Private equity eyes up City law firms
THE BELEAGUERED legal profession, says Jeremy Hand, managing partner of private equity firm Lyceum Capital, is facing “a fire-storm whipped up by the recession, smarter customers, technology, outsourcing and legislation”. If that wasn’t trouble enough, it’s also being forcibly opened up to competition that could arise from the so-called Tesco Law – the shorthand for the ongoing “big bang” liberalisation of legal services that will come into force when alternative business structures (ABSs) come into force in 2011/12. Under ABSs, firms will for the first time be allowed to be majority-owned by external investors.
The legal profession as we know it faces threats. But there are also opportunities for firms brave enough to seize them. “Major structural change is inevitable with well-positioned players taking market share away from those firms which can’t or won’t adapt,” Hand predicts.
Private equity funds including the likes of Lyceum, Fleming Family & Partners and Phoenix Equity Partners are busy courting firms. Fleming confirms that so far they have spoken to 20 top-100 City firms and “most of them are very interested in having at least one discussion”.
So what is the appeal of the legal services market to outside investors? According to Jeremy Hand it’s because the sector is “big and fragmented with only a few really well-managed firms”. “Frankly,” he says, “not many customers get great value for their spend.” Hand reckons Lyceum is looking to work with firms with “a modern, streamlined, low cost delivery model – quite different from that of the traditional partnership” to take advantage of the changed landscape as a result of the Legal Services Act.
It’s easy to see the interest in those “low risk, high volume”, easily-commoditised areas of law – like personal injury claims, will and probate, and conveyancing. But what’s the appeal of the high value City end of the market?
“The sector has been hugely successful,” says a banker who didn’t want to go on the record. His firm is interested in creating a portfolio of “upwards of five firms” (so as not to be “overexposed” to just one firm). City law is a strong international brand, he argues. “UK lawyers are good lawyers and, more importantly, UK law is good law and not too costly – well, not as costly as the US,” he says. “It’s a growth sector and our firms would like to have access to that long-term earning power.”
His firm is looking at “minority stakes in big firms” with an aim to becoming “a long-term source of capital – quite different to the normal private equity model”. He doesn’t want outside investment to “destabilise firms”.
“We don’t believe in the IPO model where all the old boys get lots of money and the younger chaps coming can’t see what’s in it for them.” Also, he points out that there is no “exit market” for law firm investors. “Who are you going to sell a law firm to? Another law firm?” he asks. “What is in it for the partners? It’s an incredibly complex area.”
“There is big fear of private equity,” comments Tina Williams, senior partner at Fox Williams and a partnership law expert who has been advising firms on ABSs. “Private equity houses aren’t charities and they generally look at a very significant rate of return,” she says. “Often it is the case that bank finance will be cheaper in the long run.” Tina Williams reckons that a downturn in the economy is encouraging firms to consider external investors. “The sort of practices that might be interested in private equity money are those that have decided that they want to jump quite quickly from the being local firms to being global firms,” she adds. But she also sees firms looking at external investment for other reasons, such as a mechanism to “enable partners to retire and take some capital out”.
Taylor Wessing LLP is one of a small number of larger firms to be openly receptive to outside investment. It recently established a five- partner “change group” looking at the LSA. “There are two juggernauts heading towards the profession – one is competition arising from the upcoming LSA and the other one is opportunity,” says managing partner Tim Eyles.
Eyles reports strong interest from a private equity house although only “a very limited number are examining the opportunity for direct investment”. There is also interest in backing outsourcing of non-legal services such as IT or infrastructure. As to the precise nature of opportunities for a firm like Taylor Wessing, Eyles is fairly guarded.
He says that “the visibility is fairly grey at the moment” because of “the nature of the economy and the precise degree of change in the profession”. “I don’t doubt we’re in a revolution in the way that legal services are provided though. I do not think that the profession has fully understood that.”
So if the new structures could be so beneficial, what is the case for bring in ABSs early? Jeremy Hand is impatient for change and calls that third party investment under existing rules should be allowed. A commercial advantage is being lost, he reasons. Non-solicitor businesses like the Co-op are actively building legal services brands and, he argues, “the current restrictive approach puts law firms at a real disadvantage – they simply can’t access capital to grow or restructure”.
David Marshall, chairman of the City of London Law Society, says it is been “surprising” that the SRA hasn’t sorted the rules. Tina Williams notes the anxiety of medium-sized firms looking for ways to fund expansions and understands that they might want to speed things along, “but I just think they are unrealistic,” she says. “The regulation required will be extremely complex. It is going to take a long time to get that right.”
Tim Eyles doesn’t see the need for rushing changes and says that 2011 seems a reasonable timescale. “This, he points out, “is a profession in which changes move very slowly.”