ABSs increasingly dominating lawyers’ thoughts but profitability is a concern

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By Legal Futures

26 April 2011


Bull: small majority of firms think ABSs will be good for business

More than three-quarters of law firms have changed their plans to reflect the coming of alternative business structures (ABS), but firms seeking to attract investors will have to develop credible growth strategies, the Legal Futures Conference heard earlier this month.

Neil Kinsella, managing partner of Russell Jones and Walker (RJW), said his firm had already begun to draw up a list of potential law firm acquisitions, in order to build sustainable revenues and profits.

Revealing the results of a survey of lawyers’ attitudes, George Bull, head of tax and professional practices at accountants and business advisers Baker Tilly, found that while firms were moving to adapt to the new structures, many lacked confidence they would deliver benefits.

He said a combination of the global recession, client demand and liberalisation of the legal marketplace would “put a cap on the size of the largest international firms” and place “more stress on the financial models of firms”. Mid-tier firms in particular, while they might see some short-term growth, should be planning for more difficult times ahead, he advised.

A massive 78% of firms in Baker Tilly’s Legal Services Act Index, which has tracked attitudes to ABSs over six months, said they had either changed their plans or expected to do so. But while this was “a pretty good place for those firms to be in”, said Mr Bull, just 59% believed ABSs would have a positive effect on their business to a greater or lesser extent.

An overwhelming majority of larger firms – 91% – expected their business to undergo major change in the next 18 months. Mr Bull pointed out this was significant since many commentators had predicted large commercial firms would be the least affected by ABSs.

In other interesting results, 50% of firms said they had already lost, or would lose,  business to non-lawyer competitors, yet 44% said they didn’t expect to. Some 84% of firms said they already had, or planned to appoint, non-lawyer managers or non-executive members to their management teams. Only a third of firms were considering incorporation, while 56% were interested in external investment.

Mr Kinsella told the same session that RJW’s approach to ABSs was “just one way that we can begin to think about having a fair fight with some of the new entrants; a way of providing quality legal advice within whatever new regulatory environment there is”.

Speaking shortly before Irwin Mitchell announced it was actively seeking external investment, Mr Kinsella warned that there would “winners and losers” and that “ABS is just a means to an end, a way of facilitating capital that is required to get transformative change underway”. Firms that do want to seek outside investment need to consider the return that will attract investors, which means assessing what profits the firm generates after tax and salaries, he advised

RJW’s own search for growth opportunities was being hampered by profitability calculations, he revealed: “We’ve started to try and look at potential acquisitions of other law firms. But very few law firms have significant earnings after they have paid themselves their salaries.”

He added that firms will have to produce “compelling” growth strategies in order to compete in the marketplace after October: “Any credible winner in this new regime needs to have a profit margin, but they need to be able to grow that profit margin moving forward. Most law firms have neither.”

A possible alternative route for law firm tie-ups with private business was proposed by Mark Lovell, co-founder of A4e, the giant public sector contractor, that describes itself as a “social purpose” company and which runs two law centres in Hull and Leicester. He said his business has dealings with some 350,000 people a year, generally those on low incomes and in receipt of state benefits, many of whom have need of legal services.

Mr Lovell said A4e was interested in collaborations with law firms for “front-of-house service” rather than “back-office integration”. He insisted that his starting point was “absolutely not about trying to create A4e as a legal services provider”, but instead about “A4e collaborating in a partnership”.

His aim was to bring together legal services, whether by telephone, online or face to face, “in a coherent manner within a fragmented market”, he said.

He concluded: “For us this is not about an opportunistic move into the market in which ABS brings a potential opportunity for our business; it’s about finding a group of organisations who share a similar vision, who are interested in growing a business and deriving value and a return through growth.”

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One Response to “ABSs increasingly dominating lawyers’ thoughts but profitability is a concern”

  1. This topic is likely to continue to galvanize the profession’s attention for some time, as we watch events unfold across the pond.

    There are some quite serious business obstacles yet to be adequately addressed, let alone even comprehended.

    As some have noted, the proceeds of capital infusions by outside investors in large law firms will likely be applied to technology and most particularly knowledge management systems, all with a view of lowering costs to consumers of legal services. The result would be increased commoditization and reduced revenues per lawyer. Thus, the consequence of such investments may well be that unless one creates a Goldman Sachs-type leverage ratio (10,000 to 1?), an extremely unlikely result for any law firm, the investor will simply not get the anticipated return.

    The practices which yield the highest return still remain in the plaintiffs’ class action bar and in big stakes high end plaintiffs’ contingency cases. Massive class actions and other high end cases chew up enormous amounts of capital. Law firms which have been active in this world have already amassed substantial capital and have the internal resources to fund these cases. Some still utilize traditional institutional lending from banks at favorable rates. Others utilize litigation funding companies which do tend to charge exorbitant interest rates; but, then again, these funding companies accept all of the risk in making non-recourse loans and at the end of the day, they do not remain partners of the law firm.

    Others have noted that outside investors in a firms would exert some degree of control within a law firm and the danger he highlights is that such investors will impair the independence of the lawyers’ judgments in directing that efficiency, rather than the clients’ best interests will be a driver in handling a client engagement, all in violation of Rule 1.1 of the Model Rules of Professional Conduct.

    But an added impediment is the preservation of client secrets and confidences. Non lawyer investor participation in law firm management necessarily makes non-lawyers privy to such secrets and confidences, with no mechanism to police the maintenance of such confidentiality by these non-lawyers.

    As American baseball legend Yogi Berra said, predictions are hard, particularly about the future, my own humble prediction is that these models won’t work for traditional Big Law. That’s what I said six months ago at http://kowalskiandassociatesblog.com/2010/10/05/will-permitting-equity-investments-in-law-firms-by-non-lawyers-or-allowing-law-firms-to-go-public-have-a-significant-impact-on-corporate-law-firms/ and nothing has yet surfaced to dissuade me.

    The ABS or Tesco models just won’t work for Big Law. But, they may very well for mass market, consumer oriented, commoditized practice, built on a franchise type model. Take something like legalzoom.com and open storefronts across the landscape. The margins may be small, but they are also small at MacDonald’s, KFC and so on.

  2. Jerome Kowalski on April 26th, 2011 at 1:50 pm

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