From Partnership to PLC
This article is part of our Future of the Professions series and is based on a roundtable discussion entitled From Partnership to PLC which was convened by Jericho Chambers and Stifel on the 28 March 2019.
5 mins.
It is now eight years since the introduction in the UK of the “Tesco Law” which sought to break the barriers to ownership of law firms. Its aim was to make consumers’ purchase of legal services as straightforward as shopping for a can of baked beans. It was to be the equivalent of the 80s Big Bang when British stockbroking was deregulated and consequently boomed.
The legal Bang is not yet that loud or large. Maybe it’s harder to be a lawyer than a stockbroker. Or maybe the legal system has proved more resistant to change and allowing outsiders in. One route opened for law firms was access to outside capital by floating on the market in London. However a mere six firms have to date gone for this option, raising £253 million between them. However, five have taken the plunge within the last 20 months. The pace may be quickening. But none of the huge Magic Circle international firms have chosen to take this course. If asked why they would most likely say there is no need to: partnership still works for them, there is loads of work about and equity partners at the top of the pile do very nicely. The average turnover per partner at top firms is £800,000.
"Now the question is when does a top 30 legal firm put its toe in the water?"
These leading firms generate huge volumes of cash - the turnover of the largest 100 was more than £24 billion last year. Margins are good - often over 30% - and they are resilient to downturn. Nevertheless, with so much global capital looking for a lucrative home and a decent return one would have thought that IPOing of law firms would have become a big business by now. But there are a number of reasons why this isn’t the case - the unusual culture of legal partnership being one. However, the last firm to go - DWF - was, by some margin, the largest and was the first to be listed on the main market. Now the question is when does a top 30 legal firm put its toe in the water?
Our roundtable discussion was the third in the series supported by the investment bank Stifel which was closely involved in the flotation of DWF. The first speaker was Nicola Foulston, the CEO of Rosenblatt which floated on AIM in May 2018 at a valuation of more than £70 million. Foulston has led a fascinating career. She cut her teeth at Brands Hatch motor racing circuit in the 80s where she turned the business round and sold it for five times money. She has run family offices and been involved in manufacturing across the United States. (When she sends out her resume it concludes with, “She has a reputation in the City for reliability, trustworthiness and delivering on time.”) A client of Rosenblatt for 30 years she became CEO of the firm in 2016 and then floated it on AIM in May 2018 at a valuation of £70 million plus.“Coming into the legal sector,’ she said, “With its view of the equity partnership model which is supposed to promote collegiate behaviour plus careful succession planning, I rapidly concluded it wasn’t suited to modern times or fit for purpose. It felt similar to Brands Hatch in the 80s - a sector that was utterly focused on regulation, engineering, Formula 1 and didn’t realise that actually it was about selling tickets, ice-cream and T-shirts. (Plus, of course, those awful burgers.) It was about bringing a focus that turned outward to the client.
“Similarly, when you arrive in legal services, there’s a lot of talk about the product and almost in a dictatorial fashion telling clients what they should want to do or should need. The focus wasn’t on being led by the client; they’re used to telling the client want to do.
“I also felt, quite strongly, that the partnership model wasn’t meeting the objectives that it was set out to do and that to a degree, that it’s contrary to human behaviour. You still end up with cabals at the top of these very big firms, operating in a similar way to a commercial firm. But there was cronyism, reward for those that were favourites and a failure to recognise entrepreneurial behaviour because it went contrary to the conservative approach of the sector. To be a lawyer for 20-30 years and then get voted in as the managing partner of a billion dollar company is to me insane.”
Nicola felt there was a better way to build employee retention in a tight legal labour market and create value for the future. This didn’t necessarily mean floating and could be a private PE model. Either way the professionalisation of the sector was long overdue.
John Gapper, Chief Business Commentator on the FT takes an interest in the legal sector has written about how, “Law firm partnerships are losing their lustre.” He agreed there were a number of forces pushing legal firms away from partnership including the end of lockstep remuneration schemes, lateral hires at partner level and ‘the Hollywood effect” in which star rainmakers, “with talent and a franchise can reach across larger global sectors and therefore accrue more personal returns with the brand at the top.”
Although law firms don’t require the capital pools of investment banks, Gapper believed the need for capital and increased financial strength put partnership under potential strain. However, the sense that individuals stand on the shoulders of others is definitely still there and its loss is perhaps to be regretted.
Gareth Hunt of Stifel explained that his firm’s research into the legal sector dated back to the financial crisis. There is not a little mystery surrounding law firms not least because of their privately held nature and few have dug around extensively inside the relevant financials.
"The margin of 31% or so was just the same, year in, year out"
“We did our research over ten years of financials via Companies House and produced a 400-page document. A number of messages came out. Firstly, the industry is optically very, very attractive with an amazing revenue profile. If you take the largest 40 firms over a five-year period only one hadn’t grown despite the huge scale of the Magic Circle. The margin of 31% or so was just the same, year in, year out. That was the sort of thing investors would cut their arm off to acquire. It was the cashflows that revealed problems - working capital and the very poor payment terms they accept from their clients.”
One participant expressed amazement that the legal sector was on the only one she’d ever come across where money was borrowed to pay the VAT bill. A structure in which all the money is taken out by partners distributing profits at the end of the year and a re-start on Jan 1st with almost nothing in the tin is odd among businesses in the 21st century.
If outside investment was being sought two critical factors were identified. Firstly, finding a way to incentivise employees who are 25 and 35 as opposed to over 45 and secondly, how to make structures look durable over the long term for investors. “The market isn’t really that interested in firms that simply wish to sell the family silver and then be gone in five years which leaves nothing for the junior layers and/or the shareholders - everyone will spot that sort of transaction for what it is,” said one panellist.
For a relatively new idea it seems that the process involves a certain amount of trial, and error. Not every firm is the same and different cultures require different approaches. “We’re still trying to frame the terms of the debate,” said Gareth Hunt.” With DWF the model was built literally employee by employee - we got to know how each member of the firm was incentivised and how much dividend they would get from their equity, what their salaries were. That showed us how critical culture is and how each firm is distinct.”
Several participants reminded that markets would always express the desire to know precisely what any finance raised by floatation would be used for. M&A is one obvious use - growth by acquisition. If money was simply going to founders of a business or, for example, as was the case with Rosenblatt to fund litigation finance.
Jonathan Cheney of Addleshaw Goddard said, “Whilst the advantages of an IPO are likely to be more applicable to firms who have already achieved a certain critical mass, and who have significant growth ambitions, ironically the bigger a firm is the harder it’s likely to be to IPO both from the point of view of getting all partners on board but also from a regulatory perspective - international structures can present many challenges.” In the USA partnerships are forbidden to float on the markets.
"That structure isn’t really operating like a partnership"
Sarah Chilton of CM Murray agreed that size is hugely important: "I like the partnership model, what it stands for and the collegiate sense that it engenders. But you get to a certain point where it becomes harder. It often becomes all about bottom line profit and inevitably and necessarily it ends up not being run by all the partners but a small group of them. Sometimes these are the very successful lawyers which in all cases are not necessarily the best managers. That structure isn’t really operating like a partnership as we used to know them. The other major factor that will likely lead to change is generational differences. There is a huge difference between existing partners and those just coming out of university and what they expect and want from life, if we don’t have future lawyers aspiring to partnership then that will threaten the continued use of the partnership model.”
So, what does the future hold? Few thought that any of The Magic Circle would IPO any time soon. They perceived no need to do so. But rivalry between firms will play a factor.
One participant observed: “The dominoes will get slightly bigger. The next one to go will be slightly bigger than DWF and so on. Eventually we will get to the Magic Circle but not for some time. When something like A&O floats that is when Freshfields will listen. Because they are so intensely competitive that they will see a rival they know being worth £10 million in shares and he’ll meet this rival in the golf club and he’ll be jealous. That’s when he’ll try to talk them into it at the next partner meeting.”If, however, one of the existing floated firms proved a serious let-down from an investor perspective then trouble could lie ahead. “I think the sector could cope with one going wrong,’ said one participant, “But multiple failures would be very damaging.” You can brawl over earnings division and fail behind the scenes as a partnership but fouling up as a PLC is a very public business.
The panel members included:
Nicola Foulston, CEO Rosenblatt Solicitors
John Gapper, Associate Editor and Chief Business Commentator, FT
Gareth Hunt, Managing Director, Corporate Broking, Stifel
Jeremy Black, Partner Deloitte
Jonathan Cheney, Partner, Addleshaw Goddard
Sarah Chilton, Partner, CM Murray
Edward Gill, Head of UK and Europe, Cognia Law
James Gordon, Partner, Gordon's Partnership LLP
Stewart Wallace, Director, Business Services Stifel.
It was chaired by Matthew Gwyther from Jericho Chambers.
