In this two-part interview, Neil Rose talks to Will Evans, a managing director at Arrowpoint Advisory, about how private equity activity in the legal market has sped up in recent months and looks set to continue
Evans: More of a ‘key man risk’ in law firms
Private equity (PE) is on the march in legal services. Research published in February by Acquira Professional Services showed it has invested nearly £1.2bn into law firms over the last five years, with a record £534m coming last year alone.
It said that, in a rapidly evolving market where standing still was simply not an option, PE investment offered law firms “the firepower to scale, innovate, and future-proof their businesses”. At the same time, it was not straightforward, with investors needing to understand “the deeply rooted culture of law firms, which are often hierarchical and reliant on the reputation of individual partners”.
So it was timely that we were approached to interview Will Evans, who leads the consultancy and professional services sectors at Arrowpoint, the mid-market advisory team of Rothschild & Co.
While his work has meant a lot of accounting deals over the last five years, he has also been involved in Inflexion taking national firm DWF private in 2023, the deals that saw Lawyers on Demand spin out of City firm BCLP into Bowmark in 2018 and then in 2023 into Consilio, and Vespa Capital’s investment in wills and probate firm the Right Legal Group last year.
The recent experience of the accountancy market – with PE investors buying and building through ‘platform’ firms that roll up smaller practices – points to what is coming to the law, especially now that the investment opportunities in accountancy are more limited than they were.
Law is a similarly fragmented market dominated – in numerical terms, at least– by small firms that are now facing ever-greater demands to invest in technology, as well as compliance burdens.
But Mr Evans identifies two “fundamental differences” between law and accounting firms that “investors are getting their head around”.
“One is that, in a law firm, the clients tend to gravitate towards a lawyer, whereas in an accounting firm you tend to gravitate towards the brand. So the ‘key man risk’ of a law firm makes them a slightly riskier investment.”
The necessary move to a corporate structure, “where partners earn less income but have more capital events”, could mean some heavy hitters are attracted away to traditional partnerships because they can earn more money every year. “So getting the structure right to retain the best people is important.”
The other big difference is that accountancy firms generally have more predictable revenues, thanks to annual audits, regular filings and so on. “From an investor perspective, that makes you sleep easy and it’s a better quality-of-earnings business,” Mr Evans says.
While legal clients are generally very loyal, “in any one year you’re not quite sure what a client’s going to buy”. But for larger, full-service firms with thousands of clients, “there’s a portfolio effect that does create quite a resilient business model”.
But overall these differences will mean that law firm deals done for lower valuation multiples than accounting, he says.
To date, much of the investment in law has been high-volume, low-value work – like personal injury, wills and probate, and conveyancing – where the key man risk is lower. Though personal injury in particular has “heinous” cash flow due to the use of conditional fee agreements, Mr Evans says, people are always going to have accidents. But the flipside is that those selling to PE will not receive a high valuation multiple.
The change in the last year “is people investing in the full-service model, which is the biggest market”.
Why is this? “There are lots of sub £5m, £10m revenue law firms saying ‘We’re spending all of our time in dealing with the back-office operational stuff when we just want to be serving our clients’. They’re looking for a new home where they can benefit from the scaled platform that is well invested.”
Then there is the partnership versus corporate debate. “They all say they invest, but the challenge with investing properly in a partnership is you have to distribute all the money and then you have to ask for it back, which is much harder than in a corporate, where you invest, the board makes all the right decisions for the long-term future of the business and then you distribute what’s left or it all accrues to equity value and everyone has capital sums every so often.”
Investment likely crystallises half of the value of a firm into cash. In exchange, partners take a lower corporatised salary going forward.
“If a partner in a law firm can take a couple of million pounds out through a capital event, they can personally de-risk so they can pay off their mortgage, put their kids through private school and have a buffer to do that.
“It completely shifts the mindset of growth going forward because you’re more likely to take risks, you’re more likely to make that big investment step or hire that senior person in a way that you might not if you were living year to year on income.”
The ‘naked in, naked out’ model of equity partnership also stifles succession: “A lot of the senior partners just hang around for longer than they possibly should because they have no reason to move on – they get nothing when they retire. So they just milk it without adding value.
“To be able to manage succession and give the more senior partners who aren’t contributing a big capital sum and redistribute some of the ownership to junior partners or others in the firm below partner level, which is what you could do in a corporate entity, and then having that sort of four-to-five-year cycle of capital events, allows you to make sure that the equity sits in the hands of the right people every year.”
One of the reasons listed law firms have not been a success – with arguably three exceptions – is because the public market “is not right for law firms to manage those people dynamics”, Mr Evans suggests.
In the second part of the interview tomorrow, we talk about how the buy-and-build platform model pioneered by Lawfront is set to take off.
I hate these people. Parasites