The magic circle firms could be worth £6.7bn if they went public – equivalent to £3.9m for each partner – the first stockbroker assessment of the viability of law firm listing has estimated.
An analyst note from Peel Hunt LLP said there is “a real economic case” to be made for public market listing – even for the largest firms, “where the limits of the partnership model may be being reached”.
However, the “clear frontrunners” for a stock market listing at the moment are those with external growth plans, mid-tier firms with scale and those with “a volume business [and] no star culture”.
Peel Hunt recognised that there are structural and legal issues that limit the immediate possibility for the large global firms to list, but “this may change in time”.
It came up with its valuation of the five magic circle firms – Clifford Chance, Linklaters, Allen & Overy, Freshfields and Slaughter and May – on the basis of each partner receiving a salary of £250,000 a year, with 50% of the remaining profit paid to partners, with the balance reported as earnings.
While investors may need some persuasion to put money into law firms – because the assets are vulnerable to departure and the “employee compensation/profit trade-off [is] hard to handle” – Andrew Shepherd-Barron of Peel Hunt said there are plenty of successfully listed people businesses from which to draw lessons.
Nonetheless, although there are some strong reasons in favour of a stock market listing, there are “a number of challenges” that will lead many to “wait to watch the experience of the early movers”.
These include “how new partners can be attracted since overall pay must be reduced by the need to pay dividends to outside investors” and the transition from a partnership to an incorporated structure.
Other challenges include the lack of an incentive to “risk change” when partners are well paid, and because there is a danger that share prices will fall, undermining hopes that stock appreciation will make up for earnings sacrificed, the note said.
Attractions of law firms for investors include high-quality earnings and good cash generation. But if firms “are to sustain adequate stock-market ratings”, they will also have to demonstrate such things as recurring earnings from repeat clients, no excessive dependency on a single client, and revenue growth, it continued.
In the long run incorporation may be “inevitable”, the note said. Its narrower management structure and “quicker decision-making” might prove decisive over “increasingly unwieldy” partnerships.
Arguments for flotation include an opportunity for partners to realise better value for their equity. Meanwhile, access to greater capital widens the range of growth possibilities and helps with recruitment of young partners who cannot afford to buy into the firm.
The financial calculation law firms will have to make is whether the sacrifice of cash taken from partners’ incomes to pay dividends will be more than made up by the capital appreciation of the equity linked to growth. “Determining whether partners are better off from a flotation is a complex subject,” said Mr Shepherd-Barron.
The biggest risk of a public flotation is that incorporation would cause partners to alter their behaviour in such a way that their “trusted advisor” status was damaged, the note said. Similarly, a slump in share values could reflect badly on the business. If share values crashed, fee-earners with shareholdings would be “vulnerable to poaching by unlisted competitors”, it continued.
Smaller but significant drawbacks to flotation include a higher profile and potentially harsher treatment by the press. Also, the process of moving to listing can be “uncomfortable” and even risks destabilising the business. “Commercial law firms are typically highly strung organisations,” the note said.
National law firm Irwin Mitchell is considering a listing as one of its options after announcing last month that it is to seek external capital.