Published: 17 January 2023
Legal Futures published their annual commentary on listed legal practices, on 9 January, and it isn’t pretty reading – at least not if you are investor in the companies.
"Not a single listed law firm saw its share price end 2022 higher than a year earlier, with some very big falls, the annual Legal Futures analysis of ‘Law PLC’ has revealed."
Ouch… but perhaps not that surprising.
Acquisition is a very good way of growing a business quickly, and with a glut of funds in Private Equity, and an appetite in the Stock Markets, there is has been a lot of investment.
With professional firms, especially in Insurance Broking and the Legal Sector, this has allowed larger firms to consolidate through acquisition of smaller ones. It has to be said that multiples paid for insurance brokers have been somewhat generous! Paying a multiple of commission is fine, as tends to be the case, but with any acquisition one should always sense check by reference to a multiple of EBITDA.
Post completion cost savings can be implemented and that can in part mitigate the amounts paid if they are on reflection, too high.
Legal practices face a different problem: culture.
My background was as an equity partner of a national firm of Chartered Accountants. I chose to escape, fortunately intact, in 2004, and could see some very obvious problems with the model. I shall say no more, and instead talk generally.
In the first decade of the current millennium, firms thought that they could grow by acquisition, and in so doing, become medium sized firm, and at the higher level potential challengers to the Big-4 firms.
Considering the leaders of those firms were Chartered Accountants, and had spent their whole careers advising businesses, you would have thought they would have had a little more sense when it came to their own firms.
Many did not think about working capital. They built ‘strong’ balance sheets; the strength of which sat at the top of the page labelled ‘Goodwill’. But in a professional firm the goodwill is derived from the key employees, or more specifically, the former partners of the firms that had been acquired and their relationships with their clients.
Why does a smaller firm want to be bought by a larger one? Well in many cases, driven by the exit needs of the senior partners in the smaller one… the sell to the remaining partners being that they can offer extra services to their clients, and perhaps, perhaps, maybe, become equity partners in the larger firm.
So, the needs of the outgoing partners are covered. Perhaps not, those of clients and perhaps not those of ongoing partners; and as I mentioned before “Culture” is very rarely addressed.
It is highly unlikely that differently sized firms will have a matching culture, and too often little is done to address the differences.
For clients, the differences can be many and varied. From a change in how easy it is to get to speak to their normal contacts in the firm, to fee levels, and even how they are billed and the subsequent and often more aggressive credit control.
If cultural differences are not addressed then clients and key people will leave the firm. Goodwill falls in value, as does EBITDA… and in the case of listed professional firms, the share price goes down.
They then, are my thoughts: let’s go back to what Legal Futures reported.
Apparently, and notwithstanding COVID, an across the board fall in share prices is the first time since Gateley listed in 2015. Apparently one of the biggest declines was Knights.
Knights made 18 acquisitions since listing in June 2018 but none since May’s £11.5m deal for south-coast firm Coffin Mew.: “After years of strong growth, Knights’ share price saw a spectacular decline – from ending 2021 at 410p, it was just 107p last month, 74% lower.”
Knights is just one example, and the article Law PLC has its worst year as all listed firms' share prices fall - Legal Futures give a raft of others.
Finally, “Mishcon de Reya, best known for having acted for Diana, Princess of Wales, in her divorce from Charles, said that their heavily touted initial public offering was off. They blamed market volatility caused by factors such as the Omicron variant of the coronavirus and Russia’s invasion of Ukraine.”
Hmmm… As regards their justification, a time will surely come when COVID is not used as a justification for all business woes, and the energy and wheat price spikes are probably not front and foremost in the list of factors affecting legal firm profitability.