July’s MTT meeting, hosted by Lewis Silkin, was a presentation on external investment in the legal sector by John Llewellyn-Lloyd, director and head of professional services at Arden Partners, a specialist investment bank that advises professional services firms on fundraising and mergers and acquisitions (M&A). Llewellyn-Lloyd has advised law firms on alternative business structures (ABSs) and initial public offerings (IPOs).
Llewellyn-Lloyd observed that law firms have, by and large, retained the partnership model. But times are changing, and more firms are raising external capital. Gateley listed on Aim in 2015 at a value of £100m, raising £30m. This was followed in 2017 by Gordon Dadds and Keystone Law, and in 2018 by Rosenblatt Solicitors and Knights Law. 2019 saw the first international IPO in the legal sector, when DWF listed on the London Stock Exchange at a value of £366m, raising £95m or 26% of DWF’s issued share capital.
Four key themes for external investment
Llewellyn-Lloyd identified four major investment trends and opportunities:
Consolidation: The market remains fragmented, so there are clear opportunities for good management teams with external funding. All the quoted models are disruptors and consolidators. It is all about getting bigger quicker using external capital. The quoted models are showing enormous growth, which reflects market confidence.
Multidisciplinary partnerships are serious market players. Nearly all the major consultancies and accountancy firms are following the Big Four by building or acquiring a legal services business.
Under the new SRA rules, insurers will be able to establish legal subsidiaries to deal with volume legal services and defendant relationships. This is likely to impact the insurance supply chain. Conversely, DWF acquired Triton which provides loss adjusting, insurance broking and legal services to insurance companies, and is one of the firm’s fastest growing divisions.
Consumer firms debut in public markets: Until recently, regulatory reform restricted public market entrance. Now, market liberalisation and clarity around the rules and regulations has made IPO a more attractive option for volume legal firms. Private equity ownership is driving major consolidation in the conveyancing market, and the personal injury (PI) sector is likely to follow.
Consumer-facing legal services depend on technology to achieve scale, which is problematic under the traditional partnership structure. It is likely that the consumer sector will move to an ‘Amazon law’ model because consumers are looking for apps and other online access in the same way as they want online access to medical advice. How many management boards understand the technology that can be applied to volume legal services, which is what consumers want, but also provides a different level of customer data access? Cost is another key factor and in the consumer market capital is a major consolidating tool.
Litigation as an asset class: Public investors have woken up to the opportunities offered by litigation funding, which has a track record of success and high levels of return on investment (ROI), which is proven with a quality dataset. The litigation funding market is opening up beyond private equity investors, and retail and other funds are getting involved.
Regulators and external entrants: Regulators are looking at scale – which offers more competition and more scope – because it is easier to regulate fewer bigger businesses and they recognise that external ownership is a catalyst to change and consolidation. External entrants are a game changer and EY’s acquisition of Riverview Law is a market indicator. Alternative legal services businesses (ALSBs) including Axiom Law, and the Big Four are delivering a deconstructed legal model as part of their high-end advisory services and competing directly with law firms.
External capital as competitive advantage
External capital is the new competitive tool – Gordon Dadds could not have acquired Ince if it hadn’t been able to raise external capital. And law firms with external ownership need professional managers who survive or fall according to how the business performs, not how much PEP they can get to the partners.
Nearly £1bn of equity has been raised in the London markets by the legal services sectors. That competitive tool will be applied against the rest of the market. Llewellyn-Lloyd reckons that that could double in the next couple of years.
Llewellyn-Lloyd pointed out that all the legal IPOs have been successful achieving significant gains in share price and value year on year. It is unusual to see this in any single sector and it explains the enthusiasm among investors.
Technology drives hybrid legal solutions
A broader diversification of the legal model is also driving a shift towards hybrid legal solutions. Llewellyn-Lloyd presented Allen & Overy’s technology-centric business model that uses business processes to provide legal advice, legal consulting, online services, managed legal services, document review and contract lawyers and pointed out its similarities to ASLBs and listed law firms.
However, A&O has invested in high-calibre management and the latest technology. For most consensual (partnership) firms, tech is a challenge because their key decision-makers do not understand it, so they would need to recruit top technology expertise. Another challenge is convincing equity partners to start on that journey.
Key messages to listed investors
Llewellyn-Lloyd offered guidance on the key messages that external investors are looking for: the qualities they seek in a listed legal entity. In a nutshell, firms need to start becoming more corporate before they consider listing, and this means adopting commercial processes.
Management: investors are looking for clear management strategy and no dissent between groups. They are looking for a track record of value-added corporate decisions.
Profit and commitment: no external investor will invest in a business unless it has a clear track record and buy-in from internal investors. DWF equity partners capitalised 60% of their earnings, so they took a pay cut in order to buy into the IPO.
Culture change: decision-making is no longer consensual as firms become more corporate. Public companies need two executives and three independent non-executives. The concept of a public board is that it is about decision-making rather than operations.
Technology: tech skills, data management (including for regulatory compliance) digital marketing.
Financials: earnings momentum, financial modelling and forecasting. A corporate finance function should be capable of delivering three-year forecasts and two-to-three-year visibility.
Scalability: Consolidation requires expertise in integrating acquisitions. The Big Four have ‘industrialised’ acquisition processes and the ability to cross-sell products worldwide. ALSBs are also focused on agility, which puts pressure on law firms.
Finally, Llewellyn-Lloyd explained in detail the changes in board governance required by adopting a corporate governance structure.
The pace of change
Law firms’ biggest challenge is the pace of change. Listed firms are geared up to cope with change, while mid-market partnerships need to take critical management decisions or risk being left behind. Professional management capabilities and buy-in from external and internal shareholders are key in a market where clients have more choice and firms face more and different competition. Llewellyn-Lloyd predicts massive consolidation in the middle markets due to too many ‘me too’ offerings and the opportunity to make efficiency gains. He believes that any firm with a turnover of below £250m that doesn’t offer niche expertise or serve a particular geographic area is under threat. The presentation was followed by questions from the floor.