What would you do with £50m?
The first of a series of extracts from Climate Change, a report on the impact of the Legal Services Act published by accountants Baker Tilly, considers what kinds of law firms and investors will be interested in taking advantage of alternative business structures
Cash injection: it may be mid-tier firms that look to fund their M&A activity through external capital
There is a growing imperative for change. The Baker Tilly survey (see story) found that around half of law firms had either lostt business to a non-lawyer competitor or expected to. So what kinds of law firms and investors will be interested in taking advantage of ABSs?
Matthew Gwynne of private bank Investec reckons that the biggest beasts in the City will not be rushing forwards.
“Magic circle firms have strong brands and strong balance sheets, and therefore may not currently require additional capital or innovative funding structures to grow,” he says. “This could explain why the movements we have seen are generally in the tier just below the magic circle and in firms which are progressive in their thinking and possibly more aggressive in their goals.
“If you look at the mid-tier, you’re talking about firms that turn over maybe £100 million to £200 million. In the UK they would be considered big law firms, but in the grand scheme of things they’re not very large companies. Even the magic circle firms are relatively small in comparison to an equivalent firm in the accountancy sector. We believe that the growth potential is there, but it may well be that only a few firms are able to capitalise.”
One problem is that some of the firms which will think ABSs are a good idea are probably the firms which realise they are struggling and see them as a last resort. This would be the worst of all worlds. Richard Meddelton, relationship director at Santander Corporate Banking, says: “The legal sector is extremely conservative and you couldn’t really afford for there to be one or two early failures resulting from the Legal Services Act. But there will be successes. What’s important is that the winners are picked early and backed, because I don’t think the market at this time can afford too many failures.”
Martin Prentice, a relationship director at Lloyds TSB Corporate Markets, predicts a ‘wait and see’ approach. “We’ve had conversations with a number of top-tier firms and the next tier down, and I think it would be fair to say that whilst there has quite rightly been a lot of talk and discussion, in terms of converting that into a more tangible forward plan, it’s tended to be more on tomorrow’s agenda than today’s.”
In fact, says Leslie Perrin, former senior partner of national law firm Osborne Clarke and now chairman of third-party litigation funder Calunius Capital, the partners at magic circle firms would probably not know what to do with £50 million to spend, “other than a one-time liquidity event for the current generation of partners, which would effectively be at the expense of future generations of partners”.
Mid-tier firms first
Rob Donaldson, head of the private equity team at Baker Tilly, draws an analogy with what happened with a ccountancy firms: “The big firms stayed relatively aloof from takingoutside capital, the smaller firms were
too small to attract the interest of outside investors, and it is the middle tier who have either gone on the public markets or found other ways to fund their M&A activities. I think you’ll have the mid-tier law firms taking advantage of the changes first.”
Matthew Gwynne’s colleague at Investec, Jonathan Harvey, also believes that “there are a lot of people waiting for someone else to make the first move”. He sees the real threat to the industry as coming from new entrants that will start a business afresh, inject capital into it, and run it in a way that is very different to the traditional law firm model. This would, however, be a “longer-term play”, he recognises.
“Law firms have historically been highly profitable, so there is a definite appeal for new entrants. It may even prove to be a more palatable option than the cultural challenges involved in investing in an existing law firm. It can be very challenging on both the private equity and law firm side to merge two different cultures together and achieve the desired growth and increased profitability from the capital injection.”
Kevin Pearson, also a relationship director at Lloyds, believes that such a start-up is more likely at the consumer end of the market. “I think that would have to be very much a commodity-related product, such as personal injury, where face-to-face contact with a lawyer is not the most important thing. That sort of business could be formed if the consumer could see that it provided them with a good service and was good value for money. But it would have to be in a relatively narrow part of the market rather than being an all-service firm.”
But Richard Meddelton is not convinced of the viability of a start-up, at least in the short term: “It’s very easy to say that law firms aren’t efficient. The model has worked for several centuries – albeit in a privileged state, yes – but the expertise is nevertheless there. I think law firms will provide steady, rather than spectacular, growth for an investor. For a private equity house this may well prove to be a challenge.”
Tony Pierre, head of Baker Tilly’s London corporate finance team, says he could easily see a supermarket setting up a legal services section in each of its stores to deal with accident claims, wills and so on. “I think they would probably want a platform to build on. They would identify a law firm that was providing commodity-type services and build on that. Private equity doesn’t really go into start-up type situations. They like to go into a business that is already established and can be taken to the next level – and quickly.”
For more on Baker Tilly’s Legal Services Act Index and to download the full report, click here.
Tags: ABS, Alternative business structures, commoditisation, external investment, Legal Services Act
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