In 2015, English barristers scratched their wigged heads when Gateley Plc., a UK-based law firm, became the first British law firm to go public. Over the last three years, its total market cap has doubled, and four more law firms held IPOs. What on earth is going on?
The ‘Tesco Law’
In 2007, the UK Parliament permitted non-lawyers to own and invest in the British law business by authorizing the creation of ‘Alternative Business Structures’ (or ABS).
Tesco, a grocery and general merchandise retailer, was the first to obtain the ABS licence, so British lawyers nicknamed this shake-up ‘the Tesco Law’. Deloitte recently became the last one among the Big 4 companies to get the ABS licence. You can check out my article about the Big 4 practicing law in Britain: https://medium.com/lawyerpreneurship/big4-legal-hand-c8ac859b3c59
This law will affect the legal industry just like the separation of church and state. Once venture funds and traders enter the legal services market, they will give start speculation and market cap races. Just keep a check on a few English law firms. They set market trends for the next decade.
Why go public?
Take a medium-size law firm, such as Axon Partners. People who work for us get shares. It is similar to a private offering. If we were a lawyer association, we would not be able to do any such thing. In Ukraine, non-lawyers cannot own or invest in any legal activities.
Public offering means offering shares to anyone interested. By going public, a private company becomes public. The question is, why would anyone need it?
Raising money on favorable terms
Our law firm is a new business model on the local legal market, plus we have our own legaltech projects and investments. If we had higher leverage, we would poach a couple of lawyers from BigLaw, launch offices in Minsk and Riga, and scale up our legal tech startups with a focus on Europe (at the very least).
To get >$100k from private investors, we would have to give them 20% of our company shares.
To figure out the value of your law firm, you multiply its total annual turnover by some 0.5 to 3.0. Did you do the math? Here you can check out a pretty good — if not so new (dated 2014) — article that gives insights on valuations of law firms.
If Axon’s value is $500k, we would give 20% of our company to investors for USD 100k (I used a 1x multiplier).
The value of a public company is always bigger than that of a private one with a similar income and thus enjoys a much higher multiplier. Therefore, if we were a public company, our value might be 3 times higher, meaning $1.5 million, with the same turnover. Consequently, we would get USD 100k in exchange for 6.5% of our shares.
Even a recent law-school graduate knows that with sales like that, there’s no way a company can go public. On the other hand, an IPO pioneer and the most expensive UK law firm Gateley Plc (GTLY.L) falls short of the proper London Stock Exchange (so far, all British law firms are floating on the LSE’s sub-market AIM).
Getting ready to exit
If my partners and I decided to leave the business, we could have two options: do it with $500k or $1.5 million. Well then, it’s as clear as day.
For hype’s sake
The first IPO is something really special, isn’t it? It would be even more special if we were the first public law firm in Eastern Europe. And what if we listed our shares on the London AIM…
We would not get any similar effect from using the usual marketing tools even after five years of intense marketing.
Google and Facebook are buying startups like crazy. The higher the leverage, the faster they buy their rivals. Well, Captain Obvious, what does that have to do with the legal services business? Don’t give up reading just yet.
Law firms based in Eastern Europe really hope for takeovers, but these hopes are mostly in vain. Takeovers happen once or twice a year at best.
It’s time for you to learn about another publicly-owned law firm Gordon Dadds (GOR.L). In 2017, these guys went public on the AIM.
With 34 million pounds turnover, their market cap is now only 49 million pounds (Gateley’s multiplier is x3). But they are smart and they grow as fast as a beer belly. Since they entered the stock market, they have increased their revenue from 24 to 31 million (given that in 2013, it was only 2.5 million). Tenfold growth in five years! Not bad, right?
So, it took them only a year to buy four British companies, while Gateley took over three firms in the space of three years.
Yes, I’m aware that a Dentons partner can take over more companies while reading a morning paper, and Australia-based Slater and Gordon Limited (the first-ever law firm to go public) bought 50 companies in the space of 10 years. By the way, here is a story of how they choked on their 50th purchase that happened to be Quindell: https://bit.ly/2JLsZaz
But let’s go back to what Gordon Dadds has been planning. They did the IPO to raise money for new takeovers. That’s what their CEO Adrian Biles said before the IPO:
“The market opportunity we identified at the time of our listing, to consolidate the legal services market in England and Wales, continues to be compelling”.
Gateley had similar plans. That’s what they wrote in their listing application:
“…moving from an LLP to a PLC would allow for faster expansion and diversification and give us a ‘first mover advantage’. We plan on using our alternative business structure to acquire complementary business services, such as professional training and regulatory advice, providing it with an opportunity for cross selling to existing clients as well as broadening its appeal”.
Keystone (KEYS.L) were the third ones to go public. These guys have a very interesting business model, i.e. the umbrella law firm. They join together self-employed lawyers who work from their own offices or homes. It looks like the US-based Axiom, or the UK-based LOD (Lawyers On Demand).
Their application does not clearly state what they want from the IPO. So, I think that they are simply building hype around their business model (or they are getting ready to exit). This looks like random words rather than a press release that is supposed to answer the question “why”:
“The UK legal services market is the second largest in the world and we believe the Keystone model is well placed to take advantage of this significant opportunity. I look forward to continuing with our strategy of quality-centric growth, providing a superb standard of legal service to our many clients and delivering value for our shareholders.”
Raising money for further development
For me, this is the most obvious reason for a law firm to go public. I don’t think you can take over a number of companies every year and survive trying to digest different cultures and values.
Therefore, it makes me wonder why this British company is set to float only in 2018. Meet Rosenblatt (RBGP.L). Here is what they say in their press release:
“Our admission to AIM will provide us with a significant opportunity to create a profitable and growing business to capitalise on the changes seen in the legal marketplace in the UK in recent years driven by regulatory reform and new technology. We want to use the funds raised to take advantage of what is a highly fragmented market to engage in consolidation as well as fund more litigation ‘in-house’.
These guys are intended to get ahead of Gateley in market capitalization. They headed to the stock market with their asset value amounting to 76 million pounds. Now their shares cost £96 million. They are getting very close to their rival.
A couple of weeks ago, another British company Knights (KGH.L) listed its shares on the AIM. They have already managed a get an investment round from some private equity fund. Now they say they are raising more money to clear their debts and build their working capital.
They don’t really talk much about how big their debts are, but rumour has it that they got two loans amounting to 7 and 22.3 million pounds.
After clearing their debts, they are planning on hiring 200 more lawyers by the end of 2020 (currently, they have 350 lawyers). In addition, they are going to buy a couple of law firms.
It looks pretty weird, but who am I to judge. These guys sold their shares and raised 30 million pounds, which is just enough to clear their debts. Where are they going to get money to buy new companies and how they managed to raise so much, I dunno LOL. Here is what they said in their press release:
“What drove the decision was the desire to grow faster through recruitment and acquisition. We feel to do this, flotation was needed to pursue our vision.”
Who invests in law firms?
Fidelity International, the US-based investment fund, bought shares of both Keystone and Rosenblatt. Miton Group invested in two companies as well and Soros Fund Management also invested in Keystone. Rosenblatt sold its shares to one of the biggest US investment companies BlackRock. And Gateley sold some of its shares to its own customers.
Gateley distributed shares among its employees. I have not found any such information about the other companies. However, most likely, their employees got shares or stock options as well. According to contract theory developed by 2016 Nobel Prize winners Oliver Hart and Bengt R.Holmström, this type of remuneration makes more sense than salaries or bonuses.
To be honest, I always thought that only lawyers can are interested in the legal business. It turns out, I was wrong. If by any chance you are making a list of investors for your legaltech project roadshow (trollface), here’s the full list of guys who bought shares from British law firms: Schroders Investment Management; Killick & Co; River and Mercantile Asset Management; Stancroft Trust, Hargreave Hale; Janus Henderson; Legal & General; Ruffer; Cascades; Blackrock Inc. and Canaccord Genuity Group Inc.
So, it’s time to wrap it up. In addition to some key takeaways that can be found throughout this text, I would only conclude that I still don’t see the point in doing a classic IPO for a law firm. Going public before exit or for marketing purposes — that’s OK by me. However, raising money for a huge expansion, let alone aiming to pay off debts — those are truly beyond my comprehension.
Are Ukrainian law firms going to go public?
Traditional Ukrainian law firms are not going to float, that’s for sure. All we have left here is legaltech. However, the timing is unclear: so far, our startups have not managed to get as far as seeding.
I heard that market leaders once thought about going public, but the 2008 economic crisis made them abandon this idea.
Here is what some managing partners said during the 2013 Annual Legal Forum.
According to Timur Bondarev (Arzinger), Magic Circle law firms do not know what external financing is (well, I don’t really agree here), however, in this context, the Ukrainian market is full of opportunities.
“Major law firms used to take a lot of loans. We have never used this option. And I keep wondering, do we need external financing?”, said the Arzinger managing partner.
Nikolai Stetsenko (Avellum) said that his law firm does not use external financing, although every now and then, we get such offers from banks:
“We do not like this idea. We are in favour of step-by-step growth. I do not see why we need any external financing. We have our working capital and our current status. A company would only need fundraising when aiming at significant expansion. “
It is unlikely that there are law firms Ukraine whose development ambitions are so huge that they need to raise extra money.
There is very little likelihood of some public law firm buying a Ukrainian law firm. However positive is the World Bank’s outlook regarding the growth of Ukraine’s gross domestic product, buying a Ukrainian company is only for the exceptionally brave (Crimea, Donbass, never-ending elections, and stuff like that).
Here is what I think.
In the United States, there is the monopoly of the bar, and lawyers cannot share profits with non-lawyers. However, this monopoly has existed for many decades. In Ukraine, we`ve just started to move towards the monopoly of the bar, even when the most ancient monopoly of the bar, the British one, finally went down. I’m afraid that aiming to develop the legal profession in Ukraine, we have to fight this holy war against the crusaders protecting their high ethical standards and the old-believer lawyers.
The more I learn about public law firms, the more questions I have. What is the effect of IPOs on profit margin and sales and how do public law firms assess their performance? How many people quit while getting ready to float? What do associates say about their post-IPO experiences? How do they do their business valuation?
Since I can’t get all the answers myself, I decided to ask these questions to other lawyers. Here is what they say:
Some get the Tesco Law, some get the monopoly of the bar
The British and Australian markets are moving towards the liberalization of the legal profession, while in Ukraine, new obstacles for the legal services businesses have been emerging. It is not even like rowing against the stream. Rowing against the stream means building a law firm that looks just like some British law firm with age-old traditions. If we were rowing there, we’d be like “well, it could be worse”. And it is worse. We are trying to stop the current and build a fence, so that we do not have row anymore.
Going public is a bad idea for companies where flexibility and privacy are of the essence
The most obvious pros and cons of IPOs for law firms
When going public, you agree to disclose information (how your business is developing, whether you have any problems, how you deal with your problems), including information regarding your financial performance.
This is a price you pay for going public, and in return, you do get some goodies: funding for business development, market valuation, and reputation.
When setting out to float is a good (bad) idea
It does not matter (in theory) what kind of company you are (unless regulations ban your company from going public). The question is, what stage of development is your company currently at? If you (and investors) are going to benefit from fundraising, then go for it. If going public is important to you, then go for it.
However, an IPO is a bad idea for business where flexibility and privacy are of the essence, and where there is no need for fundraising.
I do not think that a takeover is the best way to spend money
Here are two things you should know.
(1) To get investment from non-lawyers, you don’t necessarily have to go through an IPO, as long as the law does not ban non-lawyers from owning law firms.
Raising money is a matter of skill. As an option, you can make a good CFO your partner. This will surely make things much easier for you.
(2) For some reason, people forget about a very important consequence of non-lawyers getting shares in a law firm. As a matter of fact, your firm gets non-lawyers who are experts in some areas other than law.
Why have many businesses grown massively? That’s because experts who want to make use of their shares set out to promote and develop new products. Why do businesses become way more profitable? That’s because their experts do some cost analysis, make debtors pay their debts, do refinancing, etc.
If your co-founder is a big investment fund, it will surely keep your partners on their toes.
By the way, I don’t think that a takeover is the best way to use money. You can’t buy every single business. Lawyers are the most portable assets in any law firm. You don’t need to take over. You just tempt them away, so you get the 10–20 best lawyers. You don’t need another 200 people to do the job: you’ve got your team and technologies that help significantly improve your team’s performance. Legaltech is another great idea for investing the IPO money.
In Ukraine, the market is not big enough to make law firms want to go public
We never really gave serious thought to our firm going public. However, the very idea of doing an IPO for a law firm really excites me, since I am a lawyer who provided legal advice for a number of IPOs and person who invests in startups that will hopefully go public one day.
I think it makes sense to let shareholders (investors) inside your company only when your corporate governance and distribution both run like a Swiss watch, provided that they will work for any number of shareholders.
Nearly all more or less traditional law firms face the same problem: most of their corporate business processes, both managerial and profit-generating, are based on their partners’ performance. As a consequence, it’s hard to imagine that current partners would give similar rights to some strangers who are not going to actually work.
Perhaps in this case, it makes sense to build a law firm using a standard corporate model, where lawyers are hired employees and a corporation is funded by the founders/investors who do not actually work in this firm.
The question is, are lawyers going to settle for not being majority shareholders. At the same time, one of the reasons why law firms do not go public is the low capital intensity of legal services. Here, you do not need to build factories, buy expensive raw materials, and keep a large stock of goods in warehouses. In the old days, to launch a firm, you had to rent a small office (or even an apartment would do) and buy some basic office supplies. Now you don’t need any of it. All you need is a laptop and a cloud services subscription (like MS Office 365). And guess what, there are even more affordable options:).
Since financial investment and risks are going to zero, why attract investors and share your would-be profits? The answer to this question may be found in the recent trends in economic development. As new technologies advance, businesses, including legal services, cannot avoid them. The biggest British law firms and Big 4 audit firms invest some tens of millions of dollars in technologies, including artificial intelligence (which actually makes hundreds of millions). Sure thing, smaller law firms will be able to take part in this race only if they get additional funding.
However weird it may sound to a Ukrainian lawyer, in the Western world, people see litigation as one of the major legal profession areas where artificial intelligence can be used. And I can pretty much picture some funders creating a business project and hiring really cool (or not really cool, depending on the technologies they are going to use) litigators, developing prediction technologies to scale-up this service so that external investors get their longed-for IRR.
In Ukraine, the market is still not big enough to make law firms go for fundraising and attract investors. Besides, our market is a bit distorted, and for now, we have other “technologies” that rule here.
The thing is, some of our local law firms have already been created as business projects whose “investors” provide them with easy case-winning and licence-getting know-hows. It is not clear, however, how dividends are paid out in such cases, but perhaps our anti-corruption agencies will find out soon enough and explain this phenomenon to the legal community. These law firms are unlikely to go public due to FCPA and other international regulations requiring to abide by some rules they don’t fancy:)
To sum up, I recommend that young law firms build their corporate management and income distribution mechanisms as though they are planning on going public. This will help them to put their house in order and ensure strong opportunities for future growth
Originally published at axon.partners.