Practice management | How much external investment have law firms really seen?

External equity has been allowed in law firms since the start of last year, and there's still plenty of talk about investing in law firms. The Law Society LMS Annual Financial Benchmarking Survey, published in January revealed that one in five respondents were likely to seek external investment for expansion. At a recent conference, a number of speakers representing equity providers expressed views ranging from "external investment is the best way to ensure the future for firms" to "law firms will continue to be unattractive to private equity investors until they improve how they present their financial situation and partners invest their own cash". Interestingly, both of these quotes came from the same speaker!

So how much activity has there really been, and what is the outlook for traditional firms? Of course we've seen corporate capital involved in growing Co-operative Legal Services, as well as the legal services offered by Saga and the AA. We've seen Slater & Gordon's acquisition of Russell Jones & Walker financed via the Australian stock market. And there's been some modest personal capital invested by a handful of non-solicitor individuals, such as legal executives and practice managers. A large number of the 139 licensed ABS entities as I write fall into this category.

ABS trends

There seem to be some clear trends emerging in what we might refer to as the traditional investors' arena.

Personal injury is a clear theme - Slater & Gordon grew its business in Australia with PI work at the forefront of its strategy, and when the conditions were right to enter the UK market, it targeted a leading UK personal injury firm.

Any mention of personal injury is generally followed by insurance, and that seems to be the second thread of this theme.

The prime example here is Quindell, an AIM - listed company which has been busily growing an end-to-end solution for the insurance claims industry with a series of strategic acquisitions. Claims flow through Ai Claims Solutions, Accident Advice Helpline and also from contracts with (among others) the RAC. Recently-acquired law firms Silverbeck Rymer and Pinto Potts handle the legal work. Mobile Doctors and Overland Health take care of diagnosis and recuperation respectively, and law costs draughtsman Compass Law was brought in to keep the whole operation efficient.

Of course when claims arise there is a need to defend, and in this area of work we can see a recent investment too. Keoghs, the only top 100 firm to focus exclusively on defendant insurance work, acts for insurers, government and public bodies and large corporate and handles around 40,000 claims every year. In November last year LDC announced a significant investment into this 45-year-old firm employing more than 1,200 people. This is an investment into systems, processes and management, where the existing owners and their investors clearly see growth potential.

There have been some more generalist investments, and an example can be found in Brilliant Law, founded by Betfair creator Bert Black, who is reported to have made a seven-figure investment into a firm which will offer fixed-price legal services to SMEs, including share agreements, employment law, dispute resolution and company formation. Black has built a management team which includes former Minster Law CEO Matthew Briggs, ex-BSkyB director Jeremy Fenn and former WeBuyAnyCar.com marketing director Paul Coulter. At launch, Briggs said that additional external investment would be sought in the third quarter of 2013, and did not rule out a stock exchange flotation in the future. Whatever your thoughts on the prospects for this firm, the man at the helm surely understands ?the odds!

I've been told to expect more cases of ABS entities being formed involving links with Independent Financial Advisors, and this does seem logical for firms doing private client work, especially those which service high net worth individuals.

What do investors want?

Leaving aside for a moment the practice managers and legal executives at law firms who have assumed an ownership role, investors tend to be pretty clear about what they expect when they invest. They expect a return for the risk they accept, and they want some certainty about that return and how it will be achieved. On stock exchanges, investors will want to see share price growth or dividends - preferably both. Other investors will want to ensure they see significant capital appreciation (at least double) and a clear path to crystallising that gain, typically through a flotation or a sale. They need to be certain, therefore, about the difference that their money will make and the nature and timing of their exit strategy at the point of making their investment.

It's worth contrasting this with the approach taken by the traditional law firm investor - the practitioner owner-manager. Here we have an investor who makes an investment upon becoming a partner and expects to take the same sum out again upon departure many years later. Rather than growing value in the firm's balance sheet and reinvesting for growth, the emphasis in 'traditional firms' has been upon maximising drawings to keep wealth outside of the business. This makes long term planning and investment in IT problematic, and makes it difficult to compete with the new players.

New entrants

So is the game up for traditional law firms? I see no reason why independent firms cannot prosper provided that they are prepared to make some changes and understand the areas where they can compete effectively. There are certain areas of law that lend themselves easily to a process-driven approach, and it will become increasingly difficult to compete in those areas against new entrants who have invested heavily in IT and process management. However, just as fast-track personal injury cases can be regarded as a commodity, the more complex cases involving catastrophic injury or clinical negligence may be better suited to the more bespoke legal service and skill set that independent firms can offer.

At Lloyds TSB Commercial Banking we know that most of our solicitor customers are financed by a combination of owner capital and borrowed money, and the challenge for many is to get the balance between those two in the right order. Too much debt makes firms vulnerable to running out of cash - even if they are profitable. The partnership model does nothing to encourage the retention of profit and the building of a sound balance sheet and as a result many of our law firm customers are thinly capitalised.

Even though there has been a move towards LLP and full incorporation, most balance sheets still reflect solicitors firms' partnership beginnings.

Despite a flat economy, and forecasts of no more than three quarters of a per cent growth during 2013, many of our solicitor customers are performing well. We recently took a look at the characteristics of the more successful firms, because we wanted to understand what set them apart from the rest. Interestingly, we found it was irrelevant whether the firm was an ABS, a limited company, a LLP or a traditional partnership - it was all about behaviours. The key differentiators were these:

? Successful firms understand clearly ? what their market is, whether they ? define it by geography, the area of legal ? work they deliver, the way they deliver ? it or the steps they've taken to be more ?approachable. They don't dabble outside ? their sweet spots.

? Strong performers have a real ? understanding of the difference between ? process and advice. A young first-time ? buyer might see a conveyance as ? nothing more than a process and see no ? need to pay more than the minimum ? price - they'd love to be able to do the ? whole thing using a smartphone app! ? By contrast, older buyers conducting ? a sale and purchase which is part of ? retirement planning, involving IHT and ? wealth management, will be pleased ? to pay for advice because the conveyance ? is part of something bigger and very ? important to that individual. Well-? managed firms will ensure that the right ? questions are asked before quotes are ? given, and understand the need to offer ? different services and price points to ? clients even though the basic legal ? process is the same.

? Profitable firms tend to invest in ? accessibility. This could mean flexible ? opening hours, interactive and well ? designed websites, using mystery ? shopper techniques to test how ? enquiries are dealt with and ensuring ? that clients can check the progress of ? their matters easily.

? Firms which invest in IT are able ? to manage their business far more ? effectively. Even in the 21st century, we ? have customers who only have ? historical financial information ? available. That's like driving a car and ? using only the rear view mirror. Firms ? which have invested in IT can produce ? up-to-date financial information, ? forecasts, fee-earner performance ? information and client relationship ? management data which can drive client ? contact programmes.

? Our final observation was to do with ? management. Say that word to some ? solicitors and what they hear is 'admin'. ? If what they hear is 'leadership', we ? know we have a winning team in place. ? Law firm owners have to balance ? the three roles of investor, manager ? and practitioner, and too many spend ? the overwhelming majority of their time ? being a practitioner, try to find some ? time to be a manager, and completely ? forget the fact that they're investors ? too. Strong management teams take ? their investor and leadership roles ? seriously and are also far more likely ? to seek external advice, whether this is ? from an accountant, a specialist banker, ? a membership group or even a non-? executive director.

There's no doubt that external investment can be transformational, but it also involves surrendering independence and adapting to corporate thinking. That won't suit everyone, but our most successful customers are showing how it is possible ?to be competitive while still maintaining ?their independence.