How can law firms raise extra capital? Either go to the bank or, as some are considering, float on the Alternative Investment Market. Jon Robins weighs up the alternatives


‘Who will be the first to float?’ the legal press has been asking recently. Speculation might seem a tad premature given that the Legal Services Bill has yet to make it on to the statute books. Indeed, the recent report by the joint parliamentary committee scrutinising the Bill expressed considerable misgivings over alternative business structures with their potential for ‘an undesirable conflict between shareholders and lawyers’ (see (2006) Gazette, 27 July, 1).



But whether the fears of MPs will stand in the way of progress remains to be seen and, certainly, they are not standing in the way of law firm scheming.



The most likely place for firms to launch would be the Alternative Investment Market (AIM). Manchester-based Halliwells has been identified as a front-runner in the race to be first to take the plunge. ‘The purpose of the legislation is to improve the efficiency of the provision of legal services, and we’re obviously keen to improve our services,’ explains managing partner Ian Austin. ‘It seems to me the starting point is: “What will be gained by considering third-party investment or a flotation on AIM?”’



He goes on: ‘You have to think what you would do with the investment. It seems to me, it might well be attractive to some firms to have a war chest of funds to expand the business, invest in infrastructure etcetera. We’re keeping a close eye on what’s happening.’



So have the concerns that third-party investment represents too great an erosion of lawyers’ independence been overstated by commentators? Mr Austin thinks they have. ‘At the end of the day, it’s a third-party private equity investment in your business. You are already successful and the person who wants to invest obviously wants to see that investment continue to be successful. Where commerce can help is in providing the infrastructure and development of the business.’



What makes an AIM flotation so tempting? ‘It’s attractive to those partners who would like to realise capital value because it is an established market and perceived as a way of getting expert investors involved,’ says George Bull, a partner and head of professional practices at accountancy firm Baker Tilly. ‘This is the moment when partners might want to effectively cash in. Of course, there also has to be something in it for the external investor.’



He predicts a few – ‘and I really mean a relatively small few’ – listed law firms. ‘Most firms with a business plan requiring additional capital are simply going to go to the bank and borrow on normal business terms, because debt is relatively easy to service, and there are none of the extra disclosure requirements,’ he says. Many successful family businesses over the years have ‘listed and then delisted’ as a result of disclosure provisions.



Mr Bull sees three types of practice possibly contemplating an AIM listing. First, what he calls the ‘straight listing’, which is done ‘partly for business expansion and partly for capital realisation’. Second, there are those firms that are ‘following the original Clementi thinking’, where there is ‘a great business model with the potential to put through high volumes of business at competitive prices but lacking in infrastructure’. Third, there are those firms that are following what he calls the ‘consolidator route’, where they go round the market acquiring small- to medium-sized firms, as has happened in the accounting sector with mixed results.



‘It’s quite likely that there are firms that will be big enough to be of interest to the AIM market,’ reckons Tony Williams, former managing partner of Clifford Chance and founder of legal management consultancy Jomati. ‘But we have to get the legislation through first in its final form. The devil will be in the detail and that will depend on the oversight regulator the legal services board when it’s established. I suspect that will be at least two years away.’ He maintains that with firms increasingly operating as limited liability partnerships, they are more used to the rigours of ‘proper accounting standards’. He adds: ‘So it isn’t that much of a difficulty to take the next step.’



But Mr Williams continues: ‘The issue is to make sure that there is fairness between partners and generations of partners, and making sure the firm is an attractive place for younger people to want to become partners. That’s a challenge, but I don’t think it is insurmountable.’ He adds that there are real advantages for partners in relation to the selling of shares when they float, and subsequently, which may only be subject to capital gains tax at a top rate of 10% compared to normal income from partnerships taxed in excess of 40%.



Douglas Preece, a specialist in partnerships at City firm Fox Williams, reckons there are two drivers that may tempt a firm to float – as a capital-raising exercise and to provide an exit for the current partners, giving them a windfall. ‘They get to own any part of the firm going forward in perpetuity, which normally they wouldn’t,’ he says.



‘There will be a lot of people who would love to have the windfall that a payout would generate,’ acknowledges Simon Young, who represents the Law Society’s law management section on the Law Society Council. ‘But anyone buying into a firm would be very careful about getting some sensible lock-in to prevent partners leaving.’



AIM is an option that he feels will not have huge relevance to the small and medium-sized firms that he specialises in advising, except perhaps for those concentrating in commoditised provision, such as residential conveyancing or personal injury claims.



‘Those firms that are short of cash required for the necessary IT infrastructure might well look to outside capital,’ he argues. ‘Alternatively, they might feel they would be well served by getting an outside management team in – that’s why venture capitalists might be of help.’ It should be noted, though, that thus far there has been no reported take-up of the existing provisions which allow solicitors to share fees with non-lawyers, for example in exchange for IT.



Mr Young suggests that firms going to the market could hasten the trend to consolidation, as the principle of law firm cross-subsidisation – whereby profitable areas of practice pay for more poorly-remunerated ones – is put under scrutiny.



Mr Preece predicts that the firms most likely to list would have a market cap of £50 million. ‘We have seen with the accountants that some firms have been listed, but those firms have not tended to be the larger practices. That’s probably because they are so big that they can generate enough funds internally without having to go to a public market.’



Will firms have to shape up to appeal to outside investors? ‘Definitely,’ says Mr Preece. ‘The management format would need to change and the reporting ethos would need to change as well. Management would have to make decisions bearing in mind the impact on share price and the public perception of the business. And these are issues that aren’t at the forefront of law firm managers’ minds.’



Sacha Romanovitch, professional services partner at accountancy firm Grant Thornton, adds: ‘Firms will need to streamline their boards, and appoint non-executive directors who have enough knowledge to challenge the board on their plans. There is going to be a shortage of those people available.’ She adds: ‘How many plc boards do you see with an election for the managing partner? It’s a nonsense.’



How much money might a firm be able to raise? ‘Hang on, I have a piece of string in my pocket,’ replies Mr Bull. Mr Williams is more prepared to have a go. He says: ‘You can certainly see firms raising £10 to £20 million as a first tranche. The question is what they do with that. They might give some of that back to their partners to ease succession issues and they might use some of that as a war chest to make lateral hires to beef up a particular area, or better IT.’



When law firms rule out the possibility of a flotation, Mr Williams tells them that that is ‘a legitimate business response’, but he also reminds them how they might feel if their competitors go for it and, for example, spend £5 million on lateral hires. ‘What threat is that to you?’ he asks. ‘But also what opportunity does it represent? It could be that the firm that floats will have some partners who feel that their birthright that has been sold out.’



Jon Robins is a freelance journalist