Law firm partnership structures, once considered sacrosanct, are changing. Law.com International editor-in-chief Paul Hodkinson addressed this reality in a recent Law.com International article about failed and problematic IPOs by law firms.
Although these failures could be seen as evidence that law firms should not do what virtually every other type of business does routinely—offer equity to outsiders—these bumpy law firm IPOs merely affirm that, as in any other industry, law firms that decide to go down the IPO path should do their due diligence before proceeding with any deal.
Further, law firms should be sure to examine other options that solve law firm business problems less disruptively than an IPO.
Law firms have been able to issue public equity in the UK since 2011, following the enactment of the Legal Services Act of 2007.
According to the latest reported numbers, six law firms have listed on the London Stock Exchange (LSE) and over 1,300 now operate as an alternative business structure (ABS), allowing for non-lawyer investment in roughly 11% of law firms in the UK.
A change in the ownership model is good for the business of law: Under the traditional partnership model, law firm growth is reliant on investment from equity partners. This can lead to a short-term focus that interferes with long-term growth because those equity partners, who have built their businesses up incrementally over decades, have little incentive to invest in law firm growth given that their equity stake in the firm will be ceded upon retirement.
Access to outside capital provided by stakeholders with permanent equity shifts the dynamic and enables a long-term focus: That capital means law firms can invest more in their businesses, services and attorneys, all for the benefit of clients. These firms can also be more flexible in offering clients alternative billing arrangements that can complement or replace the hourly billing model—something that clients will find increasingly attractive as the economy becomes more uncertain.
In fact, a quarter of GCs in a recent survey said that while their panel law firms did not present cost and risk-sharing options, doing so would have aided their company success—and, presumably, would have reflected very well on the firms.
Recent criticisms around law firm IPOs have centered around arguably poorly executed acquisitions by publicly listed law firm players. These deals have subsequently led to financial difficulties for the firms. For example, UK listed law firm Ince was forced to sell off its acquisition of a corporate advisory operation Arden Partners , and in Australia there was much press around listed plaintiff firm Slater & Gordon’s near collapse following the firm’s attempted expansion into the UK.
But a bad acquisition is still a bad acquisition—whether the business is public or private, a law firm or any other type of business. Indeed, there may be many more law firm M&A deals that go bad privately but are not subject to the same disclosure requirements as a publicly listed entity. The fact that bad deals perform poorly in no way changes the core advantages of being publicly listed.
Nevertheless, while outside equity investment offers significant advantages for some, IPOs don’t make sense for all law firms. To cite an obvious factor, many firms may not wish to take on the increased public, shareholder and regulatory scrutiny that listing necessarily entails.
Fortunately, IPOs aren’t the only way for firms to gain access to outside capital. Pursuing private equity investment through an ABS offers the flexibility of capital law firms seek to invest in growth and expanded offerings, without opening themselves up to capital market fluctuations or greater public scrutiny of firm operations.
Legal finance companies, which are becoming increasingly prominent as finance experts for the legal sector, are natural partners for law firms that embrace the ABS model. In equity financing arrangements, the legal finance provider takes a minority position in the ABS. The immediate cash injection allows firms to make long-term investments without sacrificing post-tax partner capital. For example, capital can be used to make key hires, invest in efficiency enhancing technology and facilitate growth into new sectors and jurisdictions. The legal finance provider acts as a passive investor and does not exert influence on the firm’s decision making.
The advantages to firms are clear. As the founding partner of a boutique law firm recently explained at the International Legal Finance Association (ILFA) annual conference: “Outside investment in terms of growing a firm and in helping you to deliver upon your vision and strategy at times will be really important. For example, if I want to make some star lateral hires it will enable me to do that sooner... rather than having to wait a number of years. If I want to make a particular investment in technology, again which is really important for a modern law firm, access to capital will be important.”
Burford Capital was the first legal finance provider to take a minority ownership stake in a law firm with its investment in boutique UK law firm PCB Litigation in July 2020.
The soaring popularity of ABS structures in the U.K. is testament to the demand for law firm equity solutions. This is all the more relevant considering the current economic outlook, where traditional capital sources, such as lines of credit, are more costly and difficult to obtain. It is likely that in the coming months and years, we will see increasing interest in law firm equity investments as a way for law firms to innovate, grow and better serve clients.
Ultimately, it seems needlessly shortsighted that law firms continue to rely on the outdated, cash-based partnership model. Equity investments, while not a panacea, represent a pivotal change for the better.
This article was originally published on Law.com and can be found here.
Reprinted with permission from the December 07, 2022 issue of Law.com. © 2022 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.