The growing funding gap: how financial pressures are reshaping law firms

The legal sector in England and Wales is entering a period of significant financial strain. While demand for legal services remains robust, particularly in contentious and consumer-facing areas, the underlying economics of many law firms are becoming increasingly fragile. At the centre of this challenge lies a tightening funding environment, mounting pressure on working capital and a noticeable shift in the behaviour of litigation funders.

For many firms – particularly those operating in high-volume claims, group litigation or disbursement-heavy practice areas – external funding has become a critical component of their business model. However, recent developments suggest that this reliance is becoming a point of vulnerability.

Tightening funding landscape

Over the past decade, litigation funding has grown rapidly, transforming access to justice and enabling firms to pursue complex, large-scale claims. The UK market expanded significantly, with assets rising from under £200m in 2011 to over £2bn by 2022.

Yet the sector is now facing a period of recalibration. Legal and regulatory uncertainty – particularly following the Supreme Court’s decision in R (on the application of PACCAR Inc and others) (Appellants) v Competition Appeal Tribunal and others (Respondents) – has disrupted traditional funding models and forced funders to reassess risk.

More recently, financial losses among major funders have compounded this caution. Litigation Capital Management, for example, reported losses of £58m in just six months, describing it as the most challenging period in its history.

As a result, funders are becoming increasingly selective, withdrawing from certain case types or exiting the market altogether.

This shift has immediate consequences for law firms. Those that have built their business models around external capital are finding that funding is no longer as readily available as it once was.

Working capital squeeze

The withdrawal or tightening of funding has a direct and often severe impact on working capital. Litigation, particularly in areas such as financial mis-selling or group actions, is inherently cash-intensive. Firms must often carry substantial disbursements and operational costs for extended periods before any recovery is realised.

Portfolio funding arrangements have been widely used to support this model. However, regulators have raised concerns about their structure and oversight, noting that such funding operates in substance as working capital and should be treated accordingly.

At the same time, broader economic uncertainty continues to weigh on the sector. Surveys indicate that the vast majority of law firm leaders expect growth challenges, with financial pressures cited as a primary concern.

Funding model risk

Many claimant firms rely heavily on third-party funding to support cashflow and manage exposure to disbursements. However, when that funding is reduced or withdrawn, even otherwise profitable businesses can come under immediate liquidity pressure. Rising overheads, extended work-in-progress cycles and borrowing linked to acquisition-led growth strategies can quickly become unsustainable in the absence of new capital.

In these circumstances, firm leadership is faced with a pivotal decision: allow financial pressures to escalate – potentially leading to regulatory scrutiny – or take proactive steps towards an orderly restructure or wind-down.

Managing closure or restructuring

For many firms, closure is not the only outcome. Where financial strain becomes unavoidable, a carefully managed wind-down can help safeguard client interests while preserving value within the business. Early intervention allows for the controlled transfer of files, structured creditor engagement and a reduced risk of regulatory intervention, while also limiting potential personal exposure for directors.

In other cases, restructuring may offer a viable route forward. This can include exiting higher-risk, funding-dependent practice areas and refocusing on more sustainable and profitable lines of work.

Engaging specialist support is often critical in navigating this process effectively. Providers such as Recovery First work alongside firms to discreetly manage the transfer of cases to appropriately qualified solicitors, ensuring continuity for clients while maximising the value of work-in-progress. By facilitating an orderly withdrawal from specific sectors, Recovery First enables firms to retain as much value as possible, while maintaining full regulatory compliance.

Working in conjunction with restructuring and insolvency practitioners, accountants, and corporate recovery specialists, Recovery First helps deliver commercially sound outcomes across file transfer arrangements and wider restructuring strategies.

Looking forward

The current litigation funding landscape is unlikely to revert to previous levels of risk appetite in the near future. Firms with a heavy reliance on external capital or long-tail claims should be actively stress-testing their financial models and implementing contingency plans before pressures intensify.