Jeremy Boadle explains why Smith & Williamson sought external funding


Why would law firms want external equity capital? As advisers to the legal market and other professional practices, this is a question that we at Smith & Williamson are asked regularly. Our answer is based partly on our own specific experience.



Until 2002, Smith & Williamson traded predominantly using a partnership structure, albeit valuing the equity stake of each partner. Then in 2002 we incorporated with a holding company, made an acquisition, introduced an external third party as a shareholder and strengthened the balance sheet through funds raised from the new shareholder.



One of the key attractions of external capital for Smith & Williamson was to ensure that, as an investment manager and holder of a banking licence, sufficient capital was available to support the ever-increasing capital requirements of the Financial Services Authority, which regulates about half of the firm's activities. While this specific need may not be relevant to law practices, it does raise the question of how firms fund their overall capital and working capital needs. As already stated, this has traditionally been done through the use of bank debt, which may be appropriate for day-to-day needs, but the approaching retirement of several senior partners, the desire to acquire other business practices or expansion overseas may all require significant funding and therefore may not be appropriately funded by bank debt.



In the case of Smith & Williamson, there is one principal external shareholder, which owns just under 30% of the overall business. It may seem obvious, but it is fundamental that proper research is done into an external investor before proceeding. This research must explore not just their financial track record but their relationship with any businesses in which they have a holding, and the approach they plan to take with their new holding.



Smith & Williamson has benefited from having a supportive but not intrusive shareholder. The by-product is that the external shareholder has provided two non-executive directors to complement three other non-executive directors on the main board, which includes ten directors in total (the other five being executive directors involved in the day-to-day running of the firm). Clearly, a corporate-style main board responsible for the overall strategic direction of the firm, supported by quality non-executive directors, can be created in a partnership structure. However, while there are a growing number of non-partner/non-lawyer advisers to partnership boards, the discipline which arises through having a major external shareholder ensures that maximum benefit is achieved from this opportunity. The corporate structure where director and shareholder may not be the same person raises important governance issues, not least around the setting of strategic objectives and the role and scope of decision-making processes.



Traditionally, law firms that join forces have done so through mergers with consideration in the form of enhanced profit shares. However, partners are increasingly aware that their stake has value over and above their partners' capital and, crucially, that they may be able to realise this. But valuing the ownership and introducing new owners raises issues as to how profit will be divided between management (through salary and bonus) and the owners (through dividends).



Buying another law firm for cash may be challenging in terms of available funding. Besides, it may be desirable to tie in the vendors to the future success of the combined entities through the use of shares to purchase the business. While this is relatively rare in the legal sector, Australian firm Slater & Gordon has made six acquisitions in its first year as a listed law firm, using shares as a method of payment. Many professional practices from other sectors have also taken this approach.



From a partner's perspective, the possibility of realising the true value of their stake - whether they are within a partnership or a company - should incentivise them to create longer-term value. As we at Smith & Williamson did prior to incorporation, it is possible to value each partner's stake and to 'trade' these ownership units, but with a growing 'shareholder base' this becomes cumbersome. The use of actual shares in a limited company overcomes these issues and means deferred equity in the form of share options can be used to aid reward and retention - which is precisely what many incorporated businesses do.



Jeremy Boadle is managing director of the tax and business services division at accountants Smith & Williamson