than ever. By doubling down on the benefits provided to the staff, firms can continue to win back some of the capital that has been spent in recent months with cutbacks. Benefits such as telehealth, expanded forms of time off, virtual professional learning opportunities and expanded mental health benefits can show staff that the firm continues to support them. In addition, creating or enhancing mentor, coaching and similar programs can help staff through difficult times caused by COVID-19. As remote work has prompted the move to virtual communications and videoconferencing, staff are experiencing fewer contacts with colleagues, and that can often lead to detachment from the firm. Programs that encourage staff to connect with other members of the firm can create additional avenues to stay in touch and make them feel they are still part of the firm’s success.

Remote questions, digital answers

Perhaps the most important data point for firms emerging from the pandemic and returning to life as they previously knew it is their assessment of how successful remote working was for their staff. Were there roadblocks firms overcame, or are there infrastructure issues that continue to cause delays in providing legal services? Are there areas of the firms’ operations that need digital enhancements? Are there redundancies in operations that can be remediated through robotic process automation or other forms of artificial intelligence? As firms look to make more of their records accessible outside of the office, access and security challenges present additional obstacles they must overcome. Now is the time for firms to identify how their digital footprint can assist in their strategic goals post-COVID-19.

MIDDLE MARKET INSIGHT: Performing digital, security, privacy and risk assessments are ideal strategic moves for firms looking to reopen their doors and discuss what normal post-pandemic business may look like.

Business intelligence tools

Distressed financial modeling and other management tools came under scrutiny in March and April, as law firm leaders looked to models to help predict what cash flows would look like from the onset of COVID-19. Unfortunately, many firms realized their current models were not up to the test of helping them understand how the pandemic would affect the industries they rely on for revenue growth. As firms look to understand how the remainder of 2020 will turn out, they should invest in powerful business intelligence tools. Tools of this nature can mine a firm’s internal and external data to help guide strategic decisions by providing insights into client and industry trends, as well as trends in their own human capital behaviors.

Relationship status

Given the various uncertainties brought on by the pandemic, lawyers should be checking in with their clients. Most of their clients are reeling from disruptions, and there are opportunities to assist clients with implementing strategic decisions. Whether it is determining how to handle layoffs or furloughs, helping clients decide how to discontinue operations of operating units or working through a successful acquisition of a target entity, law firms should begin to strategize how best to work with clients. Virtual communications include certain challenges and communication limitations. But the legal industry is one built on relationships, and ensuring clients that firms are there to support them in their time of need is vital to maintaining healthy client relationships. Client relationships will be important throughout the remainder of 2020 and into 2021, as legal expenditures will be affected across many industries in the real economy. Gone are the days where corporate legal hires external counsel at will. Now law firms will see an uptick in rate negotiations, as well as an increase in the demand for technology to supplement their legal services. Corporate legal will look to invest in their own infrastructure and will expect law firms to match their investment in their own firms’ ability to support their legal needs.

Changing the growth culture

Now that many professionals have adjusted to a remote work environment, checked in on their clients and ensured their relationships are healthy, many law firm leaders are looking to the remainder of 2020 and into 2021, asking how organic top line revenue growth will continue. One very important way to accomplish this is to continue to invest in training and mentoring rising stars within the firms. By providing them with the resources to learn how to interact with prospects and client executives, law firm leaders will empower these rising stars to help foster new relationships, which will eventually help grow revenues of the firms. Growth programs can empower lawyers with the tools necessary to probe prospects and clients for elevated conversations that will ultimately lead to identifying opportunities to provide support for these organizations.

COVID-19 has presented many challenges for law firm leaders to date. By identifying the need to take action on critical business functions highlighted herein, law firms can position themselves for continued success as the economy begins to open up and their clients look for their advisors to assist them.

GOVERNMENT CONTRACTING

Government contracting is big business, with government outlays representing 20.2%—23.4% of U.S. gross domestic product over the last 10 years. The success of these firms depends on government needs and the availability of fiscal resources for public investments.

MIDDLE MARKET INSIGHT: Benefits such as telehealth, expanded forms of time off, virtual professional learning opportunities and expanded mental health benefits can show staff that the firm continues to support them.

Government national interest spending kicks up

Government spending not only continues during periods of economic downturn, but it can also be used as a tool to stimulate the economy, battle unemployment and protect U.S. citizens. Total government spending and defense expenditures remained steady through the first half of calendar year 2020, while government health spending peaked at the height of the COVID-19 response.

According to data from the General Services Administration, agencies spent approximately $14.7 billion as of June 4, 2020, on COVID-19 national interest programs. The vast majority of this amount was attributable to the Department of Health and Human Services (HHS), which includes agencies such as the Centers for Diseases Control and Prevention (CDC).

While the majority of COVID-19-related spending through May targeted health resources and emergency response, the pandemic highlighted risks relating to U.S. infrastructure, cybersecurity and public health. Government contractors should be poised and ready to meet government needs relating to public health, physical and digital infrastructure and national security. 

Private equity interest seeking transparency

The government contractor middle market is home to many small, highly technical service providers and other high-growth niche players. These companies are attractive to the bigger players in the hunt for growth, added capabilities and access to specific contract vehicles. The result is a robust and dynamic market for acquisitions. While COVID-19 put a pause on the majority of deal flow in the first half of calendar year 2020, matchmaking continues with the expectation of deals closing once debt markets loosen up, and management teams can meet one another physically instead of via videoconferencing.

MIDDLE MARKET INSIGHT: Recent industry growth, increased government spending during COVID-19, visibility into future cash flows and insulation from recession make government contractors a ripe target for private equity firms seeking stable cash flow streams.

Many private equity firms, particularly those that specialize in the government contracting sector, are implementing investment strategies more akin to strategic rather than financial buyers. Specifically, private equity groups often invest in a platform company and complete one or more bolt-on acquisitions before selling the larger, combined firm. This blending of financial and strategic investment strategies is unique to the sector and drives private company transaction multiples up.

We expect to see M&A activity from strategic and financial buyers in the fourth quarter of 2020 and the year 2021 based on the recession-proof nature of government contracting, limited impact from COVID-19 (excluding companies with exposure to commercial aerospace), and general consolidation in the market.

Cybersecurity of the utmost importance

For government contractors, poor cyber hygiene may not only cost you a customer, it could also threaten national security and burden taxpayers. One of the more infamous hacks was in 2017 when an Australian contractor was hacked, losing F-35 schematics and technical documents. Because of this, the Department of Defense is rolling out a new requirement called the Cybersecurity Maturity Model Certification, which goes into effect July 1, 2020. The CMMC will build upon cybersecurity best practices from well-known standards such as the Defense Federal Acquisition Regulation Supplement and the National Institute of Standards and Technology Special Publication 800-171, but it will require a third-party assessment to help verify reduced risk. This program is a significant step toward reducing cyber-risk within the government’s vast network of contractors. While this program applies only to contractors serving the DOD, other departments will likely follow suit.

We recommend all defense contractors prepare for CMMC before it is required for future vehicles and recompete opportunities on existing vehicles (some of which are this year). The chief information security officer in the Office of the Under Secretary of Defense for Acquisition, Katie Arrington, noted in April that cyber insurance will likely increase in popularity (and necessity) going forward, and cyber hygiene similar to that required under CMMC could determine rates.

Fight for talent

The federal government and its contractors struggled to compete with commercial technology companies for top talent during the recent stretch of low unemployment and a flourishing startup community. Increased unemployment and macroeconomic headwinds could result in more skilled workers looking for less risky positions. Government contractors with full pipelines should maximize the opportunity to position their workforce for the future with young, technologically savvy individuals.

National security and Election Day stakes

All eyes are on the 2020 presidential election, as the winner and their respective party will exert influence over the fiscal year 2021 budget and levels of investment in areas such as transportation, infrastructure, digital transformation and 5G.

Defense and intelligence agencies continue to voice concerns about exposure to enemies via weakening supply chains and adversarial capital, key concerns that were magnified during COVID-19. Undersecretary of Defense Ellen Lord, in her press briefing on acquisition reform and innovation on August 26, 2019, discussed two of the Pentagon’s key initiatives to counter economic influence from national state adversaries:

• Committee on Foreign Investment in the United States (CFIUS): A federal committee that has the power to block foreign investment deemed a risk to national security.
• Trusted Capital Marketplace program: A matchmaking program between the government and businesses that need trustworthy sources of capital to deliver on national-security-related products and services.

These programs are a taste of acquisition reform on the horizon for government contractors, particularly those serving the defense and intelligence communities.