LSB: mid-tier City firms could be main targets of external investment

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By Legal Futures

15 August 2011


City: firms with high growth strategies could be prime candidates for private equity

Mid-tier City law firms may have the greatest incentive to go to the public markets to fund their merger and acquisition activities, the Legal Services Board (LSB) has suggested.

But there is a risk of an “investment bubble” where external investment in alternative business structures (ABSs) proves only temporary for short-term gain.

In a report on its latest thinking about ABSs – drawn from a range of sources, including Legal Futures – the LSB identified four main factors that will affect the take-up rates of ABS: access to capital, the regulatory environment (and particularly the cost of regulation), behaviour of consumers and behaviour of firms.

The report said the largest firms have “greater luxury” of financing expansion through raising capital on external markets or using their own cash reserves, meaning it is likely that mid-tier firms – which it defined as those with a turnover of £100-200m – will be “among the early adopters”.

It continued: “Firms which are ‘highly cash generative’ but with room for expansion, for example mid-tier City law firms with high growth strategies, could be prime candidates for attracting capital from private equity houses.

“The scope for finding efficiencies could be an important reason for attracting private equity, with its access to management consultants and expertise in restructuring corporations in view of delivering greater synergies and focusing on finance bottom lines.”

The report acknowledged the risk that investors would buy shares in an ABS for short-term speculative gain only. “This risk is, however, partially mitigated by regulation of external ownership and the long-term positive benefits of external capital in law firms. This risk, nonetheless, does exist as it is also present in many liberalised markets open to outside sources of investment.”

The report – a baseline study which aims provides a picture of the legal market against which the introduction of ABSs can be judged in the future – also reflected concerns that if ABSs cause smaller law firms to shut, this could have a disproportionate impact on black and minority ethnic (BME) lawyers, who are more likely to work in such firms than larger ones.

However, it said BME consumers are likely to benefit from the more diverse ways of providing legal services, and from competition bringing down costs.

It noted that the introduction of ABS-style structures in Australia actually led to an increase in the number of law firms, and if repeated here this “could increase the number of employment and training opportunities”.

The first evaluation of ABSs post-implementation will be undertaken in spring 2012 as part of the first triennial assessment of the impact of the Legal Services Act, while there will be a full impact assessment of ABSs in 2014.

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