Grania Langdon-Down analyses how law firms could benefit from external capital while Michael Simmons weighs up the pros and cons of having outside shareholders


A survey of corporate law firms found recently that one-third would consider a public offering on the Alternative Investment Market (AIM) or the London Stock Exchange, while others would consider increasing their financial resources through private equity or structured finance through banks if they were allowed to raise external capital. But if that means acquiring a new master, is it a price law firms will want to pay?


Solicitors’ practices have already started moving towards a variation of traditional structures through limited liability partnerships (LLPs). But if Sir David Clementi recommends a liberalisation of the rules governing outside investment and ownership of law firms, some will look ahead to what they see as a brave new world.


However, others are not so sure. One senior partner of a leading City firm, who prefers not to be named, warns of the price that would have to be paid if a law firm obtained a public listing. ‘If a law firm goes public, it acquires another master. I do not know how that conflict gets resolved,’ he says, insisting that partnership – although flawed – remains the best structure for firms.


Law Society rules have already been changed to allow fee sharing, so that firms can access external investment or, for example, IT equipment, but to date there is no evidence at all that any firms have taken up the option.



Shutkever: listing puts firms in strait-jacketThe survey of 82 corporate firms – of which 35% had more than 50 partners, 17% had 26-49, 17% had 11-25 and 4% had ten or fewer – was carried out by accountancy firm Smith & Williamson (see [2004] Gazette, 25 November, 1). It found that two-thirds of firms maintained that merger activity in the legal profession meant they would need to raise external capital. Only 17% ruled out accessing such funding, while 20% were either unsure or did not answer. Asked how they would access external capital, 72% said they would look at structured finance through banks, 43% said they would also consider private equity, while 35% would seek a public listing.


Simon Mabey, chairman of Smith & Williamson’s professional practices group, says: ‘I was surprised by the extent to which firms are thinking ahead and how imaginative they are, looking ahead to a brave new world. However, I think it will be like LLPs – with lots of firms waiting to see what others do first. You generally find leaders emerge and, if they are successful, others will follow after waiting to see if they fall flat on their face.’


William Arthur, director of professional practices at Barclays, is a ‘fan’ of the idea of such funding. ‘I think firms are actually constrained by only being able to look to themselves and a banker to finance their firms. The question is, are they ready to take the opportunity? The market is a hard taskmaster. It expects certain things to happen and it isn’t very  forgiving if they aren’t delivered quite as expected.


‘However, I can think of at least five or six firms in the top 50 which have said quite specifically that they will go down the route of an IPO (initial public offering). I think most of those could probably do it but I worry about the kind of percentage talked about in the survey because, as things stand, I don’t think that many firms are in a position to do it.’


Under the current listing rules, the minimum capital required for a full listing is £700,000 for a share listing and £200,000 for a debt listing. There is no minimum capital requirement for AIM.


Carol Shutkever, a partner in the corporate department of top-ten City firm Herbert Smith, explains what is involved in listing a professional services firm. She says it would be a ‘really radical change’ for a law firm to go for a full equity share capital listing. ‘If you go that route, the whole concept of partnership is dead because the economic interest moves as the shares are transferred in the market.


‘Other “people” firms have gone for full equity listings, though interestingly none of the big four accountants has been listed. But it would mean partners giving up their equity for, presumably, a pool of shares. At least 25% of the shares would have to be in public hands.’


However, Ms Shutkever says a firm that just wants to raise debt finance could get that debt listed through a bond issue. Another option would be to do a non-listed – that is, private placement – bond issue. ‘There wouldn’t be a problem getting a debt listing as an LLP, because it is technically a body corporate. It would also mean giving up a certain amount of control because there would be covenants, although there are also covenants with a bank facility.’


The big difference is that, once a firm is listed, there is a continuing obligation requirement to announce price-sensitive information – such as a big claim against the firm, a new senior partner or merger negotiations – immediately. It is also possible that client confidentiality issues would make the disclosure requirements difficult for a listed firm.


Ms Shutkever says: ‘As partnerships, law firms can look inwards at managing themselves. LLPs have introduced greater transparency but listing puts the firm in a strait-jacket and the question is whether it is worthwhile to tap into finance in a way that pushes you into that regime. However, a firm wanting to do something major – move to a new building, complete a merger, expand – might decide to go this route if it meant cheaper money. So, while I wouldn’t rule it out, it is a huge leap from where we are now, and I believe it will be some time before we see that model of working.’


She also says she cannot see structured finance or venture capital models working for law firms. ‘Overall, law firms will always have issues raising external finance because they don’t have many assets, other than the lease on their premises, to offer as security. Their value lies in their people.’


Stuart Popham, senior partner of Clifford Chance, the world’s largest integrated law firm, says: ‘We certainly don’t have any immediate intention of accessing either some kind of public equity offering or even an equivalent in some other form, such as preference shares. I am only just stopping short of saying never on the basis that you never say never.’


He suggests it is more likely that much smaller firms might seek private capital – ‘a classic sleeping partner’ – as a way of being able to invest in technology or if they were combining with the local accountant or other professional. ‘I don’t think it will be the big firms because they are able to borrow if they need capital for their own investment and, at this stage, they would probably be reluctant to share ownership.’


However, he maintains that the public is not well served by rules that only allow one form of business structure – ‘LLPs raise the question of why not a company structure?’ He favours some liberalisation, without making it a free-for-all, though he accepts that will include a degree of experimentation.


He also rejects the Bar Council’s fears about outside ownership of law firms. ‘I don’t see a particular difficulty in having a minority ownership by non-lawyers as long as the management remains with the lawyers.’ He says it would not expose a firm to outside influence anymore than a high street bank lending money to a barrister could tell him how to run cases.


Alan Hodgart, an independent legal management consultant, says that if law firms are allowed to seek external funding, ‘my personal view is that within three years 25% of the top 100 firms will probably do something of this sort – either an AIM listing or some other external source of funding’.


However, he maintains that it will require a stronger structure than an LLP to inspire investor confidence. Overall, he says it is a ‘nice concept but I struggle a bit to see why they would want to do it. Other than for new technology or a big new office, a lot of firms aren’t too bad on cash. I have worked on a lot of law firm mergers and not one of them needed someone to go out and raise capital to do it.


‘Many firms I know would be better off spending time getting clients, billing them and getting the money in than starting to worry about borrowing money.’



Grania Langdon-Down is a freelance journalist



Firms banking on Clementi to aid their expansion



Michael Simmons assesses how rules for raising finance have evolved in other professions



Most of the initial proposals in Sir David Clementi’s review have stirred controversy on all sides. One less contentious issue for some is that the legal profession should be able to have outside shareholders, albeit not involved in management.



There are many precedents within the professions. Insurance brokers and stockbrokers took this step many years ago, and it is interesting to see how they have evolved since. There are not many independent stockbrokers, and most are now part of the banking conglomerates. Insurance brokers are either in big financial groups, or still retain their independence. In other words, various routes have been followed.



There are no professional objections to incorporation, but only tax problems. Limited liability partnership status has been tailor-made to avoid this difficulty, but, if the rewards are sufficient, incorporation may not be so painful.



Simmons: banks find firms old-fashionedThe advent of tax-effective pensions for the self-employed from 1956 onwards reduced the pressure on solicitors to try to capitalise on their goodwill. This made for an easier market in the continuity of law firms. Sadly, bear markets and government interference have meant that pensions no longer perform adequately. The liberalisation that will allow outside shareholders coincides happily with the return to the concept of goodwill and the ability to capitalise on it.

Initial thoughts suggest that the largest law firms will float as public companies, but is this realistic? The partners are highly paid and mop up virtually all the available profits in their drawings. Any company floated on the Stock Exchange must offer a return to its investors on a regular basis. Dividends paid to outsiders will reduce the take-home pay of the partners. They will be converting income into capital, but this is not always satisfactory if you are used to living up to the limit of your means, not to say beyond.


My prediction is that most of the larger firms will carry on as before, with the partners considering themselves as trustees for the firm and for future generations. As partners, their rewards will consist of high incomes, and the knowledge that they have provided for their retirement. They will not seek to capitalise on their goodwill.


The contrary position exists lower down the market. Taking the parallel of the accountancy profession, up to now the so-called consolidators have not been over-successful, but perhaps this is because of market forces. Groups of practices have been put together under the umbrella of incorporation and floated on stock markets. In the US, large financial institutions did something similar with specialist medical practices. They too do not seem to have been excessively successful, and the doctors concerned are unhappy with control from on high.

Most legal practices get by on a mixture of overdraft finance from their banks and their own capital, which normally consists of undrawn, but taxed, profits. There are various ratios popular with the banks, but the normal is 1:3 of partners’ capital to bank money. Banks are usually unenthusiastic about lending against debtors, or, still less, unbilled work-in-progress. This creates an inflexible model.

There are many law firms that struggle to raise satisfactory amounts of bank finance because of their perceived lack of management expertise. Banks, having dragged themselves into the 20th century, are scathing of many partnerships, which they perceive as still working in the 19th century.

Problems arise when firms wish to expand either internally or by merger. If the banks will not make the money available, and the partners are incapable of providing the capital, then opportunities will be lost. There are many cases where junior partners wish to buy out the older partners, but, once again, the funds cannot be found, and the uneasy relationship between older and younger partners has perforce to continue, often with damaging results. There are successful sole practitioners, who wish belatedly to ensure their succession, if only to provide their own get-out route. The lack of capital here can also be an inhibiting factor.

In advance of any regulatory framework, which will allow the provision of outside capital, Professional Services Finance Ltd (PSF) has been established. It will, of course, have to obtain appropriate regulatory permission when it is eventually able to operate. Until then, its directors are looking at options and have already identified some interesting possibilities. They have a successful record in similar operations with dentists.

The company operates on a management consultancy basis. It has several skilled consultants on board prospectively, who will be able to provide management, marketing and IT services to law firms which currently lack them. Armed with improved performance, those firms will then be able to expand financially. PSF proposes various formulae that basically include a mixture of its own money injected by way of share capital and enhanced bank finance. This is, of course, the classic method for injecting outside capital into the corporate section. If Sir David’s recommendations are accepted, it will now be possible to use it in the legal profession.

Once it has made its investment, the plan is that PSF will have an ongoing relationship with its clients by the provision of quasi non-executive directors. As the company will only ever take a minority shareholding, it is not planning to take over management, but to provide avuncular advice and occasional assistance, when it is requested and required.

This is an imaginative project that has already been formulated in detail, but well in advance of the capacity to go into action. The directors of PSF will be awaiting with much interest for Sir David’s further recommendations and their implementation. If the climate allows, it will be a pioneer in the field, but there is little doubt that others will soon follow.


Michael Simmons is a consultant specialising in professional partnerships at London firm Finers Stephens Innocent