Law firms have typically evolved at a glacial speed, but new equity structures allow for greater levels of innovation and better client service.
The legal profession has been criticized by some for lagging behind the world of modern commercial business. Traditional law firm partnership structures generally encourage and result in the annual distribution to partners of firm profits, as distinct from the corporate structure found in other industries that encourages retained earnings and reinvestment of a portion of profits annually back into the business. However, against the background of a contracting UK economy,1 the traditional law firm model faces increasing scrutiny from cost-sensitive clients looking for greater levels of innovation from their outside counsel.
Law firms have been able to issue public equity in the UK since 2011, following the enactment of the Legal Services Act of 2007, which allows law firms to take advantage of new ownership structures by applying to the Solicitors Regulation Authority (SRA) for an alternative business structure (ABS) license. Some law firms have gone one step further than this by listing on the London Stock Exchange (LSE). Access to outside capital provides an opportunity for law firms to invest more in their people and their business to the benefit of clients. These firms can be more flexible in offering clients alternative billing arrangements that can complement or replace the hourly billing model.
As of 2022, only six UK law firms have successfully completed an IPO but nearly 1,300 law firms now operate as an ABS, allowing for non-lawyer investment2 in roughly 11% of law firms in the UK. In 2019, AmLaw 50 law firm Reed Smith made history as the first international law firm to convert its UK operation to an ABS.3
As explored below, adopting an ABS structure presents advantages compared to either maintaining the status quo or pursuing an IPO—and firms that choose an ABS approach can gain a competitive edge by utilizing outside finance from Burford.
The limits of the traditional law firm partnership model
Despite inherent flaws and inefficiencies, the law firm partnership model is still prevalent.
Equity partners who have built their businesses up incrementally over decades have little incentive to invest in long-term growth if their equity stake in the firm is ceded upon retirement. There are exceptions: Some law firms have developed solutions for retired partner profit-sharing, but in the main partners will retire without future profit share accruing to them.
More generally, a near-term focus can interfere with long-term growth and doesn’t necessarily serve clients well—and companies are demanding more from their legal spend than ever before. With just under 12,000 law firms operating in the UK4, competition is stiff and there is growing pressure on law firms to address growing client demands for alternative fee structures.
There are inherent challenges to listing on public markets
While outside equity investment offers a great opportunity for law firms to expand their client offerings, IPOs don’t make sense for most law firms. Although companies that IPO do so to raise funds for expansion, the benefits of going public often do not outweigh the costs for law firms.
Among the challenges faced by a law firm listing on a public exchange, law firms open themselves up to capital market fluctuations and greater public scrutiny of firm operations. Moreover, the path to floating on a stock exchange can be turbulent—witness the recent postponement of the IPO of Silver Circle law firm Mishcon de Reya in the wake of volatile capital markets in 2021 and 2022.5
Pursuing a private equity investment through an ABS offers the flexibility of capital law firms seek to invest in growth and expanded offerings without the challenges of pursuing an IPO or of operating as a publicly traded entity. In equity financing arrangements, the legal finance provider takes a minority position and generally does not exert influence on the firm’s decision making. The immediate cash injection allows firms to make long-term investments without sacrificing post-tax partner capital. For example, Burford’s capital has been used to make key hires, invest in efficiency enhancing technology and facilitate growth into new sectors and jurisdictions.
In a recent interview with Burford’s Co-COO Aviva Will, Pallas Partners founder and managing partner Natasha Harrison expressed why she launched her firm as an ABS: “It enables me, to the extent I need it, to attract outside investment because there may be times when we are accelerating our growth or there may be times when we want to hedge some of our risk by attracting that investment.”6
Backing from a professional legal finance provider via an equity investment provides law firms greater capital flexibility than an IPO without the public scrutiny. For example, in July 2020 Burford took a minority ownership stake in a boutique UK law firm, PCB Litigation, providing outside equity that enabled the firm to target a new market for its services and incorporate innovative fee structures to better meet its clients' needs. The deal made Burford the first legal financier to provide capital in exchange for law firm equity.7
This first for the industry continues Burford’s long tradition of innovative legal finance structures that address law firm challenges in novel ways. It is also indicative of the growing professionalization and expansion of legal finance to encompass not just fees and expenses financing but also monetizations, portfolio-based capital facilities and other corporate finance structures that increasingly resemble investment banking for law.
Highlight on Australia
In Australia, non-lawyers have long been able to hold interests in law firms. Plaintiff firm Slater & Gordon was the first law firm to publicly list on the Australian Securities Exchange (ASX) in 2007.8 Many hold the visible challenges of this well-publicized listing as a cautionary tale for law firms considering an IPO, following the firm’s near collapse and subsequent recapitalization via a scheme of arrangement after the firm’s expansion into the UK. While the firm is now stable, the experience in Australia demonstrates that the public listing of a law firm brings with it significant public, shareholder and regulatory scrutiny, risks and costs, which have in some cases led to those firms being subject to the same types of class actions that they are more accustomed to prosecuting.
Generally, Australian law firms attempting public listings have met mixed results. Most recently, HWL Ebsworth’s attempts to float in 2020 fell over deep into the process, reportedly due to a lack of interest from fund managers.9 The main concerns cited were how profits would be split between partners and shareholders and how the top fee earning lawyers would be kept at the firm. This led to increased scrutiny in the region over law firm listings.
The recent election of the new federal Labor government in Australia has already led to some commentary on whether any potential package of reforms relating to class actions might permit law firms to charge damages-based contingency fees. Currently law firms are only able to charge a limited uplift fee in no win, no fee cases. The notable exception to that rule is in the Supreme Court of Victoria, where since 2020 law firms have been allowed to seek Group Cost Orders that allow law firms to charge damages-based contingency fees.10 If federal law is reformed to permit law firms to charge similar damages-based contingency fees, we can expect to see an increase in law firms looking to raise additional capital to take on the risks associated with increased contingency fee work.
The Australian Law Reform Commission Report previously made a recommendation that invited reforms to bring such contingency fees for law firms into existence so long as certain regulations are put in place to prevent potential conflicts of interest and protect the rights of clients and group members in class actions.11 If law firms are going to take advantage of any potential contingency fee laws, they may be better served by looking to professional legal finance firms for equity investments rather than trying to run the gauntlet of a more fraught public listing. The additional benefit of this approach is that the legal finance investors bring with them a deep knowledge of the business of law firms that shareholders in a public company often lack.
Law firms need new equity solutions to expand their client offerings
It seems clear that in the years ahead law firms are going to require much deeper pools of capital than they can currently access through traditional means. Big global service providers (most notably the “big four” accounting firms) and technology companies are entering the legal market and investing heavily in new services—and not even the world’s best capitalized law firms have the war chests needed to compete with them.
Like all participants in competitive industries, law firms will need to evolve to remain top of class. Clients will demand it, and in the face of a possible downturn and with new tools and models available, innovation will be essential to thrive. An ABS provides a platform for innovation, and legal finance companies can work with firms that move to an ABS structure to provide the means to invest in long term growth and meet client demands for innovation.
About the authors
Matt Lee is a Principal at Burford with responsibility for leading its investment activity and operations in Australia and focused on working with companies, funds, investors and law firms engaged in complex commercial litigation and arbitration in Australia and abroad.
Mick Smith is a Principal with responsibility for leading Burford’s investment activity and operations in Europe, focusing on companies, funds, investors and law firms engaged in commercial litigation and arbitration.
1 Elliot Smith, “U.K. economy contracts in the second quarter as cost-of-living crisis bites,” CNBC, August 12, 2022, https://www.cnbc.com/2022/08/12/uk-gdp-q2-2022-.html.
2 UK Legal Services Market Trends Report 2019, February 2019, https://www.researchandmarkets.com/research/pcpfrc/uk_legal_services?w=4.
3 “Reed Smith becomes first international law firm to gain ABS license”, Reed Smith, November 4, 2019, https://www.reedsmith.com/en/news/2019/11/reed-smith-becomes-first-international-law-firm-to-gain-abs-license.
4 “United Kingdom Legal Services Market Report 2021: Revenue on Hold in 2020 but Annual Growth of Over 4% Forecast for 2021”, ResearchAndMarkets.com, April 29, 2021, https://www.businesswire.com/news/home/20210429005544/en/United-Kingdom-Legal-Services-Market-Report-2021-Revenue-on-Hold-in-2020-but-Annual-Growth-of-Over-4-Forecast-for-2021
5 “Mishcon de Reya: City law firm’s IPO roadshow gets off to a bumpy start”, Financial Times, January 12, 2022, https://www.ft.com/content/89458568-afca-49b6-b27e-e9bab222bd78.
6 “Launching a law firm ‘from scratch’: Natasha Harrison speaks with Aviva Will,” Burford Quarterly no. 3 (2022), https://www.burfordcapital.com/burford-quarterly/2022-issue-3/natasha-harrison-on-launching-a-law-firm/.
7 Burford Capital, Burford Capital And PCB Litigation announce innovative portfolio financing and equity transaction, June 24, 2020, https://www.burfordcapital.com/media-room/media-room-container/burford-capital-and-pcb-litigation-announcement/.
8 Richard Ackland, “Stock market crash: How Slater and Gordon became a casualty of the neoliberal dream”, The Guardian, August 10, 2017, https://www.theguardian.com/commentisfree/2017/aug/10/stockmarket-crash-how-slater-and-gordon-became-a-casualty-of-the-neoliberal-dream.
9 Christopher Niesche, “Australia’s HWL Ebsworth Cancels Proposed Initial Public Offering”, Law.com, November 27, 2020, https://www.law.com/international-edition/2020/11/27/australias-hwl-ebsworth-cancels-proposed-initial-public-offering/.
10 Matt Lee, “A deeper dive: Contingency fees coming to Victoria, Australia”, Burford Capital (blog), June 23 2020, https://www.burfordcapital.com/insights/insights-container/a-deeper-dive-contingency-fees-coming-to-victoria-australia/.
11 Craig Arnott and Matt Lee, “5 minutes on... What the ALRC report means for contingency fees in Australia”, Burford Capital (blog), July 4, 2019, https://www.burfordcapital.com/insights/insights-container/5-minutes-on-what-the-alrc-report-means-for-contingency-fees-in-australia/.