The legal market has “enormous scope for consolidation and this is as opportune a moment as there will be to invest” in it, a new report has claimed.
Espirito Santo Investment Bank – which is advising Irwin Mitchell among others on their options for seeking external capital – said 2012 will see the “acceleration” of merger activity, warning firms that resisting change will be “a sure recipe for eventual competitive demise”.
“The lower tier is in desperate need of an injection of some sort to reinvigorate it,” the report said. “Alternative business structures (ABSs) are likely to be a positive force at this end, enabling wholesale change. Under an ABS, anyone with a sound strategy and understanding of the sector could consolidate the plethora of conservative partnerships, buying off their clientele and cases for a small fee.
“This could be attractive for partners working in these businesses since it could solve the succession issues and facilitate retirement.”
It added that a private equity investor “starting with the right platform and pursuing a sound buy-and-build strategy would be able to create a sizeable business”, predicting that the majority of small-to-medium-sized law firms lacking the size or capital to pursue an acquisition strategy alone “will be seeking the safety net of a parent company or investor”.
The bank said law firms have three strategic options available to them:
- Compete with rivals and new entrants by expanding on services currently provided, investing in marketing, brand development and critical mass (and also using outsourcing more);
- Protect and develop a niche or specialist area, defending it against generalist providers which offer umbrella services but lack the expertise to deal with individual cases with sufficient skill, and sell off or trim down non-strategic areas; or
- Resist making changes and rely on pre-existing strengths (an option it said is now reserved only to the top firms).
However, the report reckoned that while the top firms may be able to put off changes in the short to medium term, “such an attitude would be unsustainable in the long run”.
It identified two key drivers for the take-up of external financing: “the need for capital to fund expansion and law firms’ doubts about the internal strength of their organisations; and the need to retain human capital and keep pace with labour market forces.”
But the problem of gaining buy-in from the whole partnership, and the expectation of “significant returns on equity holdings” are among the factors holding investors back.
It said business angels expect annual returns of 60-70%, private equity around 30-35%, mezzanine around 20% and public companies 12-20%. “There must be enough profits after paying partners to encourage investor involvement. This is highly unlikely in most of the small to medium-sized law firms.”
The report said the entry of non-legal providers to the market “will change the rules of the game”, but that improved service delivery and marketing should bring down barriers to consumers using solicitors, enabling the retail legal market to expand significantly. “It is not a zero sum game.”
Espirito estimated that the legal market grew 1.6% last year to a turnover of £26.8bn, £19.8bn of which was produced by private practice law firms.