Alternative business structure, ABS. It is hardly a snappy name. It means nothing to the general public. It doesn’t mean much more to the business community. But, for private equity (PE) firms, it’s a chink of light – a way in to a £25bn market.
Whilst ABSs are the headline-grabbing feature of the Legal Service Act 2007, what’s actually happening in the UK legal services market is nothing short of a revolution. There are huge changes in the way consumers and companies buy legal services – buyer power is rising. Suppliers – law firms – are being forced to adapt: adopting new business, and pricing, models, scrutinising cost bases and processes.
PE firms are circling: for example, Duke Street Capital in Parabis, owner of two leading personal injury law firms, subject to approval from the Solicitors Regulation Authority (SRA). But PE investment in the market isn’t limited to ABS – witness Palamon Capital’s undisclosed .
So, is this a gold rush? Are we likely to see high levels of PE activity?
First things first – is the market fundamentally attractive for PE? The UK legal service market is large – £25bn – and private practice firms have grown throughout the recession. As the balance of power in the market shifts from supplier to buyer, the potential for disruption and for new operating models increases.
Barriers to entry are high, even in an ABS world – you can’t just turn up and offer legal services. And revenue streams are relatively sticky particularly in the B2B legal sector – big corporate spend on legal services doesn’t vary that much year-upon-year and they don’t, broadly speaking, switch legal suppliers often.
So, if the market fundamentals are sound, what’s the PE play? Private equity firms run companies aggressively, with a clear focus on growth and cost control. Critically, they look to invest where there’s ample opportunity to re-engineer existing processes, bring more rigour and drive out inefficiency. The UK legal market is, therefore, a perfect sandpit. There’s even ample opportunity for classic PE strategies:
- Slater & Gordon in Australia (a listed law firm which is now authorised in the UK as an ABS) has demonstrated since 2007 that a ‘buy and build’ strategy works well. It has acquired more than 25 insurance claim/personal injury firms in Australia over the past five years, harmonising their operating models and driving efficiency through strict process management, delivering organic revenue growth of 10% in the process. In March 2012, Slater & Gordon bought its first UK firm – Russell Jones & Walker and in April was approved as an ABS.By way of parallel, over the past few years, PE firms have bought up significant numbers of insurance brokers, rolling them up into large groups with significant buying power and demanding higher commissions from insurers. It’s conceivable (Jackson reforms permitting) that a similar strategy could work in the UK personal injury market – as personal injury law firm groups get bigger, they could exert power by paying lower fees to the claims management companies which refer business their way.
- Vertical integration plays are also becoming clear:
- Quindell Portfolio, a listed outsourcing player, is building an end-to-end motor claims outsourcing proposition for insurance companies including legal services, by , a Liverpool based law firm. The ABS approval is currently pending but already Quindell has secured a new £120m three-year contract with a major insurance intermediary to provide a range of services (including legal) to the insured parties, thereby validating the strategy.
- Similarly, in the personal injury market Parabis, backed by Duke Street Capital, owns claims management companies, loss adjusters and both a defendant and claimant law firm (Plexus and Cogent).
- In-Deed, launched in 2011 by Harry Hill (founder of Rightmove and former CEO of Countrywide) and Peter Gordon (former partner of 3i), provides residential conveyancing services to consumers. It had always seemed logical that there would be a referral fee chain back to Rightmove and Countrywide. In-Deed’s recent acquisition of Runnett & Co (a conveyancing firm with a large estate agent referral network) appears to corroborate this.
So, if the market fundamentals are strong and there are opportunities for PE firms to invest, are we likely to see a rush of PE money?
I expect heavy investment in certain consumer-facing sub-segments – personal injury, residential conveyancing, and wills and probate. Together, these amount to 20-30% of the UK legal services market and critically, they are high volume, generally low complexity work for consumers – meaning that driving operational efficiency is important.
But, by contrast, I can’t see money rushing to the corporate or commercial segments. The top 100 UK law firms claimed over 70% of all UK legal market revenues in 2009. Legal work here is more complex, clients’ demands are higher and so it’s harder to re-engineer work process.
And there’s another critical factor at play – exit routes. The very nature of the PE firm business model means they need to see an exit route from the start, typically within three to five years. It is part of their business model. Secondary sales to another PE firm, trade sales to other law firms and management buy-outs are all conceptually possible, but I don’t see any of them being an attractive proposition for a large group of law firm partners, which leaves a public listing.
That’s certainly possible – lawyers envy the earning potential of bankers and many a partner would love to emulate Goldman Sachs’ partners’ windfalls of 1999. But with a UK legal market in flux and a profit pool that is probably shrinking over the coming few years, it will take great salesmanship from an investment bank to build a book for a law firm IPO in the coming years.
So, for this observer, no gold rush. Ultimately there are better and easier places for PE to play. I’m sure there will be some interesting deals along the way, but I think it’ll be a long time before the big UK law firms succumb to the lure of the PE dollar.