The buying game
13 February 2006
Late last year, accountancy firm Grant Thornton began dropping hints that it was exploring the possibility of attracting outside investment from private equity groups. The firm's chief executive officer Michael Cleary revealed that the firm was in "scenario planning" with such groups.
With the implementation of the Government's white paper on legal reform looming, the issue of alternative structures for law firms is high on the agenda. News that a fellow professional services firm was already in talks to sell a chunk of the business is only likely to increase the likelihood of a similar deal happening with a law firm, once the regulations allow.
The Lawyer went to meet Cleary to hear first-hand his reasons for taking on the role of cheerleader for structural change. Heading the list was profitability.
"Profitability is vital to attract and retain the best people, who in turn generate the income and develop a business," says Cleary. Both the legal and accounting markets have been relatively stable for many years, he argues, but the past few years have seen both start the process of what are likely to be fundamental changes.
"For lawyers, what you've seen is this enormous US growth of firms and predator activity," says Cleary. "There has also been an increase in commodity-based services that can be delivered at a very high level of profit.
"There's a parallel there to the airline industry, where the budget airlines have shown that you can make a lot of money if you focus on a commodity and do it well, efficiently and cheaply. If you're not in the commodity market then what are you?
"You have to focus people on buying your technical excellence. And for that you need the very best people, which takes you back into the need for high profitability and the need to develop the brand."
Set against the context of those changing legal services characteristics is the very nature of partnerships. There is a huge degree of loyalty to the partnership model in both the legal and accountancy markets, as Cleary points out.
"Partnerships have been very successful," he says. "They're very flexible vehicles. You can change them at will. There's no outside interference, they're not in the public view, and therefore they're not easily dispensed with. But as firms grow, and in particular become more complex, so the basics of partnerships change. Partners may no longer understand the profitability drivers of the individual parts of the business."
Those drivers are what Cleary sees as key to the requirement for external capital, be that via private equity or an IPO. "If a firm is developing specific services and specific markets, then inevitably there will be tensions between the profitability of the different parts of the business to deliver different levels of profit," he says. "And these will have different investment needs, which may require different management structures."
Crucially, the ability to make what Cleary calls "a quantum shift" in scale may require external capital. "I stress the 'may'," he says, "because you could equally borrow money. But to make a quantum shift to produce premium profit that you wouldn't otherwise have earned - and that's the critical feature, actually changing the fundamental profitability characteristics of your business - there's a case for some sort of private equity, which may or may not lead to an IPO."
For law firms, just as for accountants, there are two crucial decisions: do you want to make that quantum leap, and if so what sort of investment is that going to be? Grant Thornton's average profit per partner of around £370,000 could be catapulted beyond the big four's £500,000-plus with the right deal, which is something Cleary is exploring. The firm has been conducting a strategic review to outline the areas on which it will focus over the coming years. International restructuring and financial markets are just two of the groups that are likely to feature highly, but Clearly is aware that building these areas significantly will require funds. Attracting private equity investment may be the way to do it.
"To build those two [areas] may require us to look at our funding," he says. "And I do stress the 'may' - it's preliminary. An announcement isn't about to be made. But discussions are taking place and, in my view, it will happen."
The preferred route is a private equity investment, which according to Cleary "has the benefit of developing part of the business for the benefit of the whole to get it into a shape where you can go to market with a very attractive offering". The exit from that investment would then most likely be an IPO.
"We're deep in debate about this and partners' attitudes will vary," he says. "A significant number will believe in the traditional partnership structure, and that structure and culture has been very successful. Don't deny its success. But the debate is coming to a head."
Next month, Grant Thornton will hold its annual partners' meeting, at which Cleary will outline the results of its current strategic review. The proposals for a private equity investment will feature.
"We won't be presenting it in a concrete way, but we'll be presenting clear guidelines that will move to a decision point," he says. "I suspect that's a little way away. You're probably talking a couple of years, but not much more than that.
"We're not at the stage to know percentages, so don't ask me about p/e [price to earnings] ratios. But I don't think partnerships will necessarily be the acceptable way forward for larger, multidisciplinary businesses for very much longer."