Law Firms: Private Equity’s Gordian Knot?

Big Law's Investment Appeal

Private equity’s hunger for investment in professional services firms - from auditors to restructuring specialists - seems insatiable, yet traditional law firms remain largely untouched. While investment in non-traditional legal services has been buoyant, direct investment in partnerships has been little more than a trickle. This article explores why, and how that might be changing.

The appeal is obvious. TheCityUK legal services review 2024 reported the global legal services market is predicted to reach $950bn by 2027, with total revenue of the world’s 100 largest law firms breaking through the $150bn mark in 2023/24.

Law firms, especially global giants, can be money machines with top firms exceeding 40% profit margins and multi-million-dollar profit-per-partner figures. This, combined with the potential for growth, consolidation and efficiency gains, makes the sector tempting.

Regulatory and Structural Barriers to Investment

So why the lack of deals?

The partnership model is a big barrier to entry. Its emphasis on shared ownership and decision-making is fundamentally at odds with private equity’s preferred approach of concentrated control and swift, decisive action.

Regulation adds complexity. In December last year, the European Court of Justice ruled that EU countries can choose to restrict non-lawyer ownership, a practice mirrored in most US States. These regulatory constraints complicate PE investment, often limiting its scope.

Even in the UK where external investment has been allowed for more than a decade, PE investment remains relatively muted. While more than 350 UK legal tech companies attracted £5.5bn ($6.8bn) of new investment in 2023, according to TheCityUK, direct investment in traditional firms is a fraction of this. Recent deals, such as the buy-out of #DWF by #Inflexion and the acquisition of #StoweFamilyLaw by #Investcorp, are exceptions, not the rule.

Beyond regulation, industry structures present hurdles. Revenue streams are often viewed as transactional and cyclical, so less ‘sticky’ and harder to value. The industry is fragmented, and proven investment success stories are scarce. Law firms have also usually been capital-light, funding operations internally, with little need for external capital.

The Partnership Model and Cultural Resistance

However, the crucial difference with other professional services lies in the partnership dynamic.

Most firms operate as partnerships. Equity partners own the business and share profits.

Within the partnership, a small group of “rainmakers”- perhaps typically 15-30% of the partners - generate a disproportionate share of revenue. These individuals, with their client relationships, reputation and expertise, hold considerable power. Typically, more so than other similar-sized professional services businesses. Their departure could cripple a firm, a prospect that makes investors nervous.

From the partners’ perspective, external investment is a hard sell. Lawyers can be risk-averse and slow to change. Partners value partnership status, autonomy, and community.

Introducing external investors raises valid fears of losing control or compromising ethics and values. Some will feel threatened by the prospect of increased performance pressures. It will be alien to a lot of partners to share profits with people who don’t work at the ‘coalface’ as they do. The democratic nature of many partnerships, with leadership elected and key decisions subject to partner consultation, is hard to square with PE’s more hierarchical, performance-driven approach.

Even if these objections can be overcome, private equity investors will be wary that this cultural resistance may hinder the implementation of new strategies and operational changes that they often seek to implement.

Private Equity’s Opportunity in the Legal Sector

For all these reasons, it seems unlikely that private equity will be investing in many top-tier firms any time soon.

However, change may be coming elsewhere in the sector. With $2.51tn in dry powder held by global private equity and venture capital funds at the end of 2024, according to private market data provider Preqin, there is pressure to deploy capital. And the legal sector’s profitability, even if tending towards cyclical, remains attractive.

Private equity can provide law firms lower down the food chain with much-needed capital for investment in technology, systems and expansion. Funding could be directed into building a better business - new service lines, market expansion, or acquisitions, facilitating consolidation strategies common in the PE playbook for professional services. Investors know that scaling can dramatically increase back-office efficiencies, boosting profit margins to deliver impressive returns.

Private equity can also inject a dose of business acumen into law firms, introducing the strategic, financial, and operational expertise sometimes lacking in lawyer-led management teams to drive faster, sustainable growth. It can also facilitate succession, helping firms to transition smoothly to the next generation of leadership.

Disrupting the Traditional Model

A way forward might lie in disrupting, not conforming to, the traditional model. Hence the flow of investment into legal tech. Recent deals - focused on creating consumer law brands that can transcend the client-pulling power of individual lawyers and benefit from the economies of scale - also demonstrate this.

It’s both a failure of, and an opportunity for, the legal sector that in the UK and elsewhere there are few well-recognised national brands with consumer-friendly platforms serving perennial needs like conveyancing, divorce, personal injury or wills.

Another possibility lies in building bespoke legal practices from the ground up, cherry-picking teams of lawyers and embedding them in a ready-made corporate structure with a new generation of business-focused leaders. These bespoke practices, perhaps focused on high-demand or repeat business niches, can be designed for rapid growth and eventual sale, attracting ambitious lawyers and leaders with the promise of significant returns.

Finally, another strategy - already in vogue - focuses on alternative legal services, such as LPO, contract lawyers, e-discovery, and document review. These services, often commoditised, can be scaled and automated via legal tech, and without the complications of a partnership structure. PE investment in these companies can leverage operational expertise and drive profitability.

A New Era of Big Law Investment?

This is not the end of lawyers or law firms. Far from it. It’s the start of an exciting new era of innovation in new business models and delivery of legal services that could make them more accessible, unlock significant value for far-sighted investors and reshape the future of the industry.

How ripe for disruption is the sector and which strategies are most likely to succeed? I’d love to hear your comments.

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