I have blogged previously on the difficulties of valuing law
firms. The process tends to be complex
because the net profit reported by most firms does not take into account an
accurate representation of the remuneration costs associated with running the
firm. Many firms do not pay partners a salary
at all, or pay only a relatively modest salary which would not be sufficient to
retain that partner absent his share of the profit distribution at the end of
the year. However, most firms tend to
distribute all or most of their profits to the partners annually, so the
overall work-related income received by each partner is far higher than any
notional salary element.
The critical question to answer in trying to value a law
firm, therefore, is how much remuneration it is prudent to assume partners would
need to be paid in order to keep them working for a law firm business and
properly motivated – ie what percentage of the overall salary and profit
distribution should be properly classified as remuneration, and what percentage
as equity participation? Only by stripping out the realistic
remuneration element can one arrive at a true net profit figure to which a
valuation multiple (which may be in double figures) could be applied. This is an issue currently exercising the
minds of potential investors in law firm businesses following the market
liberalisation enabled by the Legal Services Act.
Europa Partners have recently published a report in which
they have grasped the nettle and sought to infer a valuation of the UK’s
biggest law firms. In compiling the
report, they have assumed that a realistic compensation would be 56% of the
firm’s revenues, based on data from comparable professional services
businesses. If they are right in this
assumption, then the outcome is that law firms in the UK are big business
indeed – in fact, the valuations would show that 6 UK law firms would make it
in to the FTSE 100 if they were listed entities.
The Europa calculations place Allen & Overy in the number
one spot, with an estimated valuation of £2.6 billion, closely followed by
Freshfields at £2.5 billion and Linklaters at £2.3 billion.
Slaughter & May, on this basis, comes in
at a valuation of just under £1 billion – a reflection of its considerably smaller
size, but once the figures are looked at on a value per equity partner basis
then Slaughter & May shoot up to the number one spot, at just over £8
million of value per partner, some £500,000 per head ahead of Linklaters.
A full copy of the report can be found here:
For the purposes of their valuations, Europa have assumed a
valuation range of 12-15 times net profit.
This may seem high given the usual range of 7-11 times for other
professional services firms which have annuity-type income (such as trust
companies), but at the top end of the law firm market it is a recognition of
the sheer scale and power of the brands of the big firms. However, once outside the top 20 or so law
firms, it is difficult to see that multiples of this size could be sustained.
There is no doubt that over the next few months some of the theory of law firm valuation will be put to the test as private equity investment in the area steps up. Watch this space.
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