2011 Is Not Far Off

Richard Turnor, a partner in the Private Client Group at Allen & Overy, has penned for Managing Partner Magazine one of the more thoughtful pieces on the implications of the Legal Services Act in the UK.   In particular, he asks the same question I've been asking for some time: 

"After ‘Big Bang’, many, if not most, of the historic financial institutions in the City of London disappeared – replaced by the global giants that feature so prominently in today’s reports of turmoil in the financial markets. Will the Legal Services Act have a similar effect on the law firms of today?"

He begins by reviewing the reasons sophisticated firms might welcome outside investment—embracing the so-called "Alternative Business Structure" model—which include:

• Building their brand;
• Upgrading IT systems and infrastructure in order to compete more cost-effectively in existing markets;
• Financing the development of "know-how" (knowledge management to Yanks) systems and precedent banks;
• Covering investments in penetrating new markets, presumably either practice areas or geographies;
• Using the newly-created market for equity in the firm itself to incentivize non-lawyers in senior positions at the firm, or to buy out underperforming partners, or simply to let current partners monetize a portion of the discounted present value of their anticipated earnings stream.

Usefully, he provides a recap of the regulatory hurdles outside England and Wales.  They are numerous:

• At the moment, Australia is the only other jurisdiction that permits "ABS"'s.
• Scotland is beginning to consider amending its rules to conform them to those in England and Wales, "so as to enjoy a level playing field," but that process is far from complete.
• Spain permits up to 25% non-lawyer ownership since 2006.
• In France and the Netherlands, lawyers cannot share revenue with non-lawyers, making ABS's a non-starter there.
• Germany focuses more on regulation of individual lawyers than on firms' structures, so the jury may be out as to what's ultimately permissible there.
• And finally, of course:

"The US, in particular, would be a problem for international firms with branches in New York and New York lawyer partners. If non-lawyers were admitted as partners, every partner who was a New York lawyer would be in breach of the New York Code of Professional Responsibility and subject to disciplinary action."

Conflicts and client confidentiality, as well, will need to be seriously addressed.  At a bare minimum, there can be not the barest scintilla of a suggestion that outside investors could sway what matters a firm does or does accept, who it does or does not represent.  And client confidentiality must be maintained with the utmost punctilio.    In reality, I view thse problems as far more hypothetical (and even hallucinatory) than real:  What firm in its right mind would compromise on either of these counts one iota?  The damage to reputation would immediate and probably fatal.  Nor, I might add, do we see self-defeating debasing of standards in other industries where public companies are the norm:  Airlines have no interest in accidents and crashes for the same reason that pharmaceutical companies have no interest in adulterated drugs and Goldman Sachs has no interest in shading its advice post-IPO.

But Mr. Turnor rightly fingers a more telling consideration: 

"Firms will also need to convince their own lawyers, and the managers who may be partners from 2009, that an ABS can offer a career as rewarding as a career in a more traditional law firm – despite the fact that future profits will have to be shared with investors. Will the introduction of outside capital, and the opportunity to participate in the equity and make a market in shares, create value and earning power that counterbalances the diluted profit shares of the partners? Why not borrow from a bank instead?"

This, to me, is the heart of the economic debate that must be resolved before ABS's will be attractive to investors—and to existing partners and other stakeholders in conventional law firms. 

Put simply, if the outside capital cannot increase the total profits pie by more than the amount it will be withdrawing for a reasonable return on investment, then the entire exercise should be aborted before birth.  

Unfortunately, we have seen this in some professional service industries before.  Famously, in the 1980's, much of the New York-based advertising industry went public or was acquired by already-public firms.  The sad but typical experience was that senior executives and other favored insiders at the time of sale cashed out their interests to the tune of tens of millions of dollars, but the underlying economics of the ad agency business did not change. 

It still required virtuoso copywriters coming together with inspired art directors under the strategic direction of clear-eyed account management to identify and articulate each client's "unique selling proposition."  The fact that some who had the luck of fantastic timing and were able to exit at the top did not expand the agencies' war chest for recruiting top talent or wooing top accounts.  They were simply one-time monetizing events, with the vast majority of proceeds captured by exiting inside shareholders.

But fortunately, we know this model doesn't work and with luck we won't go down that path again.  (I hate to be the one to break the news to those of you in the audience who are 55—65 and at your career peaks in terms of "points" and so forth....)

Are we getting ahead of ourselves? Will the potential outside capital even be there? I have no doubt it will, and Turnor chimes in: "Lyceum Capital certainly thinks so, and has announced the appointment of a heavy weight team (Tony Williams, Richard Susskind and Paul Hewitt) to advise as it seeks to establish a position in the legal sector." [Disclosure: Tony Williams has been a friend for years and "Adam Smith, Esq." is in a strategic alliance with his consulting firm, Jomati, while I also Richard Susskind a friend.]

So let's assume the money is available, either from private equity or the public markets. What might we confidently predict will happen?

• Certainly, consolidation and potentially "roll-up's" of existing consumer and family-oriented legal services should take place, including practices such as:
  • Routine small scale real estate transactions;
  • Matrimonial law: Pre-nup's, divorces, child custody agreements, separation agreements;
  • Small business law: Incorporations, partnerships, shareholder resolutions, routine contracts, employment issues, general housekeeping;
  • Garden-variety employment disputes: Harassment, unfair terminations, discrimination;
  • Torts and negligence: Personal injury, car accidents, workmen's compensation, occupational hazards, slip and fall, etc.
  • Low-level criminal defense work: Misdemeanors, DWI, and so forth.
• Perhaps the introduction of legal services into the "product mix" of companies with large retail branch/distribution networks where legal advice is not too far afield from what they traditionally provide. Here, I doubt that "Tesco law" will be first (although Tesco is a consummately innovative organization so I could well be wrong). But what about banks or other financial services industry providers. Why wouldn't Bank of America (say) introduce BofA Law, or H&R Block, or Charles Schwab? They have trusted brand names and provide services inarguably relevant to legal advice, already.
• Essentially, any area of law where price, convenience, and baseline reliability are more important considerations than pedigree, impeccable quality, and bespoke services is a candidate for new entrants.

Beyond that?

I'm not an expert on corporate and partnership structures in the UK, but the good Mr. Turnor hypothesizes that outside investors could participate through more traditional law firms structured as LLP's permitting outside investors "in" in the form of a corporation which is a new member of the LLP. Assuming this is structurally correct (and it sounds eminently plausible to me), the next question is what dynamic influence their introduction into the LLP would cause.

Permit me to suggest a few:

• Pressure for more merit-based pay and performance evaluations.
• The expectation of senior non-lawyer staff that they'll be able to participate in the profits and growth of the firm.
• The inexorable introduction of more professional senior "C-suite" executives.
• Greater lateral mobility between firms (yes, I do mean even greater), especially for the newly empowered C-suite executives.
  • Meaning "the rich get richer"--this is part of capitalism's charm.

And overall, the changes will increase the tempo and decrease the cycle time of decisionmaking.

So what's to be done?

Most important of all, it's time to realize that we can't predict what will happen. The only failure that is inexcusable going forward is a failure of imagination. If law firms have never had meaningful access to capital on market terms (true), the challenge is not to think linearly from that world, but to think disruptively about what could happen--what business models could be invented--if capital access opened up. Will there be failures? To be sure. Successes? To be sure.

First, start thinking about these changes now. Once your competitors are not thinking about them but acting on them, the clock will have tolled midnight.

Second, take a hard, unblinking look at your firm's capabilities:

• Its internal strengths and weaknesses;
• Its external threats and opportunities;

and what your partners and partnership are capable of. (Let me add this counsel: Don't underestimate what people are capable of. "Stretch" goals often inspire inspiring behavior.)

But whatever you do, be hard-headed and realistic. Go it alone may not be an option, for example. That you should not take as a counsel of defeat. Rather, pursue that path (whatever path!) from a position of strength, not weakness.

One thing is certain: If "stay the course" seems a comfortable and time-tested strategic plan, that may be a complacent luxury you will soon be unable to afford.