Picking at the bones
30 November 2009
As smaller firms feel the pinch, their larger counterparts are taking the opportunity to snap them up. Clyde & Co’s takeover of Shadbolt is just the latest in a string of consolidations - and market conditions dictate there will be more to come
The news that Shadbolt & Co is being taken over by the super-expansionist Clyde & Co is not only a big deal for the 21 partners at the construction boutique. The takeover will also send shivers down the spines the managing partners at smaller outfits, which may be feeling vulnerable right now.
These are perilous days for law firms. If you are not big enough, strong enough or well-known enough in your core areas, or if profit and fee income are starting to dwindle, the pressure is on.
Shadbolt might have thrived under former chairman Dick Shadbolt, but since he stood down in June 2006 the firm’s rivals have moved into the international arena, leaving it straggling.
Its tie-up with Clydes comes after it recognised that, in order to compete internationally, it would need the backing of a firm that has been there, done that.
But this is not all one-way. A Clydes insider says the firm will also benefit from the additional expertise Shadbolt has in the domestic construction and projects markets.
The talks are in the early stages and there are questions over whether Clydes will take on the entire partnership.
In September Clydes chief executive Peter Hasson told The Lawyer (7 September) that the market was full of opportunities for an expansionist firm.
“The quality of people available to us is better than in years, and these are people who question some of the traditions entrenched in the profession,” he said. “A huge opportunity, yes. But we need to be careful.”
“The current market provides a great opportunity for us to strengthen the transactional business,” says the insider. “It’s a buyer’s market and one in which the profession will shrink and the market will grow.”
According to Simon Hodson, senior partner at Beachcroft, which moved into the Welsh legal market in May following the acquisition of Kingslegal’s insurance business, “there are too many law firms that are too small”.
It is a theme echoed by Ipswich-based Birketts chief executive Alistair Lang, who says “there are a lot of small firms looking for a rescue”.
The Lawyer UK 200 Annual Report 2009 reported that Birketts was on the lookout for firms, or parts of firms, to absorb. Over the past five years its turnover has grown by 173 per cent, from £6.3m to £17.2m. In this ‘buyer’s market’ it is well-positioned to continue that trajectory.
Lang is happy to admit that Birketts is “opportunistic” in terms of hunting for mergers or bolt-ons and adds that in the current climate there are more opportunities out there.
“Since the last PI [professional indemnity] insurance renewals round, we’ve seen a lot of very nervous three- to five-partner firms,” reveals Lang.
Also, if a firm dissolves it has to
buy run-off cover for six years. The additional expense of this insurance has led firms to try to be taken over rather than wind themselves up.
Now insurance rates for firms with two or three partners have soared
– particularly for those with conveyancing practices. These bills can reach an eye-watering seven figures. For those recording a turnover of less than £10m that is a sizeable amount.
“If you’re a smallish firm with older partners you can’t close your firm down without providing run-off cover and the premiums have soared,” explains Lang. “The multiples used to be two times, but now we’re seeing multiples of five. And the annual premiums have also gone up.”
There are other concerns for smaller practices too. There is a growing number of firms on the banks’ ’intensive care’ list, raising questions about the availability of funding.
Banks, not exactly in rude health themselves (the main lenders to the legal market are RBS and Barclays), are much more reluctant to expose themselves to the ever-growing working capital requirements of law firms and consequently are more likely to put firms on a watch list.
Also, banks are increasingly demanding arrangement fees for lending, term loans or overdrafts and tightening up covenants, such as requiring a minimum number of partners, that could trigger the repayment of loans.
“These could be sparked if a firm doesn’t appear to have control of its finances,” says Jomati consultant Tony Williams. “Many firms these days have very capable finance directors. Several don’t.”
Safety in numbers
The likelihood is that this potent cocktail will lead to an increase in merger (or takeover) activity in the coming months. Certainly this year has seen a large number of deals.
In May Hill Dickinson merged with London boutique Middleton Potts to boost its commodities expertise (The Lawyer, 11 May).
Just days later one of the biggest London deals emerged when Speechly Bircham announced it was in talks to merge with West End outfit Campbell Hooper. That deal had gone through by the end of the month (The Lawyer, 25 May).
Elsewhere, Withy King and Marshall & Galpin, EMW and Picton Howell, and RadcliffesLeBrasseur and West End boutique Lithgow Pepper & Eldridge all secured deals.
Although the partners involved are unlikely to admit that these were anything other than ‘great strategic opportunities’, the likelihood is that the prevailing market conditions played a major part.
If nothing else there is a growing feeling that there is safety in numbers. “As a strategy,” quips Lang, “some firms will be mopping up smaller practices.”
Earlier this month the merger between Bristol-based Veale Wasbrough and City boutique Vizards Tweedie went live. Managing partner of the merged firm Simon Heald says the increasing demand for a commercialised approach to the law is creating pressure on smaller firms.
“There’s a constant drive at firms to increase efficiency,” says Heald. “Firms of all sizes need to invest in new IT, knowledge management, risk management and so on. They also need to hire people to look after these things, which means another salary, so you have to build your turnover to pay for these people. I’ve got people doing these jobs on my £17m turnover. [Vizards] has got [similar] people on their £5m.”
For Heald it is simple: his firm wants to grow and so realised organic growth would not be enough.
“We knew we’d have to look at something more substantial,” he admits. “We also have to maintain our profit shares. Not so much what it is in terms of an actual figure, but whether it’s competitive. If not all our star performers will be poached. The key thing is to keep pace with our competition.”
Heald refuses to comment on the details of the financial integration with the 17-partner, nine-equity partner Vizards. The latter firm’s managing partner Ron Perry appears to consider questions on the topic an affront. “That’s private,” he snaps.
But as larger firms continue to swoop on smaller outfits, the equity partners of the target could find themselves out in the cold.
A buyer’s market
Beachcroft’s acquisition of Kingslegal’s operations strengthened the larger firm’s capabilities in areas such as volume defendant insurance, public and employment liability claims and road traffic accidents.
“We were interested in the operational efficiencies and we were looking to update our models to be more like theirs,” says Beachcroft’s Hodson. “It was an investment in technology as well as people.”
Structurally the deal was different from many law firm acquisitions in that Kingslegal was a company rather than a partnership.
“We acquired part of that business, which we then Tupe-ed [Transfer of Undertakings (Protection of Employment) Regulations] across, respecting their business operations,” Hodson explains.
The business was then rebranded as ‘B2 from Beachcroft’ and is now a subsidiary company of the firm.
“We kept it as a separate company so we could better understand how it works, so for the first six months it’s working how it worked before,” Hodson continues. “Details of the acquisition remain confidential.”
What is known is that 109 staff transferred to Beachcroft, including three equity partners and four salaried partners, all seven of whom became employees upon the transfer.
Although strictly speaking this is not a law firm acquisition, it reinforces the impression that in this buyer’s market firms are being more aggressive about not allowing partners into the equity.
“As a broad generalisation it’s true,” agrees Lang. “The buyer has the upper hand.”
There may be more pain for firms already feeling the squeeze. The Solicitors Regulation Authority (SRA) is proposing a major shake-up of the compulsory PI insurance regime, with two consultation papers published on 19 November 2009.
Rates for those in the assigned risks pool (ARP) - the insurance provision of last resort - are extortionately high.
Just by applying firms will earn a premium, priced at 27.5 per cent of fee income, or 30 per cent for an LLP. If firms fail to apply and have to do so by default, rates start at 47.5 per cent of fee income. Firms had until last 27 November to buy cover in the open market and escape that premium.
The SRA proposes to scrap the ARP. Instead it has given three options. One: those that fail to renew on the open market will be given a month’s grace and then closed down if they fail to merge or close voluntarily. Two: the ARP will be closed to new firms. Three: reduce the maximum period that firms can participate in the ARP from 24 to 12 months.
The closure of the ARP will force smaller firms unable to get cover to consider being the takeover target. This in turn will drive the consolidation of the profession.
Smaller firms are already looking for shelter from financial pressures. There is no doubt this will gather pace. By the end of next year the legal market will have a remarkably different demographic.