Private equity circles the legal market, but not all firms are viable for investment boost
It is no surprise that law firms have become a new target of interest for private equity firms. The legal sector is a significant moneymaker, expected to grow to £51.9bn by 2025.
Private equity firms are drawn to businesses that have strong, steady cash flows, along with high growth potential, which is why the legal sector is being targeted.
Last month, the south coast firm Trethowans was acquired by a private equity-backed legal services provider, Lawfront. While on Wednesday, PE firm LDC, part of Lloyds Banking Group, invested in commercial firm Harper James.
This comes after private equity firm Inflexion hit the the headlines in 2023 when it de-listed DWF from the London Stock Exchange.
“Law firm investment is one of the hottest topics in private equity right now,” Axel Koelsch, COO of Lawfront, told CityAM.
The private equity sector has already been circling the professional services market like a hawk looking for its new prey. Over the last few months, private capital has poured millions of pounds into firms, particularly those with accountancy arms.
From Apax successfully bidding for Evelyn Partners’ accounting arm for £700m, to the UK arm of Grant Thornton positioning itself for private equity backing.
Koelsch stated: “Professional services roll-ups have proven to be a great success, particularly in accountancy, but the legal market is double the size and much more fragmented – offering a great investment opportunity”.
Challenges facing firms
Over the last several years, the mid-tier legal sector has faced its fair share of challenges.
Issues include recruitment difficulties due to a salary wars among City firms, and the UK’s broader economic malaise, with lock-ups frequently prolonged as clients take longer to pay their bills.
For the firms that are able to avoid most of these challenges, their problem is trying to keep up with the rapid rise in technology.
The downside of the partnership model at law firms is that, in order to invest in the firm, partners must draw from their profit pool, which has the potential for conflicts.
Koelsch explained: “The reality is that the equity partnership model, particularly in the small to mid-market, struggles to deal with the need for substantial capital investment and rapid transformation of the business.”
“It is also not necessarily attractive to the next generation of partners to be putting their own money at risk through this model,” he added.
What makes private equity so attractive? Toby Harper, founder and CEO of Harper James, the business that received backing on Wednesday, told CityAM that he had been “seriously considering” private equity for the past couple of years.
“Over that period, I’ve been approached by 20 to 30 private equity firms, which naturally prompts reflection on the role external investment could play. However, we only kicked off a formal process to evaluate our options and find the right partner around nine months ago,” he explained.
Hands up for PE
Harper isn’t the only senior lawyer who has eyed up the private equity market.
Data shared with CityAM earlier this month revealed that mergers within the UK legal market declined by 25 per cent in the past year as senior partners held out for a share of this private capital.
“In today’s market, clients and legal talent alike are looking for alternatives,” Harper noted.
However, just because some firms may want private equity backing, not all law firms will be viable for this funding boost.
Private equity houses are not currently looking to invest in a graveyard but instead want firms and legal businesses that can demonstrate strong financial growth.
Part of the deal is to provide funding that can help accelerate innovation, talent growth and client service improvements, which would have been much harder to achieve alone due to the costs.
At the time of its backing, Harper James had achieved double-digit year-on-year growth, with revenue increasing annually by an average of 33 per cent over the past three years. Trethowans has experienced “organic growth” over recent years, resulting in the firm approaching £30m in revenue.
“We look to invest in successful regional practices, which are already run under good management,” stated Koelsch.
While, Harper added: “From our experience, and what we hear through advisers, there appears to be strong appetite from private equity firms looking to invest in the legal sector – especially where they see scalable, tech-enabled models that offer something different to the traditional partnership structure.”
This comes as over 2024, 498 law firms ceased practising, according to data from the legal regulator Solicitors Regulation Authority (SRA), citing issues such as financial difficulties and the mishandling of client money.
So, for those managing partners of firms seeking to knock down the doors of private equity houses in order to propose your firm for funding, a good business plan and positive revenue growth will be needed to set you apart from the rest of the competition.
Eyes on the Law is a weekly column by Maria Ward-Brennan focused on the legal sector.