External investment and even flotation are being championed as ways forward for legal businesses, but most law firms will do just fine without either, says Chris Langridge


The traditional partnership structure has served the profession well. Recently, the number of such structures for law firms has declined, with the number of incorporated practices trebling over the last five years.



Most incorporated practices are limited liability partnerships, with relatively few firms opting for company status. This is in contrast to firms in other professions, many of which have become private or public limited companies and some of which have floated.



The issue of raising external capital to fund legal practices has of late become much more interesting to law firm management teams.



Lyceum Capital, the mid-market private equity firm, recently announced the launch of a £255 million fund to take advantage of the opportunities emerging from the legislative reforms. Solicitors can expect similar announcements between now and 2012, when alternative business structures (ABSs) in the legal sector become a reality (Splashing the cash?).



Although a number of firms have publicly confirmed that they are considering flotation or private equity investment, this route is probably not for the majority of firms. Those that do wish to raise external finance will generally fall into one of a number of discrete camps: mid-market firms that wish to expand domestically or internationally by purchasing a firm through debt or equity; top 75-100 firms that wish to merge nationally to form an Eversheds-type rival; those wishing to recruit or offer an incentive to existing or new staff or partners; smaller high-street firms that face increased competition following the Legal Services Act and wish to merge to gain critical mass; and those with streamlined offerings, with high use of IT and a high proportion of non-qualified staff which present an easy target for new entrants.



Despite the fact that a flotation offers the prospect of large windfalls for partners, there are many reasons why firms will either not choose to or will be unable to pursue this route.



The sale of a firm might bring immediate financial benefits for partners, but they are effectively selling not only their future earnings for a capital sum but also the 'family silver' of junior or future partners' earnings, which will be reduced by the payment of dividends to shareholders. Unless improved profits per partner are achieved, remuneration will fall. There is no evidence in other sectors that profits increase solely as a result of external capital.



Indeed, over the last five years growth in law firms has exceeded growth in the corporate sector by a significant margin. What is more, following a drop in remuneration post-sale, partners and ambitious staff may be tempted to leave and join a conventional firm, with the prospect of higher earnings, possibly resulting in major instability for the newly floated practice. Firms will need to balance short-term capital gains for partners against what is best for long-term success and stability.



However external equity is introduced, it is an emotive subject for lawyers which raises several fears. First, will the current professional practice of law be replaced by the commoditisation of legal services - 'Tesco Law'? Second, most lawyers will not want to lose their independence. Accepting alternative investment in whatever form will inevitably mean giving up some degree of control. Most lawyers value being masters of their own destiny and owning their own businesses. Many will consider that they are making enough money as it is and will question whether it is worth selling their independence. Accountancy firms Tenon and Vantis have both had arguably bumpy rides since incorporation.



Third, the perceived loss of a partnership culture. Many firms still have a collegiate culture to some extent and would not want to lose this.



Fourth, the undue influence non-lawyers may bring on lawyers within new business structures. Would economic incentives and targets distort behaviour and conflict with legal ethics - in particular, the paramount interests of the clients?



Lastly, what would clients think? Control is not just an issue for partners - clients want to be represented by lawyers who are independent, subjective and professional. Some may question whether this would still be the case if the firm has been sold or has accepted external investment.



Many firms will also have to face the uncomfortable truth that they do not have an attractive enough business to float. This may be because the firm is not large enough or not profitable enough after paying partners a market salary. Furthermore, is it likely that venture capitalists or private equity houses will put their money into the traditional model of most firms, with their hourly billing, expensive premises, expensive people, an unusually top-heavy pyramid structure, and a tendency in clients to want to deal in future with the same individual (who may leave the practice)?



Whatever the enthusiasm investors may have for this new sector, it does not easily fit into the markets with which they are familiar. If such investors were to start afresh they would be more likely to buy a firm for its brand name and do away with the over-resourcing, duplication of effort and reinvention of the wheel that they may perceive to be found in many firms - that is, too many lawyers and too few clever systems.



Some firms may prefer to build commoditised services divisions organically without external finance, and sell them at a high premium to the practices which have raised external finance.



The implementation of the Legal Services Act may still be years away, but already most lawyers are aware of the proposed changes and are keeping a watchful eye on developments. The most likely scenario is that some firms will take advantage of the ABS on offer. A few may float or accept external capital, but of those who adopt ABSs in the short term most will probably do so to enable managers and key support professionals to have a stake in the business.



After all, the issues for firms remain the same. The profession must think of their practices as businesses and recruit better management. It is this that will drive efficiency and lead to improvements in service to clients and an increased bottom line.



Chris Langridge is a partner in the partnerships group of Cripps Harries Hall