Taha: Law firms can do themselves what PE will do
While it is not surprising that private equity (PE) is interested in investing in law firms, the real question is why law firms are giving away stakes in their businesses, a leading consultant has argued.
The motivation for some firms that have sold to PE looked simply like the chance for the equity partners to cash out, said Adil Taha, in the first of a two-part interview.
Mr Taha is a former private equity executive who moved into the law in 2019 – he has helped save two London law firms, first Child & Child and earlier this year Rosenblatt, ahead of the collapse of the listed RBG Group.
He has also launched three firms from scratch and worked at others, such as at gunnercooke, where he was global head of operations, as well as holding the chief operating office role at a top 50 UK Accountancy practice.
In August, he set up a consultancy with Jonathan Watmough, former managing partner of City firm RPC, to advise law firms and private equity on how best to combine.
Mr Taha told Legal Futures that, of the 9,000 or so law firms in England and Wales, only around 350 were big enough to be investable.
While PE could quickly learn the commercial aspect of how they worked, understanding the “emotional, egotistical, insecure and political” nature of law firm partnerships was much more difficult. “So we’re seeing private equity are pitching to a number of firms and hoping that one of them says yes.”
When it came to law firms, he went on: “We’re asking the question of why do you think you want to have private equity invested in your business? And apart from the classic ‘to help us grow’, which isn’t really an answer, there’s not a lot of thoughtful answers coming back, which makes me think that this may be fueled by a capital event for partners in firms that are stationary, with some going backwards.
“Potentially there’s a firm that’s struggling to move forward and, if there’s an opportunity to take a huge amount of cash off the table and maybe share that challenge with an outside investor, then why would they not do it?
“These are people businesses being run by people, so I expect some partnerships to look after themselves at the end of the day.”
But there were other options for law firms that were not struggling in that way, with banks “quite willing to give revolving credit facilities or even M&A facilities to allow you to grow, as long as you’ve got a good business”.
Mr Taha added: “Once you give a portion of your business to PE, it’s very, very rare that you’re going to get that back. You’re going to have to continually flip that to new investors, which can be an issue as well, as somebody at some point is going be left holding the bag, and then what?.”
PE investors seem to have moved on to the law having taken what they could from the accountancy sector, but he said law firms were different.
“With accountants, you are basically acquiring a client book and recurring revenue, and the people come with it. Whereas with law, it’s the opposite way around: you’re actually acquiring the people, and you cross your fingers and hope that they’ll stick around and continue to generate client fees.”
He explained that PE’s interest in the legal sector was sparked by Covid, when law firms in general thrived when many other sectors faltered badly.
“What PE saw was that a law firm in their portfolio was a huge hedge against any macroeconomic events. And if they can scale that asset in the meantime, then they’ll make more money off it.
“They’re also taking advantage of the fact that law firms are massively underinvested. Equity partners have taken every pound out – many decent-sized regional firms are held together by Microsoft Excel still, with a real lack of data and transparency of their numbers, as the investment in the operating model has not been there.
“Now many firms are rushing to make technology-based decisions and likely to be overpaying for the wrong products.”
This meant that, through providing working capital, it was relatively easy to find efficiency gains. “If a private equity firm can go in and help them with pricing, improve their efficiencies by 5-20%, can get rid of some staff costs or some operational costs that are no longer needed due to the technology that’s about, and then help reduce their lock-up, then they will make money.
“But can PE do this, or more accurately, will equity partners let them?”
Thus the question was not why PE was investing in law, “because I think that’s quite obvious”, but “why are law firms even entertaining the idea?”
Mr Taha said: “Apart from the fact that the equity partners get a nice capital event and get to take a bit of money off the table, everything else private equity bring a law firm can bring to itself.
“But that would take re-investment, taking a hit now to aim for long-term growth and equity partners to be honest with themselves when looking at their business, their people, performance and what is needed. It won’t happen in many cases.”
They would be better off investing in a chief operating or strategy officer from an investment background to steer them through debt-funded acquisitions if growing via M&A is their goal.
“You don’t have to give away a large portion of their business to do that. If you want to build something and then flip it to private equity down the line, you’re going to get a lot more money for it. I think what’s really driving this is it’s the capital event.”
Mr Taha said a database he and Mr Watmough had built showed that regional firms have declining profit margins, increasing salary bills and longer lock-up periods. With equity partner drawings being squeezed, when you account for inflation, “their wealth is declining”.
He acknowledged investment could help with succession “because it allows you to grease the pipes to basically move the sludge on, so to speak, something needed in many regional firms”.
To do that internally without an external investor “requires a certain type of performance culture which allows that to happen organically”. And that in turn requires strong leadership, “which I think most law firms are hugely lacking at the moment”.
Indeed, it was arguably the harder choice for a law firm “to take a step back, look at your strategy, restructure the business, bring in some fresh blood at the senior leadership level who aren’t lawyers and do it the old-fashioned way”.
In the second part of the interview, published tomorrow, Mr Taha explains how a change in the type of investor will attract top law firms that have hitherto shunned external capital.
We will be discussing private equity investment and other forms of growth strategy at the Law Firm Growth Summit [1] on 18 March in London. Early bird tickets are now available.