PRINT THIS PAGE Legal services: a new destination for private equity capital?11/06/2008. Source: AltAssets. 
Cleantech, China, infrastructure, Russia – private equity investors always look for new areas in which they can apply their proven growth models to generate returns. The next hot area – at least for UK-focused private equity investors - could be legal services, as the Legal Services Act 2007 is gradually coming into force in the UK. By allowing for alternative business structures to be implemented, it is bound to fundamentally reform the way legal firms operate. A barrier is about to break: the Legal Services Act 2007 will make it possible for external investors such as private equity firms to invest in solicitor firms or even own up to 100 per cent of those firms. For private equity firms this will throw open doors for investment. Non-lawyers such as finance and marketing directors will soon become partners and owners of law firms, providing regulated legal services. However, this will happen gradually as the Act is being implemented.
Experts argue that international mergers and acquisitions of law firms, many probably supported by outside financial backers, will completely change the legal landscape in the UK. The parties AltAssets interviewed for this feature expect that private equity firms are likely to focus their investment activities on the mid market, rather than the big international or smaller, niche firms.
The Legal Services Act 2007
The Law Society, which makes the rules that govern the legal profession in the UK, undertook a review in 2004 that came to a very similar conclusion as an enquiry by the UK government into the way law firms were run. The conclusion was that in today’s market there was no reason why the existing ban on external investment into UK law firms should be maintained. The government’s belief is that clients may receive an improved service for their money from law firms that are structured more like other services providers such as financial services firms.
The liberation of the legal services sector is happening in several stages. Since 2004 fee-sharing between lawyers and non-lawyers has been permitted, meaning law firms are no longer restricted to raising capital from their own resources or through loans. They are now able to attract investors that are keen to take a share in upside that their investments can generate by offering them a share in the fees earned.
In a year’s time individuals (but not firms) will be allowed to become partners in law firms. However, firms may not have more than 25 per cent non-lawyer partners. At this stage, private equity firms could send investment professionals to law firms in which they invest, but only to get a greater understanding of the sector. The non-lawyer partners will not be allowed to represent the interests of the private equity firms on the boards.
In 2010 a Legal Services Board will be set up to establish a licencing structure that will eventually allow investors, including private equity firms, to take minority and majority stakes in law firms. Experts reckon it is likely to take the Legal Services Board about two years before it can allow alternative business structures. The Board will have to go through a drafting and consulting phase before it can come up with a new set of rules and monitoring procedures. There will then be no reason anymore why any activity that has to be supervised by The Law Society or one of the other regulatory bodies could not be carried out by non-lawyers, as long as certain regulatory and quality requirements are fulfilled.
Current private equity investment activities in the sector
To date, not many private equity firms have signalled an interest in the sector. Some probably observe and wait, given that the Legal Services Act 2007 will not come into force for a while. A few weeks ago UK mid-market buy-out house Lyceum Capital became the first private equity firm to announce that they are actively seeking investment opportunities in the legal services sector. As AltAssets has reported in its News section, Lyceum has hired three professionals dedicated to the legal services sector: Paul Hewitt, Tony Williams and Professor Richard Susskind. The firm believes opportunities are already there, and now is the time for investors to get into position to be able to secure the best deals later.
‘We have been looking at the legal services space for just over a year now,’ Jeremy Hand, managing partner at Lyceum, told AltAssets in an interview. ‘We will not wait for the Act to be fully implemented. Chunks of the legal process could already be provided by a services company as long as they are supervised by lawyers. There are real opportunities for private equity firms to invest in legal services today. The idea we have is to build a legal services firm which we can merge in with a law firm or two later on.’
Private equity firms are allowed to set up holding companies that provide services such as IT infrastructure or operations management services to law firms, with a view to build long-term relationships and gain the necessary expertise to later take over entire law firms.
Lyceum has not completed a deal in the sector yet but is believed to be in negotiations.
Opportunities to come
The legal services market is estimated to be about £20bn in size. It is a growth sector and one that could significantly benefit from embracing business and IT expertise as many other sectors such as financial services and manufacturing have long done.
Within the legal services sector, there are certain activities that could be systemised easily and provide much better margins, such as re-mortgaging or personal injury work.
'The legal services sector is large, fragmented, and offers considerable potential for continued growth - all characteristics of the sectors in which Lyceum has been successful. We anticipate consolidation of small and mid-sized legal services businesses and believe that, in spite of increased professionalisation of the legal industry in recent decades, many opportunities remain to improve service standards, efficiency and profitability,’ Hand argued.
Lyceum typically invests between £20m and 50m in businesses with a turnover of £20-80m, which positions the firm in the mid market.
Hand continued, ‘Some partners in law firms may see this as an opportunity to exit their business or take money out. Offering minority and majority stakes to external investors will be a new route to raise capital for the firm’s development and for the partners who have grown the firm.’
Positive reception
The reaction by law firms has been mixed, with some hesitating to embrace change. However, Hand said that his firm has received a very positive response to its approach in the sector: ‘law firms are unbelievably receptive and they want to know what value a private equity firm can offer them.’
He concluded, ‘We believe that the value-add that a private equity firm can bring to the table will give private equity investors an advantage over other financial and strategic investors. We offer them business tools that historically have not been available in-house. The opportunity for a private equity firm to step in, to provide capital and provide expertise in this very attractive market space is very significant.’
AltAssets would like to thank Jeremy Hand of Lyceum Capital, Simon Witney of SJ Berwin, Russel Wallman of The Law Society, Alison Crawley of The Solicitors Regulation Authority and the UK Ministry of Justice for their help with this article.
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