Alternative Business Structures – the future of the legal market
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 Paul Lupton, partner and the head of corporate finance for the UK regions at Deloitte
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THE Legal Services Act will encourage market consolidation and create a more dynamic legal sector, but it is not a panacea for every firm, according to Paul Lupton of Deloitte. The introduction of alternative business structures (ABS) by the Legal Services Act has the potential to radically change the face of the legal profession by enabling non-lawyers to control and own law firms. However, it seems only a portion of the market is receiving interest from potential suitors. An external investor and acquirer can bring business expertise, new systems processes and capital to any business, and law firms are no different. But for private equity investors, many law firms do not have clear and recurring income models that are scalable and ready for rapid organic and acquisitive growth. Insurance litigation is one of the areas of this newly deregulated industry that private equity is interested in. As demonstrated by LDC’s recent investment in Bolton-based insurance fraud specialist Keoghs. A quality firm with clear revenue streams will be attractive and presents a good investment opportunity. These firms may also be used by private equity as the vehicles for buy and build growth strategies. Equity providers are not the only potential investor in this market and may face competition from other insurance industry investors, including brokers and claims management businesses as models develop that seek to maximise the downstream claims income such as rehabilitation, medical provision and loss-adjusting. It is still unclear, however, whether the insurance industry will find this an attractive proposition or whether it will shy away from the challenges of either developing an in-house capability or bolting-on acquisitions as many will view it as too much of a distraction for a non-core activity. Outside of insurance litigation, the impact of alternative business models has yet to take hold. At the top end of the legal market, size and reach matters. A recent Deloitte report found that the UK’s top 100 law firms saw fee income rise 3.8% in the quarter to July 31 compared with the same three-month period in 2011. This seems to be driven by their exposure to, and presence in, the emerging international markets. There is little evidence of appetite for external investment in this sphere. Mid-market firms, which are largely transaction driven and focused on domestic business, have struggled in recent years and are being squeezed by tough market conditions and a banking sector that is reluctant to lend. Although there is an appetite and need for external investment in this area, their partnership model appears unattractive to both private equity and the public markets. Small high street firms, focusing in the main on personal injury, criminal and family work, are finding themselves in the perfect storm driven by legislation around referrals, in the shape of the Jackson Reforms, cuts in legal aid and greater difficulties in accessing bank funding. These firms also face ABS driving the prospect of strong consumer brands, such as The Co-operative, entering the market and taking market share. These pressures could encourage local and provincial firms to merge together under an umbrella brand in order to best combat cost pressure, greater marketing spend and brand equity from new arrivals. This may yet be seen as an opportunity for an external investor. Given the differing prospects of firms within the sector, it is clear that the impact of ABS needs to be assessed from different standpoints. In the short term, it is the mid-market firms that have secured the recurring incomes from commoditised work that will stand to benefit the most from ABS. With scalable and sizeable businesses, such as Keoghs, ABS will provide the opportunity for sustainable growth under a more dynamic business model. Outside of this group, the introduction of ABS is less likely to drive investment and more likely to drive competition. The main hurdle to transactions completing in the sector will be the Solicitors Regulation Authority (SRA). Applications will take up to nine months to complete so it is important that deadlines are realistic for all parties. With the SRA still formulating its position on certain structures and classes of investor, the outcome of the first year of the Legal Services Act will be uncertain. With consolidation already taking place and non-law firms lining up their own propositions, we are likely to see more alternative structures created in the future. However, it is clear that ABS is not an opportunity open to all. Paul Lupton is a partner and the head of corporate finance for the UK regions at Deloitte, which advised Keoghs on the LDC transaction.
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