Deal analysis

Law firms on private equity agenda

With the introduction of the Legal Services Act, law firms are becoming an increasingly enticing prospect for private equity, says Simon Sale of Dundas & Wilson.

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At a glance

  • Newly introduced Alternative Business Structures have allowed much greater competition
  • The legal industry is edging towards a phase of consolidation
  • The first private equity investment in a law firm has already been made – Palamon and Quality Solicitors
  • A successful investment will have to overcome some cultural obstacles

The days of consumer-focused legal brands are coming – if they haven't already arrived. Following the recent implementation of the Legal Services Act 2007, the consumerisation of law firms is here to stay and the world of the high street firms has changed forever.

In October 2011, Palamon Capital Partners invested in Quality Solicitors (QS), a high street legal brand started by ex-barrister Craig Holt in 2009. Palamon's was the first major investment in the sector from a private equity firm.

The growth at QS has been impressive as it successfully addresses one of the main challenges facing local law firms: the acquisition of customers in an increasingly competitive and sophisticated marketplace. The establishment of a real high street brand will, I believe, over the next few years, transform the way consumers choose and purchase high street legal services. In the short term, it does seem as if the high street firms, where commoditised legal services are provided, will be principal beneficiaries of the initial investments. Of course, it won't stop there – private equity and other investors will inevitably move to the commercial end of the legal market. For now, though, there are plenty of opportunities to target.

The legal landscape is changing rapidly and while many law firms are adjusting positively to the new environment, many others are getting left behind. The industry is edging towards a phase of consolidation as we have seen across numerous service industries including dentistry, healthcare, care homes and the accounting profession.

ABS explained

Alternative business structures (ABS), introduced under the Legal Services Act, are a new form of practice that will allow non-lawyer organisations to provide legal services and give lawyers much greater flexibility in the way they practice. The purpose of the act is to allow greater competition in service delivery and innovative ways of meeting consumer demand. The introduction of ABS will permit lawyers and non-lawyers to share the ownership, management and control of the business which provides legal services to the public and will also permit external investment.

The final stages of the legislation remain to be implemented; ABS can't be authorised by the Solicitors Regulatory Authority (SRA) until it is a licensed authority. The SRA has applied to become a licensed authority for this purpose, but a parliamentary process needs to be followed to designate it as a licensed authority with secondary legislation needed to give the SRA the necessary powers. This is expected towards the end of this year, or early next year.

There are many reasons why private equity investors are interested in the profession, including:

  • The market is ripe for consolidation – economies of scale
  • While many think they are, not all lawyers are natural managers. On the counter side, some lawyers simply enjoy being lawyers. While this is not a reason for needing private equity investment, the legal profession could benefit from its operational and management skills. Lawyers advise on risk and by nature are risk-averse – they will not find it easy to cede control to external investors
  • Law firm structures are, on the whole, inefficient, with many still run as partnerships. There are savings to be made and scope for revenue growth from simple structural changes. Many partners fear the change to a corporate structure would result in a loss of collegiality. However, while loss of collegiality is a phrase heard all too often law firm partners, one could argue that collegiality develops around the people themselves rather than the structure

QS has deployed a marketing piggy-backing strategy by taking advantage of the high footfall traffic in busy WH Smith outlets, advertisements using the celebrity Amanda Holden as brand ambassador, as well as targeting other media to raise awareness. It now has significant financial resources to support advertising and marketing, and drive economies into the businesses and improvement in services offered to their customers.

Law firms need to either be prepared to implement change or accept that unless they restructure and take the lead themselves, such as becoming a niche specialist provider, those firms will become vulnerable to the increasingly competitive market. That said, neither the private equity industry nor the law firm revolutionaries should underestimate the cultural obstacles.

Simon Sale is a corporate partner at Dundas & Wilson.