Lawyers have so far mostly taken a cautious approach; alert to the potential but aware of the potential downsides, too.
It has been just over a year since legal reforms paved the way for the licensing of the first so-called “alternative business structures” — allowing external investment to be raised through a stock exchange listing or private equity investment. But so far, law firms have treated the opportunities created with caution.
A recent survey by our company of top 100 law firms found that 77 per cent of those firms polled viewed private equity investment as an inappropriate source of financing for law firms; and 88 per cent said that they considered a stock exchange listing as inappropriate for a law firm.
So why are law firms much less enthusiastic about the prospect of taking on external investment than the investment banks and private equity funds that are now courting the sector?
Bringing in non-lawyers as significant shareholders would be a radical change for most law firms. While the biggest law firms are run as highly efficient and profitable businesses, there is a concern that external shareholders would put lawyers under extra pressure to keep growth and dividends going – no matter what.
Many partners feel that this pressure could put at risk the client-first approach that they treasure, while some may not relish defending their approach or actions to shareholders. Partners may also be wary of opening up their business to the level of public scrutiny that goes with external investment.
It is possible that the sector has been put off by the chequered experience of professional services firms listing on a stock market. Accountancy firms such as Vantis and Numerica, and property consultancies such as DTZ and Colliers CRE, have all had notably tough experiences on the stock market that ended in rescue or insolvency.
There might also be concerns among senior managers at law firms that inviting external investment would disincentivise partners – a law firm’s biggest asset. The risk here is that fee-earners may find the temptation to “cash out” on their shares.
This point has been raised in the past – if a partner has cashed out on their stake in the business by selling their shares, what vested interest do they now have in their firm? Would that partner still be as motivated to work as hard if their stake in the law firm was turned into cash in their bank?
This is not to say that external investment will not work – just that lawyers are aware of the potential downsides. But there are, of course, potential upsides to the changes, too, including the increased scope for investment in IT, management systems and in brand building.
Some private equity investors will offer investee businesses substantial management expertise. This can range from help with strategic planning to hands-on assistance to make operational improvements.
A stock market listing might provide a law firm the currency, in shares, to acquire other legal sector businesses or simply to attract new staff.
For a few, opening up law firms to external investment could also mean better access to finance for small and medium-sized firms looking to grow but who are struggling to get adequate funding.
One of the aims of the Legal Services Act is to create more competition in the legal sector, and some law firms will decide that it is best to take on new equity to help prepare themselves against the new market entrants.
For their part, investors believe that the high margin but fragmented legal sector is an attractive, if uncharted, investment opportunity. Private equity investors are attracted because they think that the management processes and expertise that they could deploy will make law firms even more profitable.
The nervousness around ABS is understandable. Adopting a new untested business structure is a risk for those comfortable or indeed thriving as a limited liability partnership.
It might be that the industry is waiting for the first few firms to take the plunge to see whether or not ABSs can be made to work. Private equity investors, however, will be keen for law firms further to embrace the opportunities that they offer, and it will be intriguing to see whether the concept of “first mover advantage” will apply in this case.
The author is managing director of Thomson Reuters Sweet & Maxwell, the legal information and solutions provider