6 of the UKs biggest law firms large enough to be in FTSE 100

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:

http://www.scribd.com/fullscreen/82998116?access_key=key-1nz11tjoclo94dvsy71z

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.

SRA authorises its first 3 ABS structures

After a period of some frustration over delays, the Solicitors Regulation Authority has approved its first alternative business structures (ABSs), enabled by the Legal Services Act.

The big name amongst the first 3 authorisations is Co-operative Legal Services, which for some time has offered legal services which were not specifically reserved for solicitors (such as employment law and wills).  Under their new ABS structure, they will be permitted to add litigation and probate to their service offering, and plan to launch a full range of consumer legal services, including family law, later this year.

The other two authorised businesses are much smaller -  Lawbridge Solicitors (a Kent based family law practice) and John Welch and Stammers (a small Oxfordshire practice) .  In both cases, the primary motivation for the switch seems to be to enable non-lawyers who are heavily involved in the management of the practices to take an equity interest in the businesses.

The SRA continues to process approximately 60 stage two ABS applications, after initial interest from almost 180 organisations.  It is not clear at this stage how many of the remaining expressions of interest will translate into stage 2 applications.

Eversheds Agile - Proof that the dispersed-law-firm model is gaining popularity?

It is interesting to watch the growing success of non-traditional law firms, which have fee earners working on a dispersed basis (either from home or from client offices).  The advantages for lawyers are clear to see – working essentially as freelancer for a firm with an established brand name gives a reputable source of work referral, the back-up resources of a large organization, but with a great deal more flexibility and quality of life that is unattainable in most traditional, centralized firms.  It is to be expected that the model would appeal particularly to women who may be trying to balance a career with motherhood, but actually the attractions of the model from an employee perspective are likely to appeal to a much wider demographic – there can’t be many lawyers who would not be attracted to the opportunity to continue to do high quality work for a top salary, but to avoid a daily commute, punishing billing targets, office politics and limited holiday time? It has long been acknowledged that there is an issue with retaining lawyers in the long term, as they become disillusioned with punishingly-long working days and needless travelling, so it should come as no surprise that they are looking for alternatives which take advantage of technological advances and an enlightened approach to working arrangements.

From the client perspective, the clearest upside is lower cost – achievable because of the very low fixed overhead associated with such business models.  They get essentially the same service (and the same indemnity policy comfort) without having to pay the cost of keeping lawyers housed in expensive City locations, or, if they are taking lawyers on secondment, without the long-term costs associated with making them permanent members of staff.

Many sceptics said that the model would not work well, as lawyers like working best in a community environment with their peers, where they have the opportunity to interact with others face to face.  That is probably true for junior lawyers who are still learning their craft, but many of the dispersed law firms are staffed exclusively with lawyers of 10+ years experience, where this is much less of an issue.  Add to that the increasing ease with which lawyers can communicate freely electronically with a network of like-minded professionals, and there is no need for a lawyer working on a dispersed basis to feel unsupported or isolated.  These sceptics also fall into the error of thinking that how the market will evolve will depend upon what lawyers would like or not like, when in reality it is the demand of clients that will dictate the future shape of legal services – time and time again lawyers look at the issue through the wrong end of the telescope, and this seems to be no exception. 

In any event, the volume of entrants into this market would seem to suggest that the sceptics may have called this one wrong.

Many firms have been successfully developing this way of working for some time - Axiom now has over 300 lawyers on its books, Berwin Leighton Paisner’s Lawyers on Demand initiative seems to have been a success with over 80 lawyers now working for it, and a plethora of other similar businesses having been established.  The numbers may yet be small in the context of the overall legal market, but they are not insignificant and they are growing rapidly.

Eversheds are the latest major firm to confirm their permanent offering in the market.  Since September of last year, Eversheds has been piloting a service under the name “Eversheds Agile” - a pool of lawyers that the firm will second to clients for temporary assignments across Europe, Asia, Africa and the Middle East.  The lawyers work in the clients’ offices or remotely, and have access to Eversheds’ resources and network of offices.

Its aim had been to have between 10 and 15 lawyers in the programme in the first year, but after only 7 months the number of lawyers on the roster had grown to almost 80 and the firm has confirmed that the new business line will become a permanent arrangement. That is quite an impressive growth by any standards, and proof that there is a clear market demand for this type of arrangement.

ABS authorisation delays cause frustration

There is increasing frustration being voiced at the length of time it is taking for the SRA to deal with applications for firms to become alternative business structures (ABS), and the lack of clarity in the process.

It is known that almost 150 stage 1 applications have been submitted to the SRA and therefore it is no great surprise that there is some pressure on the licensing authority in the initial phase.  However, applicants are voicing frustration about a lack of clarity, and that the delays are now impeding transaction timetables. 

The main problems seem to stem from the fact that the information that the SRA requires at stage 2 of the process is determined on a case-by-case basis rather than through a standardised process and documentation, making it difficult for applicants to ensure prior to a process beginning that they have all the information they need.

There is also concern regarding timetables.  The SRA has 6 months within which it must have adjudicated on applications, but it is not clear from when the clock starts running.  The SRA’s website states that

“We intend to process most applications well within the statutory standards which are set out in the Legal Services Act. We will try to meet any relevant dates you tell us about, but it would help us if you make your application in plenty of time. We will make a decision within (i) six months of receiving your complete application, or (ii) nine months if we require an extension, which we are required to tell you about in writing.” 

Given that the stage 2 application process is bespoke, then it may be some considerable time after submission of the initial expression of interest forms before the 6 month time-period is counted, as the process of agreeing the information required for the stage 2 application can be protracted.

The Lawyer reports that Parabis has been forced to delay its ABS deal with private equity house Duke Street because of the SRA delays.  Parabis agreed a £50m funding deal with private equity house Duke Street in January with the aim of going live at the end of February. That could now be delayed until the end of April.

The Lawyer is also reporting that Silverbeck Rymer, which agreed a deal with AIM-listed Quindell Portfolio in January, is also facing regulatory hurdles that are causing delays to the deal going live.

The issue of valuing large law firms - FFW and Kennedys take up the challenge

There is increasing evidence that alternative business structures (ABS) are being considered by some substantial existing firms, which may come as a surprise to those who thought it would only have a material impact on high-street law firms.  Two Top 50 law firms have recently confirmed that they are actively considering taking external investment and converting to ABS – Kennedys and Field Fisher Waterhouse. 


Legal Week has reported that FFW is bringing in an external body to value the business with a view to potentially seeking external investment during the next financial year.  


Valuation of law firms is not an easy process as it requires, amongst other things, a detailed understanding of what remuneration policies would look like under an ABS structure – these need to be fundamentally different from the usual income-stripping model currently operated by most law firms, and comprise elements of both income and capital. It is certainly not a simple exercise to design something which will work to motivate and attract lawyers, whilst at the same time allowing a collegiate culture to flourish. The difficulty is that as this is such new territory for law firms, there are no easy templates to follow, so to some extent law firms are going to have to reinvent the wheel.  On the face of it, it may appear simple, but when you overlay complexities such as liquidity for future share repurchases, the issue actually becomes very complex.  


If valuations are to be worth the paper they are written on, these issues need to have been thrashed out in detail.  But of course firms can't take external investment without having a sensible view on value.  FFW and its valuers will clearly have their work cut out in leading the way on this, but others are bound to follow.

Will a £15 million TV ad campaign change the game for law firm marketing?

Outside the sphere of personal injury claims, it is highly unusual in the UK to see television advertising of law firm services.  Most firms tend to rely on word of mouth and a few glossy brochures to promote their activities, and believe that doing a good job for a client is the best form of advertising.  However, the world of law firm promotion is all about to change, as QualitySolicitors (QS) (which has famously linked up with WHSmiths to provide legal services through booths in stores) is launching a huge TV advertising campaign that will see 8,000 adverts being broadcast throughout May.

And this will be no amateur effort – the 90 second ads have been created by Saatchi & Saatchi and have are scheduled to be broadcast in some prime-time slots. 

Such marketing does not come cheap – it is reported that QS plans to spend £15m on advertising over 12 months – a figure which is a quantum leap away from the marketing budget of most firms, although when divided between the 150 or so member firms which operate under the QS brand the figure starts to look less scary.  QS can afford such sums thanks to the investment by private equity firm Palamon Capital Partners 5 months ago, which has also financed a ramping up of the firms infrastructure and some new senior recruits.

Most advertising is aimed squarely at winning customers and of course QS will be aiming to do just that with its campaign, but I suspect that in almost equal measure it is hoping to raise its profile further amongst other small law firms.  QS aims to have a network of firms in 1,000 locations by the end of 2012 – an ambitious project, but one which may well be achievable if the TV blitz makes more firms want to jump on the bandwagon.

QS is no stranger to pushing the boundaries when it comes to advertising.  It has a tie up with TV star Amanda Holden to promote its activities.  She caused outrage (mostly amongst disgruntled competitor law firms rather than potential clients, but also incurring the wrath of the Law Society) when she blatantly promoted QS during an interview on This Morning, saying that they are “solicitors who are kosher, who are not going to rip you off”. Ofcom ruled that ITV was in breach of its code for allowing Ms Holden to promote QS in this way, but imposed no sanction beyond publication of their findings. 

It remains to be seen whether QS get value for their £15 million marketing budget, but I suspect that they will.  They are operating in a consumer-orientated market, where they need to get a simple message out to millions of potential clients.  TV is a natural medium through which to do it.  It’s not an approach which is likely to be relevant in the worlds of the high flying commercial law firms, but the small high street firms who have been merrily relying on word of mouth recommendations for generations must be quaking in their boots.

DLA's Riverview adopt new Peppermint Technology platform

One of the likely consequences of the changes being brought about by the Legal Services Act is a renewed focus on technology to enable legal services to be delivered in a more efficient, flexible, cost-effective and client-friendly manner than has been the case in the past.  To some extent the pace of change is being forced by the entry into the market of businesses from other disciplines, which are bringing with them a new mindset and a new business rigour focused on efficiency and scaleability.

A very small number of firms, such as Epoq, have already made some strides in changing the way that technology can be used in law firms, but relative to other spheres of business there have been surprisingly few innovators in the field to date, perhaps because lawyers have tended not to be early adopters of new technology and therefore not historically a particularly fertile market.  However, there seem to be some early signs that this is changing, and this week has seen the launch of a new entrant into the market which has ambitious plans to shake things up.

Peppermint Technology has developed a new generation of legal technology built for law firms, alternative business structures and in-house legal teams.  The platform is being used by Riverview Law, the new venture backed by DLA Piper and it is understood that at least 2 other law firms will be going live this year, with others under development.

The platform claims to be different from traditional practice management and case management systems, in that it brings together applications, content, collaboration tools and transactions on a single unified platform.  The system is centred around a client relationship rather than a particular transaction, and enables all data relating to a client (communications, documents, activity records, financial transactions etc) to be linked to the client.  Peppermint has further plans to launch the Peppermint App Shop, which will brings together in one platform a wide range of complementary partner products and services designed and built for legal service providers.

Peppermint Technology CEO Arlene Adams has said: “The platform recognises that successful legal providers of the future will be able to turn data and applications into meaningful, relevant and personalised content for clients, anytime, anywhere. To do this, a company must have an end-to-end system in place that can track and connect every data point and activity to a client. That’s what the platform is all about.”

It is good to see that one of the consequences of the current shake-up in the legal market is an increased focus on using technology in a way to improve client delivery - something which has been sorely needed for some time now.

Admiral Insurance may establish in house law firm to handle claims

Admiral Insurance has said that it is “considering its options” over whether to become an alternative business structure (ABS) and establish an in-house legal function to deal with insurance claims.  The move is believed to be a response to the anticipated loss of income which will occur following a ban on referral fees in personal injury cases.

Although profits at Admiral rose 13% in 2011 to £299m, the company is clearly keen to try to mitigate the effects of the referral fee ban, which is scheduled to come into effect in April 2013.

Personal injury referral fees currently earn the company around £7 per vehicle, with a further £5-6 per car in referral fees from credit hire (which are also currently under threat due to an Office of Fair Trading investigation).  

Given that Admiral insures 3.3 million vehicles, these numbers soon start to add up, and Admiral states that referral fees account for approximately 5.5% of its total UK profits.  It is therefore not surprising that they are very keen to find ways of preserving that income.

Walkers sells fiduciary business to Intertrust

Walkers, the Cayman head-quartered law firm with offices in British Virgin Islands, Dubai International Finance Centre, Ireland and Jersey, has announced that Intertrust Group has agreed to acquire Walkers' corporate, fiduciary and company secretarial business, Walkers Management Services (WMS). 

Intertrust, which is backed by Dutch private equity boutique, Waterland Private Equity Investments, was founded in 1952 and has become a global leader in the trust and corporate services domain, with over 1,000 employees in 20 jurisdictions.   The acquisition will assist Intertrust in further expansion of its international footprint, particularly in key markets in the Americas. As a combined group after completion of the acquisition, Intertrust will operate with more than 1,100 people from 30 offices in 21 countries. 

The sale appears to be further confirmation of two trends - the divestment by certain of the offshore law firms of their fiduciary businesses to  allow a focus on core legal services, and the emergence of a small number of "super-consolidators" in the fiduciary sector - firms who are gaining a material size and global reach sufficient perhaps to sustain an IPO in the future.

WMS has been part of the Walkers Group since 2001, providing management services through its three core divisions: corporate, fiduciary and company secretarial services. Walkers and the Intertrust Group have announced that they intend to continue to work closely in the future, and to avoid disruption to existing client teams where possible.

Law firm subsidiary businesses - a source of conflict?

The Lawyer has reported that, in a rare example of apparent misjudgment, DLA Piper co-chief executive Sir Nigel Knowles has become embroiled in a partnership storm after it emerged last week that he and a small number of other DLA partners have personally invested in LawVest (of which Knowles is non-executive Chairman) without declaring it to DLA’s board or the partners.

DLA Piper reportedly invested £62,500 into LawVest last year, and is aiming to redefine the lower and mid-market for corporate law services, by offering fixed price annual contracts.

  

What makes the personal investments in LawVest particularly controversial is that DLA Piper and LawVest have both stated that they expect that smaller DLA Piper clients will be referred to LawVest, which intends to trade under the brand name Riverview.  In a previous blog posting I have commented on the fact that this could create an interesting dynamic as it will apparently see a shift of existing business from DLA to Riverview, albeit at the smaller end of their client base.  In these circumstances, it is perhaps surprising that Knowles and the other partners who invested personally in LawVest are said to be shocked that their actions were being perceived by their colleagues as giving rise to a conflict of interest.

The purpose of this posting is not to examine what has happened at DLA in particular, but instead to highlight a complex area that more and more firms will find themselves having to navigate as ABS structures become common, and in particular as more law firms start investing in subsidiary businesses as a consequence of an increasingly competitive and dynamic market.  

Owning valuable capital assets within partnership structures often leads to tensions at the best of times.  In the offshore environment, the vast majority of law firms set up their own trust company businesses many years ago, which in many cases became very profitable and highly valuable, saleable assets.  In the early days, owning these businesses seemed to be a genuine win-win for the law firms – they were established by the partners in the business at the time, and were very cash generative.  Everyone was happy.  But as time went on, in most of the firms the political dynamics became increasingly complex, and in some cases led to relationships between partners breaking down.  There were a number of reasons why this tended to happen:

• In some cases, as the subsidiary companies became more valuable, it started to cause difficulty with building an economic business case for bringing new partners into the law firms which owned them, particularly if the prospective partner was not working in a field which would be likely to generate more work for the subsidiary, because their fee earning potential could not “justify” the interest in the trust company that they would acquire through partnership.  Firms responded to this in a myriad of different ways.  Some cut right back on offering partnerships in those areas (which of course led to longer term recruitment and retention problems), whilst others started to offer newer partners a share of the law firm profits, but no interest in the subsidiary businesses.  This latter approach led to two-tier (or sometimes multi-layered) partnership structures – a potential source of enormous tension and bitterness for those who don’t make it to the higher tiers;
• Some firms allowed individual partners, as opposed to the partnership, to have personal investments in the trust companies, whilst other partners had no interest.  This could lead to friction in relation to referral arrangements, such as suspicion that law firm fees were being discounted in order to be able to secure work for the subsidiary company – an arrangement which would benefit only those who had a personal investment.  The mere perception of a lack of transparency (as seems to have happened at DLA) would only inflame any tensions in this respect;
• As the subsidiary business became more successful, they in many cases started to out-perform their law firm founders and this in itself could become a source of tension – on the one hand from the people running the subsidiary business (who sometimes felt that the law firm partners were getting rich off the back of the subsidiary’s success, whilst contributing little directly to it), and on the other hand from the law firm partners, who might resent the fact that the contribution of the law firm to building the subsidiary brand in the subsidiary was being under-valued.  This dynamic is perhaps something which afflicts the professions more than some other more commercial businesses spheres, but is not unique to law firms.  Anyone who has studied the enormous rift that developed between Arthur Anderson and its consultancy business, leading to its bitter split, will know that the seeds of that debacle lay in exactly the sort of tensions described here;
• If the subsidiary business needed material capital investment, then this added an extra layer of complexity, because partners at different points in their careers are likely to have different views and vested interests in investment and divestment decisions.  For example, a partner who is close to retirement is not likely to be willing to take a large income sacrifice to finance a huge IT project which will not deliver any benefits during his tenure, whereas others might feel it is essential for future growth and that older partners, if they block it, are putting a brake on the business; and
• Finally, as some law firms started to divest their subsidiary businesses, it became apparent that the structures established by many firms had resulted in something akin to a pass-the-parcel situation: interests in the subsidiary business would be passed down from generation to generation of partners, but those in situ at the time of a sale would be in line for a huge pay-day.  As partners approached retirement, there was therefore a natural tendency for them to press for a sale of the business, whilst those who had been working towards, but not yet achieved, partnership would fear that everything they had been working towards might be sold out from under their feet. 

All of these are enormously complex dynamics.  The offshore law firms, and many of the accountancy practices, have been grappling with them for years, trying a myriad of different solutions and with varying degrees of success.  As the UK legal landscape changes and becomes more dynamic and competitive, and law firm businesses become less homogenous, so the firms here will need to start addressing similar issues.  The DLA Piper/LawVest venture has hardly got off the ground before the first problems have surfaced, and we can expect more to follow. 

There needs to be clarity, transparency and a shared vision of the future at the outset, which is clearly articulated.  If there is an absence of trust between those partners that those taking the key decisions are working towards a shared goal, have only the best interests of the firm as a whole at heart, and have a proper mechanism in place for recognizing what was once termed goodwill, tensions may become unbearable. 

UK firms can and should be seizing the opportunities open to them to reinvigorate and expand their businesses.  But those who rush into such ventures without thinking through the consequences and learning the lessons from some of those businesses which have gone down that route before them, might live to rue the day.