Recently, the legal press has been full of reports of firms applying for alternative business structure (ABS) status. Notably, in the last couple of weeks we have learnt that Irwin Mitchell’s application has been granted and that insurance firm Parabis is set for a £50m cash injection after being granted an ABS licence by the Solicitors Regulation Authority. In a previous blog we commented on how external investors may structure their deals with law firms and noted they may insist on locking-in partners for a number of years in order to protect their investment in the firm’s human capital.
Continuing with this theme, a key consideration for any law firm looking for an external investment is whether such investment will end up eroding the firm’s culture or whether external investors will seek to impose their own, more corporate-based, culture.
In order to understand whether external investment may have an impact on the culture of the firm, one needs to ask what does 'culture' actually mean? There is no one answer which applies to all firms but solicitors may argue that it can be best described as the common approach used by a firm’s members and/or management teams when handling various situations or making decisions. This will manifest itself in a number of ways from, for example, how internal policies on HR or recruitment are drawn up, to how budgetary and strategy decisions are made or conflicts are handled.
It is unlikely that private equity firms, for instance, will be looking to make immediate wholesale changes to a firm’s structure and ethos as this may introduce a much higher level of risk to their investment than they would be prepared to live with. They are more likely to carry out thorough due diligence at the outset and invest in firms that are structured more along corporate lines and which can demonstrate a track record of strong management and leadership. Such firms are likely to have an established culture, which is likely to be resistant to change.
External investors, however, will expect to be represented on the firm’s management committee and have the right to oversee any strategic decisions. If a firm continues to be run by the same management team, it is difficult to see how an additional face in the management team will lead to an apocalyptic clash of cultures. Certainly, this is unlikely to be an issue if the firm is meeting targets set by the external investor. However, the relationship between management and external investors will be tested if the firm is not performing well and falling short of its financial targets.
In such circumstances, an external investor is more likely to become less passive and seek to direct the firm’s strategy. Depending on how the firm’s constitutional documentation is drafted, the external investor may be able to do so without consensus. It is in these difficult circumstances where there is a risk that an external investor’s approach may be at odds with the firm’s usual way of handling certain situations.
For example, the culture of a firm will often dictate the approach taken by management on how to deal with underperforming teams or partners. It is very possible that external investors may not be as sympathetic or supportive and seek to force through more radical changes. If such changes are not accepted by some of the firm’s partners and, importantly, not communicated effectively to the rest of the firm, then such an approach may lead to the erosion of a firm’s culture.
Culture will also depend upon whether partners see themselves as owners of the business as opposed to temporary custodians of it. It is this unique view on succession planning and legacy which law firms have generated over decades which, at first sight, sits at odds with the more short-term investment objectives of private equity investment. However, if such objectives are not aligned from the outset, it is difficult to see why an external investor would part with its money and invest in a firm of solicitors.
It has also been suggested that there is a danger that external investors will exert a high degree of control which may compromise a lawyer’s independence, leading to situations where lawyers will act in the best interests of their external investors and not in the best interests of clients. This is unlikely. Solicitors will continue to be a highly regulated profession and client service will continue to be paramount in such competitive times.
Also, it is worth remembering that, at the time when many firms converted to LLP status, some commentators speculated that limitation of liability would perhaps lead to lawyers being less concerned about the quality of their advice since their own assets would not be at risk.
This has not been the case.
In conclusion, external investment will not necessarily lead to a detrimental change in firm’s culture particularly as, in most cases, external investors will be investing in a firm’s existing management and their business plans for the future. It is when such objectives are not met that relationships may become strained and lead to different approaches being adopted. This will also happen in firms that do not have external investment. The pressures of not achieving targets or surviving in such competitive markets are the reasons that firms will approach situations differently. An external investor, however, may not be as understanding as fellow partners.
Miguel Pereira is a partner in the partnerships & LLPs group at Lewis Silkin LLP, Fergus Payne (pictured) is a partner at Lewis Silkin LLP, and joint-head of its partnerships and LLPs group