Investing in professional services is not seen as an AA-type of investment for many private equity firms. With alternative business structures (ABSs) set to come in on 6 October 2011, there are still many regulatory issues to settle. At the same time, there are now numerous conferences and seminars for partners to help them understand the implications, opportunities and changes they may need to make to gear themselves up for this change in their profession.
Whist the top 30 law firms may see this as an irrelevance and the high street firms will be viewed as too small, it is the mid-tier firms who should be in focus as investment opportunities. When garnering views on the legal profession from those in the private equity world, there is the perception that most law firms are:
- Old-fashioned, slow-moving monoliths, bound by some quaint idea of collegiality with no rigour or management of performance – so lacking in corporate structures regulation or disciplines;
- A service business vulnerable to a few big-hitters, usually partners, and if they left, would dramatically affect clients/turnover;
- Inherently difficult to plan and budget for through not having scalable, replicable nor repeatable services apart from conveyancing, re-mortgaging, personal injury commoditised services – which have been done – and had some high-profile casualties; and
- Sufficiently risk averse that they would not be sufficiently corporate in vision to break with old habits.
Steve Tudge, a partner at ECI, suggests “the biggest barrier is the resistance of the partners and their need for control. The industry has been protected by statute and regulation for far too long and there is a huge gulf between law firms and the corporate world”.
Views expressed by the partners of law firms are, of course, as wide-ranging as there are firms. There are some extreme views on the benefits, opportunities and “ghastliness” of what external investment could mean for them. Many of the current views (of both law firms and private equity) are based on the much publicised stories about heavily commoditised personal injury powerhouses such as Russell Jones & Walker and Irwin Mitchell, or HBOS and AA undertaking huge volumes of legal work, or marketing vehicles such as Connect2law, etc. Hammonds Direct has hit the headlines too as an example of how any commoditisation can be vulnerable to the vagaries of the market – property in this case.
Many commentators on the legal sector see the Legal Services Act as a portent of a fundamental change to the legal landscape, expecting the number of law firms to halve over the next five years, economic downturn aside. By enabling firms to have external investors who are not employed within the firm (whether lawyers or not), the scope for fundamental shifts in practice structure is challenging the old concepts of partnership. This opens the opportunity, too, for private equity investment or perhaps, although less likely in the current market, for fund raising on AIM, if they but knew about the changes.
Is the gulf is too wide?
It is true that commoditised legal services can become victims of the economy, such as the extraordinary slowdown of the housing market. Sceptics may say this is proof perfect that investing in law firms or commoditised legal services is way too fraught to bother. The question is who in the private equity world is aware of the Legal Services Act creating the opportunity for them to invest? Fascinatingly, very few are even remotely aware of these future changes or would even consider investing in the legal sector due to many out-dated perceptions of law firms.
An opportunity for both?
At a time when private equity houses may have a dearth of good investment opportunities in more traditional sectors, now could be a wonderful opportunity for the legal sector to show just how sophisticated some can be and so dialogues should start.
Phillip Rattle, a partner at August Equity LLP, was intrigued by the concept as he, amongst others, was unaware of the changes in regulation. As part of the conversation, he suggested that he could see the opportunities but limited to one of scalability, having regular, replicable services which should be, in his view, focused on a specific client group.
Clearly, though, commoditised services is not the only route, and a number of managing partners have suggested that there is scope for many firms to benefit from private equity investment to get the value and growth out of their firms as niche practices, or develop a larger regional or national presence.
Central to any external investment, however, will be the requirement not only to have an equity stake but also a controlling influence. This is causing many partners to dismiss the idea, as it means the end of their partnership structure in exchange for a corporate one. Thus the Act is posing a catalyst for firms to address unity and common purpose of vision.
To be an effective investment opportunity by, say, 2012, Ian Austin, managing partner of regional firm Halliwells, believes firms need to have in place the following key attributes:
- A clear vision and strategy for the firm with strong growth plans;
- Client-focused services which are repeatable, reliable and sustainable;
- Evidence of a management structure which manages the performance of everyone, demonstrating a cultural shift; and
- Seasoned and strong finances (profit and cash) and sound infrastructure.
It is evident then, that for firms who can see the opportunities, they should be using the review of their structure in not just the ailing departments, but the whole firm to meet an external investor’s requirement.
A partnership structure, based on consensual management and paternalistic governance, where management and staff’s futures are still beholden to the whim of a few individuals, will have to change. Critics of the partnership culture suggest it is an unsupportable closed shop into which non-lawyer managers and/or non-executive directors and chairman (likely to be from the private equity house) would not fit.
Managing all the partners and staff within a corporate structure, with its management board, remuneration committee, defined corporate governance, etc, will cause a shift in culture too. There is no place for maverick fee-earners, a prima donna partner, protected under-performers or passive observers at partner or staff levels. This is probably the greatest challenge for any partnership looking to grow through external investment and should be managed actively.
Often, resistance to change is based upon mis-understandings, fear and a lack of confidence on the part of individuals to deliver what the future may require. It is also worth noting, that some people take longer to change their views, so the sooner the plans are developed, the sooner the shift in the practice, the better.
Being part it or watch it
Partners should not be so naive as to think Investors will not look thoroughly and minutely at their management structure and the commitment from all the partners and management team to the growth plans.
External investment is not some panacea, or war chest, nor loaded gun to help get rid of problem partners, or shore up aberrant practice areas whilst the rest of the partners are sitting on a Caribbean island in happy riches. It is a serious opportunity to develop a vehicle to deliver sustainable legal services differently from the insurance and commodity businesses we see today.
Napoleon said that if you are inside your castle defending it, you have already lost the battle: attack is the greatest form of defence. Clearly some members of the legal profession see the opportunities; however, there is a greater number who either can’t or won’t see the changes on the horizon and so are doing nothing.
In this economic climate the opportunity of investing in sound businesses has to be a challenge for fund managers. The Legal Services Act offers effectively virgin territory, so now is the time to build an understanding of what modern law firms need to be a new strand for investment.
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