American frontier: Expansion strategies for overseas law firms

In our article 'Going for growth' in the previous issue of Managing Partner, we explored some of the factors to consider when expanding your law firm's operations. Here, we assess the United States as a possible destination.

Boasting the largest national economy in the world, political and currency stability and the availability of well-educated employees, the US is an attractive option to consider when expanding. But, while English is the most universally-understood language, the business terminology in the US is fairly unique for firms looking to set up there.

The US legal sector

The US has the largest market for professional services in the world, with approximately 770,000 firms. At 22.1 per cent of total revenues, legal firms accounted for the largest proportion of professional services revenues and generated US$294.4 billion in revenues in 2012, driven by a rise in litigation cases, investigations and international arbitration.

Approximately 80 of the world's largest law firms (by revenues) are based in the US. However, the US legal profession is highly fragmented, with the 50 largest firms accounting for less than 15 per cent of total revenue. The smaller firms tend to serve niche areas of the market or particular states, presenting opportunities to law firms that are prepared to offer something different.

Entering the market

A decision will need to be made as to whether local law will be practiced or foreign law (normally from the location of the expanding firm). To practice local law, the quickest route to enter the market is to merge with a US law firm.

US law firms often have high PEP and may therefore be difficult to attract into a merger if the merger partner will be dilutive in the short term - unless it is facing commercial challenges of its own. However, US firms have had their own challenges in expanding outside of their home market and may see a merger as giving them access to new clients that they can also service in North America.

Foreign firms focused on giving non-US legal advice in the US will often have a deliberately small presence in the country. This gives them the advantages of limiting their investment exposure and providing a service that domestic US firms do not have. Here, competition is with other inbound firms and with US firms with overseas capabilities.

Where foreign law will be practiced, expansion will generally start by one or more partners regularly visiting their clients. If the firm has a particular sector focus, its clients may be centred in a particular state which has strengths in this area. This gives the opportunity for the firm to expand into the US with only one or a few offices and for it to be where its clients are - something that US clients value.

Opportunities for growth

As US organisations become more complex and outsource an increasing amount of work to outside firms, the opportunities for law firms are potentially huge. According to BTI Consulting, legal spend by the Fortune Global 500 accounts for two-fifths of US corporate legal spend and is growing at a compound annual growth rate of 7.2 per cent.¹

Meanwhile, the legal outsourcing market has been expanding by a third each year for the past three years, according to the LPO Program, and the formerly 'cheaper' outsourcing locations in the BRIC locations are falling out of favour.² The opportunities for US-based companies and their advisors are significant.

The US is a highly competitive market, so understanding your offering is key.
In the past, general legal practitioners
used to flourish; laws and the legal system were readily transferable and no specialisation was necessary. With more legislation came the need to become involved in a specific practice such as criminal law, corporate law or family law. Now there are even more opportunities
for firms serving niche sectors.

In 2008, a raft of top law firms set up offices in Silicon Valley, despite the recessionary conditions. Big-name firms such as Kirkland & Ellis and Reed Smith set up offices to address the increasing volume of corporate and IP law cases, which were being borne largely from the lucrative technology ventures springing up across the valley.

Similarly, Texas is home to specialist oil attorneys, whilst rural areas such as Kentucky have a number of thriving equine law firms (such as McBrayer, McGinnis, Leslie & Kirkland).

Law firms that are retained to influence political decision makers need to be well connected. International firms will struggle to get into this sector without those connections and, therefore, expansion into this area lends itself to a merger situation with an established firm.

There is also an opportunity to provide legal expertise on M&A, particularly with an increasing amount of deals requiring the services of law firms with specific sector knowledge. There were more than 11,000 M&A deals involving US companies in 2013, with an aggregate deal value of US$1.16 trillion, according to Thomson Reuters and Bloomberg.

Given that businesses are now beginning to spend the revenues they saved up during the recession on inorganic growth strategies, the opportunities for acting in M&A transactions are set to be even stronger in 2015.

Larger law firms have been asked to act on some of the highest-value transactions ever recorded recently, with many of those originating in the TMT sector. These range from Comcast's US$17 billion purchase of NBC/Universal Media from General Electric to Verizon's US$130 billion buyout of Vodafone's 45 per cent stake in Verizon Wireless.

The energy sector is also another important market for M&A in the United States. Due to the shale boom in Texas, companies have been looking to expand or cash out. The state's energy sector accounted for 70 per cent of its largest M&As in the first half of 2014, with deals involving Houston companies amounting to $10.7 billion during this period, according to bizjournals.

Consider the state

The US is a large market ripe with opportunities, but its size and scale can also cause significant complexities. Different states have different rules on taxation (in addition to federal taxes), regulations and even time zones, all of which need to be taken into consideration.

Each state also has differing regulatory requirements for the licensing of foreign lawyers. You should therefore consider if the regulations relating to your business allows it to own the US operation via the UK or if it will need to be structured as a separate entity in order for your lawyers
to practice.

Partnership structure

The tax treatment of certain US structures, such as limited liability company, may be alien to those based outside of the US.

Some structures, depending on their legal set up, whilst taxed in the US as a partnership, are treated like companies in different jurisdictions and are taxed as though partners receive a dividend when profits are distributed. Understanding this is key to ensuring the parties involved get tax relief for the relatively high rates of tax paid in the US.

When considering appropriate structures for expansion, consider ringfencing the profits that will be subject to US tax to protect the profits of the wider firm.

Structuring so that US start-up losses can be set against a partner's wider taxable income can also be attractive, reducing the after-tax burden of the initial investment. Care will be needed to prevent every partner from being required to file a US tax return, while giving them access to the expected future US profits.

Working culture

The working culture in the US should
not be overlooked. It is not uncommon
for partners to move firms with little notice, taking their clients and associates with them. The median length of service in a professional service firm in the US is 4.2 years, according to the Bureau of Labor Statistics.

Research by the Center for Economic and Policy highlights that the average paid vacation provided to workers in the United States is just 16 days in total - this would not even meet the minimum required by law in 19 other rich countries. Furthermore, the United States is the only advanced economy that does not require employers to provide vacation time. This creates a real onus on law firms to ensure both partners and staff are incentivised and rewarded in line with local norms to stem attrition rates.

Next month, we are going 'down under', with a guide to expanding
into Australia.

Anna Jarrold is head of professional services taxation at BDO
(www.bdo.co.uk)

Endnotes

1. See BTI Market Outlook and Client Service Review 2014, The BTI Consulting Group, 16 January 2014

2. See Legal Services Outsourcing: What it is & how it could help your legal practice, CPA Global, October 2012