Working for private equity houses has yielded good business for law firms, but soon the hunters will become the hunted. Polly Botsford reports


Private equity has proved a lucrative practice area for law firms since the market first emerged in the 1980s. In its most recent survey, the Impact of Private Equity as a UK Financial Service, the British Private Equity and Venture Capital Association (BVCA) estimated that in 2006 alone the revenue generated by private equity houses for lawyers totalled as much as £1.2billion.



Soon, however, not only will the private equity houses be hiring lawyers to act for them, they will also be looking at law firms as targets for their funds. The recent launch of Lyceum Capital’s £255m fund for buying into legal services may only be the beginning (see [2008] Gazette, 13 March, 4).


Over the past six years, private equity funds have raised more than £95 billion of capital for investment in unquoted businesses, £34 billion of this in 2006. Unsurprisingly, as clients, private equity houses have had a huge impact on law firms, not just in terms of fees generated – breathing new life into corporate teams with activities such as debt financing, management buy-outs, management buy-ins and co-investment plans – but also in more structural ways.



The growth in private equity-generated fees has contributed to a redressing of the balance of power between firms that traditionally represented the large listed companies, banks and other established corporate institutions, and firms which, having spotted the potential in private equity work, got involved in that area early on.



Charles Barter, head of private equity at City firm Travers Smith, which developed its private equity client base – including 3i, Bridgepoint, and Barclays Private Equity – from as early as the mid-1980s, explains: ‘If you go back 20 years, corporate finance was all about Plcs and flotations, and private equity was viewed with suspicion.’



Not so now – the UK houses hundreds of private equity firms and is the second-biggest private equity market in the world.



There have been cultural shifts too. Andrew Harris, European head of private equity at international firm DLA Piper, which acts for houses such as Engelfield Capital and Duke Street, says: ‘For private equity, it is all about the people. Very often they choose individual lawyers to work with rather than law firms.’ One house in particular has embedded its lawyers to bring them close to its business. Alchemy Partners, made infamous by its ultimately unsuccessful bid for Rover in 2000, uses Macfarlanes as an in-house lawyer, fully integrated into the business – lawyers attend internal meetings at Alchemy and have unparalleled access to its business. Jon Moulton, managing partner of Alchemy, has described the relationship as ‘a bit like a good marriage – you hardly notice it’s there’.



The overarching importance of the private equity market to the legal profession is illustrated by the profession’s willingness to lobby on its behalf. When a new EU directive on money laundering was introduced in March 2007 which threatened the efficacy of private equity operations in the UK, ten City firms, including Linklaters, Herbert Smith and Allen & Overy, campaigned against the negative impact of the new regulations on their private equity clients. A recent Private Member’s Bill, which proposed that the TUPE employment protection regulations should apply to acquisitions and disposals made by private equity businesses, was withdrawn due to lack of support. Private equity houses are, it appears, almost untouchable.



External investment

For lawyers, there will soon be another side to the private equity coin. Following the Legal Services Act, one private equity house has so far publicly expressed an interest in a new type of relationship with law firms: that of external investor. Lyceum, which is already involved in sectors such as healthcare and education, has recruited three top names in the profession to help it break into the market.



Jeremy Hand, managing partner of Lyceum and vice-chairman of the BVCA, says private equity houses are ‘looking to invest money wisely’. In return, they can offer law firms external investment that will enhance efficiency and thus profitability, help with potential acquisitions and foster greater professionalism. Private equity does not just offer capital, but also know-how, in short: ‘We like to add value to the portfolio of companies that we select,’ says Hand. ‘We can bring our expertise from a broad range of sectors. We are not seeking to threaten existing management teams but to complement them.’



Barter at Travers Smith believes that external investment of this sort is not likely to impact hugely on the larger firms. ‘The Legal Services Act was [more] designed to allow the high-street type of firm to raise capital, not the City firms, which can just go and get a bank loan,’ he says. Unless, that is, the private equity houses can find a way of valuing goodwill in law firms and creating new financial rewards for partners when they leave a firm. Barter explains: ‘When you leave your firm as a partner, you don’t benefit in the same way, you aren’t ‘bought out’, so to speak. If you could find a way to do that, so there was a capital sum rather than income at the end of your time at a firm, with the tax benefits that brings, then that would be worthwhile.’



For the non-City firms, there are concerns that external investment from private equity houses will simply lead to commoditisation and consolidation at the expense of small legal aid practices and unprofitable practice areas such as crime. There are also fears of a disproportionately negative impact on the regions.



But Hand believes that, if these eventualities are realised, it will not be the fault of potential investors. He draws an analogy between legal aid and the care home market, in which Lyceum has been heavily involved. ‘When the state decides to cut the price of a service delivered and cuts the price too far, the service suffers,’ he says. ‘In care homes the number of available beds was reduced drastically, causing problems. Then the rates went up again, and a balance has been restored.



‘The legal profession has nothing to fear from private equity. We get a bad press from the unions and in the media that we are all about slash and burn, rape and pillage, but we are there to create wealth, to create stable, profitable businesses – you can’t do that if you behave how they say we behave.’ But, he says candidly: ‘We don’t have a social agenda, we are not a social fund. If there are areas that suffer, that’s life.’



Whether or not law firms welcome the Legal Services Act, Hand strongly believes it heralds an era of fundamental change for the legal sector. ‘My prediction is that the legal profession, which is currently large and fragmented and not very efficiently run, will be radically changed over the next 20 years,’ he says.



Of course, in the short term, private equity houses may be keeping their doors firmly shut if the credit crunch continues to crunch the UK economy. As predictions get gloomier, a downturn could hit private equity houses hard as debt becomes more expensive and funding more difficult to come by. As Harris says: ‘There is still cash out there, but it’s becoming increasingly difficult to access.’ So far, however, this does not appear to be too much of a worry. A Simmons & Simmons-sponsored survey looking at private equity trends for 2008, published by Private Equity News in February, found that venture capital houses, and the mid-market players in particular, were well-positioned for the coming year. Arthur Stewart, head of UK private equity at Simmons & Simmons, says: ‘[Those areas of] the market appear to be holding up well and expectations remain cautiously optimistic.’



Barter believes that it has been a slightly unnatural first quarter to 2008 because many companies are trying to push deals through ahead of 5 April, when rules for capital gains tax change. On the whole, though, most clients, and thus most of their lawyers, appear not unduly pessimistic. ‘The houses have proved they can make a lot of money in [volatile] markets like this,’ he says.



Private equity houses look toward 2011, when the Legal Services Act is fully enacted, with guarded optimism. From then on, they will no longer be just clients to law firms – they may well be their predators too.



Polly Botsford is a freelance journalist