Irwin Mitchell: we’ll float and take on the mid-tier

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  • Floating a law firm is just a bad idea. Here's how it would inevitably work: the firm floats and gets a load of cash up front, which it uses to offer stonking amounts of cash to a few 'big name' partners, who will most likely be coming to the end of their careers but will be looking for one last big pay day. The new 'big name' partners will have to be guaranteed minimum payments every year, which will be much bigger than the sums paid to existing partners in the firm. This will create resentment, and ultimately a really bad atmosphere at the firm. While the 'big name' partners are offered wads of dosh, the floated firms will struggle to recruit associates to match the new partners' practices, unless the associates working with the 'big name' partners also get paid more. This will create more resentment, and an even worse atmosphere. All the while, the existing partnership sees its profits eroded to pay dividends to the firm's new shareholders.

    Then, after 3-5 years, the 'big name' partners either retire or go to other firms, leaving the floated firm with a hollowed out corporate practice (assuming that's where the 'big name' partners were), angry shareholders and an obligation to either pay dividends in perpetuity, buy-back the shares at potentially a high cost, or face action by shareholders to do the equivalent of sacking the board (if shareholders would not have recourse equivalent to sacking the board, or no other powers in the event that no dividends are paid, why would they invest in the first place?).

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  • This topic continues to galvanize the profession’s attention for some time, as we in the United States watch events unfold across the pond.
    There are some quite serious business obstacles yet to be adequately addressed, let alone even comprehended.

    As some have noted, the proceeds of capital infusions by outside investors in large law firms will likely be applied to technology and most particularly knowledge management systems, all with a view of lowering costs to consumers of legal services. The result would be increased commoditization and reduced revenues per lawyer. Thus, the consequence of such investments may well be that unless one creates a Goldman Sachs-type leverage ratio (10,000 to 1?), an extremely unlikely result for any law firm, the investor will simply not get the anticipated return.

    The practices which yield the highest return still remain in the plaintiffs’ class action bar and in big stakes high end plaintiffs’ contingency cases. Massive class actions and other high end cases chew up enormous amounts of capital. Law firms which have been active in this world have already amassed substantial capital and have the internal resources to fund these cases. Some still utilize traditional institutional lending from banks at favorable rates. Others utilize litigation funding companies which do tend to charge exorbitant interest rates; but, then again, these funding companies accept all of the risk in making non-recourse loans and at the end of the day, they do not remain partners of the law firm.

    The Irwin Mitchell experiment raises some questions for which we do not quite have enough facts to make any intelligent responses, lacking adequate information. For example: Why would equity investors provide capital for a firm to enter middle market practices, where the margins are lower than in tort cases and lower than that earned at magic circle firms? In addition, we already know from several decades of experience that the ultimate additional profit to a law firm in hiring laterals is only marginally incremental, as firms are required to pay for the ramp up of the laterals and the lion’s share of profits earned by new laterals are actually paid to the laterals, with the increase in firm-wide profits is only incremental

    Other comentators have noted that outside investors in a firms would exert some degree of control within a law firm and the danger he highlights is that such investors will impair the independence of the lawyers’ judgments in directing that efficiency, rather than the clients’ best interests will be a driver in handling a client engagement, all in violation of Rule 1.1 of the Model Rules of Professional Conduct under US rules; we do know that proposed new UK rules are designed to have a different result.

    But an added impediment is the preservation of client secrets and confidences. Non lawyer investor participation in law firm management necessarily makes non-lawyers privy to such secrets and confidences, with no mechanism to police the maintenance of such confidentiality by these non-lawyers.

    As American baseball legend Yogi Berra said, predictions are hard, particularly about the future, my own humble prediction is that these models won’t work for traditional Big Law. That’s what I said six months ago at http://kowalskiandassociatesblog.com/2010/10/05/will-permitting-equity-investments-in-law-firms-by-non-lawyers-or-allowing-law-firms-to-go-public-have-a-significant-impact-on-corporate-law-firms/ and nothing has yet surfaced to dissuade me.

    The ABS or Tesco models just won’t work for Big Law. But, they may very well for mass market, consumer oriented, commoditized practice, built on a franchise type model. Take something like legalzoom.com and open storefronts across the landscape. The margins may be small, but they are also small at MacDonald’s, KFC and so on.

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  • With a fair wind and and an improvement in market confidence they may just raise enought to pay their trio of advisers! Four and a half partners working flat out, the investment bank and the accountant's fees to pay. May be enough left over for a couple of glasses of cava at the launch party........

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  • Barry, that's where Irwin Mitchell's plan is so brilliant: they have no 'big name partners' to worry about :)

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  • Two words (well technically three if you include the "&") for Barry: Slater & Gordon. Average annual revenue growth since IPO, 30%. Actually that's more than two words but I've lost count now.

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  • The biggest advertising agencies and investment banks are listed. Staff costs forming a very high proportion of total costs is no impediment to law firms successfully listing per se.

    Clearly the biggest opportunity is for firms which are not currently in a leading position, and have the chance to use listing as a means to expand aggressively. However even the biggest firms could benefit, the thing which will hold them back is the perceived self-interests of the current partners in wanting to keep control, not the interests of the firms as businesses.

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  • @y4ucallmydog - yep, Slater & Gordon floated in 2007. Lets see where they are in 2-3 years' time.

    My whole point is that an IPO will give a big injection of cash up front, which will inevitably give a fast growth spurt, but in the long term it's a very bad idea.

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  • y4ucallmydog: but what is their profit growth have they had since the IPO, any ideas?

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  • Looking at Slater & Gordon is instructive: their track record since flotation mid-2007 has been pretty good. The IPO was at A$1, the shares are now circa A$2.50, despite significant dilution from subsequent issues.

    They are growing pretty fast by acquisition (consolidation of PI firms) - the last 6 month report if annualised indicates fee income about A$170m (A$63m in 2007) and market capitalisation at A$367m, ie a multiple of 2.2x fees, which compares very favourably with the (extremely loose) rule of thumb we have used traditionally, ie 1x fees. The market cap indicates a P/E ratio of 16x, which is respectable by any standards, given market conditions over recent years. Essentially, the market is saying it likes the model and backs the management. The availability of valued equity is a powerful tool, used in conjunction with generous bank borrowing facilities, for effecting acquisitions and incentivising key personnel.

    The net effect is that Slater and Gordon are now a significantly greater force in their market than they were 4 years ago.

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  • Anon, you're quite wrong - listing is off the table for international firms, as the US and most jurisdictions won't allow it. So it's only firms with a UK focus that can take advantage of ABS and, as Jerome Kowalski correctly observes, the economics are only going to work for highly leveraged and commoditised businesses.

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  • How anyone can say it's a good idea because Investment Banks floated is beyond me...

    Investment banks need capital to fund their activities, outside of enticing in new talent (which is all law firms will be able to do with any funds raised). I agree it may work for very low end commoditised work, but anything that relies on the talent of the lawyers dealing with these issues, will not benefit. The value of any law firm is in its lawyers, outside of human capital I doubt there is any value in its balance sheet.

    Floating a law firm would be like floating a football club (both rely entirely on the talents of their employees to earn all their capital) and both or terrible investment opportunities if looking for a reasonable return. The majority of football club shares would be owned by fans, or nowadays billionaires who want a trophy asset to play with. I doubt law firms will be considered a 'trophy asset' by anyone!!

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  • I think the move to external investors will be transformative as this will give the insititution many more levers to incentivise performance apart from cash. Barry is thinking old style. The use of options and such like can allow firms to incentivise "partners" and staff over a longer period of time linking their success with the success of the firm at the same time allowing for longer term investment rather than cashing out the profits each year in the form of partner draw. By unlinking the ownership from the management, firms will be able to hire leaders who are focussed on delivering shareholder value and good managment and the "patner" can concentrate on delivering the revenues. Furthermore, if a "partner" does not perform then the scrutiny from external investors and the board will probably be more robust than current partnership structures. Good luck to IM - I hope the succees.

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  • Surely the best way of achieving a high ROI is for the investor to also "add value" to the practice, not just cash.

    My company is preapring to enter into several agreements post ABS - we provide the software, funding and clients and the practice provide the legals.

    Cash alone has not worked for us in the past because of several of the aforementioned reasons given by other commentators.

    This methodology does work for both ourselves and our legal partners.

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  • There seems to me to be a major "disconnect" at play here. To Jerome's point - IM is a firm which is better suited than any UK firm to provide volume, commoditised, consumer facing private client services. As such, this half of the quation balances and makes sense.

    The disconnect comes on the Corporate side of the equation. In any given town or city, there are firms which have always balanced the Private and Corporate work, but increasingly these firms look like a dog's dinner in terms of their branding. Nationally (and with the funding IM are looking at, it very much has to be national brand) I can't think of one firm which succesfully balances Private Client/PI and Corporate work.

    The reasons for this are various but include cultural differences, different operational models, charge out rates and profitability and, not least, conflicts of interest. As such, if IM were looking to do this purely as a PI/Private Client Business it makes sense, but I suspect Barry is nearer to the mark given the apparent push on the Corporate side.

    As a detatched observer, it will make for fascinating viewing.

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  • A publicly quoted legal service delivery business may finally remove the mystique of the traditonal modus operandi. The new business model should, at last, deliver a greater focus on the customer. Most clients are unable to discern the qualitiative nuances in the legal products they buy - most are only interested in the outcome. Property buyers are not intersted in lawyer interviews - they want nothing more than clear title to a property. The incumberances encountered along the way are of no interst to the customer. This is hopefully what the new model will deliver as it has in Australia. As a side issue there is money to be made too!

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  • Playing the long game! Probably not. In future profits at 30% - 50% are likely to be the exception as publicly owned law firms build a model with fewer directors and look for an ROI in keeping with market norms. This is just the start and the industry will have to get used to the notion that the price of external capital is conformity. It rather begs the question why would any public company even imagine it might need hundreds of directors. After all what would their management functions encompass?

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