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Why should anybody invest in a law firm or a legal services provider?
Over decades the legal services market has been dominated by law firms. Nowadays time is changing in various views. We are still experiencing the consequences of the financial crisis in 2008, customers focus on insourcing work and new entrants, that do not work like traditional law firms, try to win a piece of the cake. Any key points to keep in mind when talking about such changes?
Historically, law firms have had a hegemony on legal service delivery -they did it all. In recent years things are different due disaggregation of legal services as well as a global labour arbitrage facilitated by technology, as described so well in Tom Friedman’s „The world is flat“, and by re-regulation of legal services in the UK, Australia, and, to a lesser degree, in other nations. As well, the notion that „only lawyers can do certain tasks“ has effectively been debunked, especially after the global financial crisis of 2008 created belt tightening by business. As a consequence the delivery of legal services – as opposed to the practice of law – is changing very rapidly. The practice of law, which includes the rules of evidence and the ethical rules governing the conduct of lawyers, have not changed much at all since I became a young trial lawyer more than 35 years ago. However, the structure by which they deliver it has changed quite a bit. I would therefore underscore the distinction of these two points – legal practice versus the delivery of legal services – and not to use them interchangeably because they are different.
What distinguishes law firms from these new entrants to the legal market?
Let’s take the U.S. as an example – and this applies to several other countries as well, although they might have slightly different answers to it. In the U.S. a law firm is regulated by 50 different state bars governing what is defined as „engaging in the practice of law“. Law Firms are not allowed to engage in multidisciplinary practices, they are not allowed to share profits with non-lawyers, and they are not allowed to take in investment capital from outside non-lawyer sources. Unlike legal service providers law firms retain ultimate risk and are deemed to be engaged in what we call „practice of law“. Law firms have operated from a partnership model. In contrast to this, other legal service providers are allowed to do all of the things mentioned previously that are forbidden to law firms. This liberalization you can see with the UK Legal Services Act of 2007 which allows so called Alternative Business Structures (ABS). However, with regard to the strict prohibition for non-lawyers to invest in law firms let’s keep in mind, that this should not be understood in a strict sense. This prohibition is drawing a very artificial line since the funds received from big banks are the financial lifeline of big law firms in the States – and elsewhere – even today, albeit under the terminology of operating capital or lines of credit, which are a form of dependency which, if withdrawn, may lead to bankruptcy.
I understand that a lawyer interested to start his/her own private practice is usually not really required to think about investment planning and business models. The cost calculation will be reduced to renting an office, buying a laptop and hiring a secretary. And the revenue stream will be created by simply billing the own work at the hour. Therefore, why should a lawyer bother at all about building a business case?
One of the challenges lawyers face is that historically law schools have not required law students to think about the business and technological aspects of law. However, lawyers are facing today a competition they have never seen before. All lawyers should have their own business plans for various reasons. If a lawyer is practising law in a law firm he/she will today, based on statistical evidence, not make a career there. In early years the average lawyer had fewer than two jobs projected for his/her career – today the number is seven. That means they will either not make partner in that law firm or not stay there for their entire career. A business plan is required since there are tremendous business opportunities out there for lawyers who have valuable content to share on social media and who are attuned to the rapidly evolving marketplace. Clients are hiring expertise as never before, and with social media a lawyer will be able to get the message out to much a broader audience than never before. So we have a legal market that has both greater competition and greater opportunities.
Anything in particular to consider for lawyers with regard to financial planning?
Today law is both profession and business. Some even say it has become a commodity, at least with regard to certain tasks. As a consequence it is important to do all the basics of business planning like a sandwich shop would do. This requires a lawyer’s education include being able to write a business plan and to be familiar with technology. By the way, 15 states of the U.S. now require lawyers to be familiar with technology developments, i.e. this is no longer an elective course, since such knowledge is deemed
necessary to represent a client zealously and competently. Technology is now embedded in the delivery of legal services. Most legal innovation is driven by the client side. And since we have a buyers‘ market lawyers have to wake up to that reality and realize that most of them do not deliver „special“ services that cannot readily be obtained elsewhere. Let me describe it as follows: lawyers are like hammers and every business issue is a nail for them. Today, however, it is the clients who decide which issue is becoming a legal issue and they determine this from a business perspective.
Looking at the annually published rankings based on law firm’s profit per partner, at least in Big Law a partner can still make some good money. If running a law firm seems such a good business, why should not third parties be able and allowed to participate as investors from a financial point of view (disregarding regulations)? We have heard about first law firms going public in Australia (Slater & Gordon), UK (Gateley) and China (Shandong Deheng). Looking at the stock price of Slater & Gordon, it was issued at 1 A$ in 2007, soared up to over 6 A$ in 2014 and is now back to some 3 A$. This still seems a pretty good deal for an investor, doesn’t it?
If regulations allowed it I would consider it a very good investment. In the U.S. where this is not permitted (compared to the UK and Australia) there has been a tremendous uptake in money in the legal vertical such as legal service companies and legal technology companies. Let me give you two examples: AVVO which is a kind of lawyers‘ network recently raised 71 million USD on top of the some 62 million USD they had previously raised, and the most recent raise was based on a 650 million USD of market evaluation. Legal Zoom is another example – it raised over 100 million USD in the U.S. where regulations forbid investments in law firms. I think it is a great investment. Also law firms could be a decent investment option, provided a different delivery structure is implemented. They need to move away from a pyramidal structure with its leverage model since clients are not any longer willing to sustain it. Looking at the profit per partner in law firms these numbers are deceptive – law firms still continue to be very profitable in terms of profit per partner, however, this is at the expense of laying-off experienced and costly lawyers who do not generate new business, regardless of their service value to clients which is often considerable. This is a short-term strategy and not sustainable for the future.
If I were asking you to invest USD 10,000 in the legal space, where would you put this money to and why? What would criteria would you assess before investing in the legal space at all?
Let’s pick the UK to avoid regulatory restrictions. I would probably invest in a diversified legal services company that has proprietary and partnership technology. I would look at criteria applied when buying a stock in publicly traded market, i.e. I would look at the earnings, senior management, the differentiation from competitors and any other business criteria. One company I would consider would be Legal Zoom since it has a very strong brand name and it secured an ABS license. Even as a U.S. based legal technology company it has now the possibility to engage as a law firm in the UK and this could be a springboard for other markets as well.
What should law firms take home from this discussion?
One of the challenges law firms are facing is the conflict of economic interest within the law firm. Most of the equity partners are in their fifties and older and they like the present economic system. They do not have a financial incentive to change it. Younger lawyers who still have some 30 years of practise life ahead have a different view on this and what their firm should look like. If I were talking to a law firm with lawyers of the same age with an identity of economic interest I would tell them to be more client centric and not to focus on short-term maximization of profit, and rather take a longer term view to be more efficient and to better service clients. And I would tell them to get rid of their secretaries and expensive offices because clients even 25 years ago rarely visited the lawyers’offices and then asked themselves why they were paying for the fancy office space and corporate art collections. Lawyers will have to accept that they do not deliver bespoke legal services, excepting a handful of firms. They have to view the market value of their services from a client’s perspective and what their rates should be. Finally I would tell them to stop trying ‘to be all things to all clients‘ and to focus on areas that they truly excel in.
Any good news for the profession?
The prevalent view is that the legal profession is under attack, it has seen its best days and that there are not many opportunities left for younger lawyers. In my view this is not true. There are still a lot of opportunities in the law but to capture it will require more than just the traditional doctrinal skill set which historically has ensured that lawyers had a comfortable life. Law schools need to appreciate this as well. This is also critical to understand for those who are contemplating a career in law. Lawyers have thought for so long that law is different. They should look to doctors and the medical profession and they will see that medical delivery (not the practice of medicine) has been coopted by business people. I do not make a judgement whether this is good or bad for society, however, what you see now is the early stages of this same transformation in the legal vertical.
Mark A. Cohen has had a long, distinguished, and multi-faceted career in the legal and business fields spanning nearly four decades. He is the CEO of Legal Mosaic, a legal consulting firm for investors, providers, and educational institutions in the global legal marketplace. He is also an Adjunct Professor of Law at Georgetown University of Law Center, a regular contributor to Bloomberg, Today’s General Counsel, BizCatalyst 360, and other media sources, as well as a speaker at Harvard Law School, Reinvent Law, and scores of other global legal symposia, academic institutions, and events. Mark is active in a number of cutting-edge pro bono projects in the legal field and has served on numerous for-profit and not-for-profit Boards.
11/2015Read more interviews