Lessons in investment
9 October 2007
The Legal Services Bill has paved the way for law firms to raise external capital. Whether this external investment comes from private equity or an IPO is up for grabs. Although this landscape may be new for lawyers, for other professional service sectors, such as accountants, it is not. So what lessons can be learned from them and how successful will any law firm float be?
It seems unlikely that the top-tier firms will aim for the listing route on the basis that they are ‘doing alright thank you’, unless they are seeking merger options or want to fund ageing partners’ pension plans. The mid-tier firms may think that a public listing will assist in raising their profile in a densely competitive market, or expanding domestically or internationally through acquisition of other firms or discrete lateral hires.
But any injection of external capital runs the risk of an exit of human capital – that the bonanza for existing partners becomes a barrier for prospective partners and a brain drain ensues. The challenge will be to turn the risk into an opportunity: inventive share option schemes may incentivise a wider workforce.
It is well known that stock market listing has attracted at least one firm already – Slater & Gordon in Australia, which debuted in May. Its performance so far is heartening to firms considering the same path. As a volume personal injury firm, it has seen its stock rise from A$1.3 (57p) to a consistent range of between A$1.6 (70p) and A$1.7 (74p). Slaters has not stood still either, as it quickly added to its armoury by aquiring, two months later, a firm specialising in military compensation.
However, perhaps the best benchmark to assess the potential value of law firms is the accountancy profession, which, it has to be said, has had mixed success. For instance, Tenon Group has met with various difficulties since it was admitted to AIM in March 2000. From a debut value of 117.5p, it fell to around 30p by December 2002, where it remained until it rose over the past couple of years to around 60p. This share price activity should be compared to that of Vantis, which debuted at 96p in May 2002 and has risen steadily to over 200p.
These contrasting fortunes produce their own lessons. Tenon followed the ‘consolidator’ model – an acquisitive strategy that relies on the effective integration of acquired firms and the consequent benefit from cost savings in, for example, IT, human resources, marketing and finance – all factors that are equally attractive to a law firm. If those savings are not realised, then profit (and the share price) is bound to decline. Indeed, the relative success of Vantis in this consolidation process – where its successful integration of Numerica in May 2005 is cited – is one of the main reasons for the divergence in share price movement to that of Tenon. Vantis was also an established firm and therefore perhaps better able to absorb acquisitions.
With any flotation, timing is important. Vantis was the last accounting specialist to list and it is acknowledged that it had more time to prepare for the flotation and its aftermath. The state of the financial markets is also important: Vantis launched in the middle of a relatively long-lasting bull run which no doubt sustained its share performance.
The management of Tenon has not been consistent and has seen various high-profile departures. The stability of human captial, as already noted, will be critical to the success of any law firm post-flotation.
So will law firms be an attractive investment? Their appeal will rest on such factors as the scale of the business, the longevity of its exsiting and future income streams, whether they are underpinned by contracts, the quality of management and operational systems and its asset base – fixed assets and work in progress but, most importantly, the retention of its main asset, its people.
The consolidator model followed by the accountancy firms seems to work better where an established firm integrates future acquisitions. This is one of the routes that law firms are likely to take. If funds are used to expand teams more aggressively through lateral hires, then consolidation may follow naturally. But who will go first? Floating the boat too early may risk sinking the ship.
James Stanbury is a partner in RGL – Forensic Accountants & Consultants