Five Statham Gill Davies partners made an average of £700,000 each when Tenon bought out the firm. But with the Tenon share price on the slide, is it a workable model in the long term? Helen Power reports
The only thing lawyers generally like to be shown by accountants is how to fill in a tax return. But in the last days before the Enron scandal hit the accountancy profession, lawyers were looking longingly at the offices of a tiny niche media practice in the West End. When Statham Gill Davies sold out to the consolidators – a new breed of accountants – the deal caught lawyers’ attention; partners all over the UK did fag packet calculations to work out how much they could get if the accountants came knocking on the door. As the biggest accountancy consolidator Tenon’s shares have struggled, the £7m
Statham deal may still provide a pleasant daydream for lawyers, but it looks increasingly like an anomaly.
Last October, Tenon bought out the five partners of Statham for £7.1m. Of this, just 49.9 per cent was in cash, with the rest made up in Alternative Investment Market (AIM)-listed Tenon shares, but it was still enough to catapult the partners towards the Millionaires’ Club. Traditional law firms looked on in envy as the Statham partners managed to trade in the value of their equity for capital in the same way any other non-professional entrepreneur who built up a business could. Plus the whole Tenon structure showed how accountants, unhampered by lawyers’ professional conduct rules, could pump investors’ money into their businesses in order to fund rapid expansion.
“The question is whether we should allow entrepreneurial law firms to be more imaginative in fundraising”
Ed Nally, Regulation Review Working Party
However, the reality for Tenon and the companies it has taken over is that it has been a hard slog commercially. Tenon was forced to issue a profit warning to the markets last December. Analysts had predicted that Tenon Group would make a profit of around £6.2m in 2001, but the company put out a statement that it would make between £500,000 and £1m. The Statham partners bought out by Tenon saw a third wiped off the company’s AIM share price overnight, and all sorts of questions were asked about Tenon’s strategy.
There is no doubt that the consolidators have had a major impact on the accountancy profession. Tenon and Numerica have come from nowhere to become a real force in the second tier of accountants. The idea behind Tenon is a simple one: to take good-quality niche financial services practices and put them under a single management infrastructure in order to take advantage of the economies of scale. Tenon effectively buys partnerships and turns them into corporations.
The Lawyer understands that Tenon calculates the consideration on the basis of partners’ post-tax income averaged out over the last three years. It has paid as much as 12 times post-tax income in the past, but by the end of last year it was offering around six to seven times that amount.
Former partners are then put on fixed salaries of between £100,000 and £120,000 per annum, with share dividends and capital appreciation providing a performance incentive. There is a three-year lock-in period before the shares can be disposed of and Tenon protects jealously the goodwill it has bought so that the restrictive covenants on the partners who sign up are onerous. The Statham partners who went over to Tenon also had to hand in their practising certificates because Law Society rules prevent fee-sharing between lawyers and non-lawyers.
A payout of six to seven times annual salary could look pretty attractive to many law firms, but the Statham deal was a one-off for Tenon. The company’s chief executive Ian Buckley negotiated the Statham deal personally. “When we took over Statham Gill, we already owned Godfrey Allen, a leading tax advisory business for media, entertainment and sport,” he explains. “The firm did primarily media and music work, so the acquisition gave us the opportunity to provide an integrated service offering. We’re servicing just one niche sector, which is a very small marketplace.”
Buckley said that the key reason behind the lack of interest in lawyers is referrals. “We don’t bite the hand that feeds us,” he says. “Reciprocity is very important to us in terms of law firm referrals. We’re certainly not going to emulate the big five in building legal services arms.” Furthermore, there is a rumour going around the accountancy profession that, for as long as Tenon’s shares remain below 80p, its financial institutions will not allow the company to make any more acquisitions.
Numerica, the other accountancy outfit conceivably interested in law firms, is also AIM-listed. The firm prefers to be described as an integrator rather than a consolidator, but operates on broadly the same principles as Tenon. Despite a corporate finance joint venture set up with Howard Kennedy, Numerica takes a similar stance. “One has to tread very carefully to ensure that mutual referral systems aren’t jeopardised,” says Numerica’s chief operating officer Julian Synett. “I think law firms generally are something we’ll stay away from. MDPs [multidisciplinary partnerships] aren’t for us at the moment and don’t fit into our regional development plan.”
Tenon’s shares have taken a battering and are currently sitting at 68.5p, having been issued to the Statham partners at 115.5p per share. Former Statham senior partner Kaz Gill declined to speak to The Lawyer, but a poor integration of the individual businesses was clearly a contributing factor to the profit warning. In its statement to the markets, Tenon said: “In the period since its formation in March 2000, Tenon has acquired 16 businesses with a broad range of service line specialisations. A consequence of the pace of this acquisition process has been the cost of integrating these businesses.”
“We don´t see this as a retirement deal, we´re looking for good-quality firms who want to build the business”
Julian Synett, Numerica
Buckley is facing the markets head-on. “We’ve completed phase one of our development and now we have to demonstrate to the markets that we can be profitable,” he says. “Internally, everyone is focused on delivering the profits we need to get the share price back up.”
However, there are still concerns about Tenon’s ability to integrate idiosyncratic units into a functioning whole. Phil Shohet, managing partner of the Cato consultancy, which advises the accountancy profession on mergers and acquisitions, has his doubts. “What you’ve got is an amorphous mass of unintegrated business units. Some of these businesses are now virtually unintegratable because they’re so set in their ways,” he explains. “The profits Tenon has announced are ridiculously low and they haven’t even discounted goodwill, which could take the company into minus a couple of million.” Shohet also believes that the company’s foray into the legal market was premature. “I would have integrated one profession first before I took in a second,” he states.
Numerica’s share price has held up better, but it has been much less acquisitive than Tenon, with just three purchases to Tenon’s 15. Buckley points out: “The fundamental difference between us and Numerica is that they’ve built their business around just one big practice – Levy Gee. We went out to acquire leading independent practices.” Although Numerica’s growth has been significantly slower, Synett claims that his company has benefited from IT, HR and other centralised administrative structures already in place at accountancy firm Levy Gee, which is the structural kingpin of the whole setup.
Integration issues will be a serious concern for any law firm desirous of selling to a consolidator-type business, but there are other intrinsic hurdles when transforming a partnership into a corporate structure. Chief among these is motivating partners who have sold out for a chunk of cash.
Keith Sealey was a partner in the Lathams Group, a successful accountancy outfit that serviced the owner-managed business sector by vigorously cross-selling different financial services. Sealey chose to go his own way when Lathams was bought out by Tenon in 2000. Tenon paid £20m for the partnership and the partners sold a jointly-owned property for a further £8m, leaving them with £28m divided between 13 partners. “Tenon has a massive administrative job to do now and that just isn’t me,” says Sealey. He took his share of cash and he says he is now formulating a deal to set up another accountancy firm in the south of England, although he admits he would gladly sell out to the likes of Tenon again if the opportunity arose.
What consolidators buy at the end of the day is clients’ goodwill and partners’ expertise. Crucially, Sealey believes that “people pretty much discounted the value of the shares. If anything comes of them, it will be a bonus. Whether shares are enough to motivate the people who’ve sold out is a very good question.” Shohet quips that most of the partners are probably now spending a significant amount of time on the local golf course.
Synett and Buckley, both of whom are regarded very highly in the accountancy profession, know that motivation is crucial. “We don’t see this as a retirement deal, we’re looking for good-quality firms who want to build the business,” says Synett. “Its crucial to our business model that there’s a meeting of minds.”
“It doesn´t take one of Tenon´s collection of numerate practitioners to recognise that shares in the accountancy group have thus far proved a poor investment”
Financial Times, 12 January
Buckley also points out that the corporate structure can provide major advantages when motivating people below partner level, because there is more flexibility to reward key people with share options. However, working within a corporate structure is still the wild west, and many lawyers will have doubts about jumping in, at least until the accountants have proved that it works.
The fact that litigation is still an area of professional services reserved for solicitors and barristers is another major hurdle. While most Statham partners handed in their practising certificates, the two-partner litigation practice had to split off from the firm. The partners formed boutique media litigation firm Forbes Andersen, which retains a working relationship with Tenon. Andrew Forbes would not comment on what he got out of the Tenon buyout, but it is extremely unlikely that the two partners walked away without a wedge of Tenon money. Given the subsequent problems, some might think Forbes Andersen has got the best of both worlds, but Andersen maintains: “I would have gone to Tenon with the rest of the firm. It was only the regulatory restrictions that stopped me from doing so.”
It seems unlikely, then, that the consolidators will offer many more opportunities to law firms. This still leaves firms with the problem of how to get big chunks of capital into the partnership and how to allow partners to take equity out. But an unlikely champion has emerged in the shape of the Law Society. Although Chancery Lane has dragged its feet over other liberalisation issues such as MDPs, a vote, due to be cast this Thursday (21 March), is likely to allow law firms to sell off some of their equity to external investors.
In 1999, as part of a wider brief on practice rules, the Regulation Review Working Party began a review of Rule 7 on fee-sharing. Chair of the committee Ed Nally explains: “The origins of the rule were to preserve the independence of law firms from non-lawyers. Firms are currently prevented from factoring debt or allowing a financial institution to take a stake in them that is rewarded through profit share. The question now is whether we should allow entrepreneurial law firms to be more imaginative in fundraising and whether we can do so in a way which still preserves their independence.
“It would be a shame if we found in the critical analysis that the Tenon deal was down to our restrictions rather than a purely business decision.”
The Law Society has been lobbied by both City and provincial firms that want it to reconsider Rule 7. According to Nally, the requests range from City firms that want to put in place complex banking arrangements for debt to small firms which want to sell off some equity in order to finance expensive marketing or IT needs. “I’d definitely like to see more firms given this opportunity,” Nally says. “What we’re wrestling with at the moment is whether to do it by capping the amount of debt or limiting the percentage of shares which can be sold.” The likely outcome is that minority share sales to outside investors will be permitted.
Although the Law Society’s rationale is not to allow partners to take equity out of the business, the reforms may well have this effect. “That would be a side-effect of the rule change, and if the overall change is beneficial, so be it,” says Nally. “Any reform would have to be in the public interest, but it’s wrong to presume that a rule that benefits the profession is not in the public interest. It’s certainly in the public interest to have a vigorous and financially solvent profession.”
Shohet warns that the Tenon model has an unfortunate precedent. “I’d hate to think we might see a replication of the scenario when estate agents sold out to building societies in the 1980s and later on bought back their offices for £1,” he says. From a purely self-interested standpoint, a few of the partners that Tenon bought out would score a double whammy, but for other professionals it would be a blow.
Failure of the consolidators may sour the City to professional services investments, which is something lawyers definitely do not want to see just as they are being given the chance to be more flexible with their own offerings. Although many lawyers have scrambled to distance themselves from the accountancy profession in the wake of the Enron scandal, attracting outside investment is yet another area where the professions are linked in the eyes of the outside world. The Statham deal may have been a blip, but lawyers should hope that Tenon turns its finances around.