Are the law firms of tomorrow going to be owned by a smaller group of entrepreneurial lawyers prepared to risk more capital for the rewards that were taken for granted a few years ago?
This seems increasingly likely in a legal market where law firms continue to de-equitise equity partners (owners) as a response to lower profits. Although this maintains PEP it increases the amount of capital that each remaining owner has to inject into the business to replace that of the leaving partners and generally increases the risk of the remaining owners.
Most lawyers are naturally risk averse because of the nature of the work. When being an owner partner was a one-way bet this didn’t matter. However, in the new environment, where law firm failures are likely to become more common place, ownership may increasingly appeal only to more risk taking entrepreneurial lawyers, with others happy to accept the greater certainty of a fixed remuneration package and bonus.
If it was just the recession that had caused the risk profile of ownership to change, we might expect things to revert to normal when growth returns. New entrants to the legal market are, however, likely to put further pressure on revenues and margins in law firms.
This is already apparent in the volume PI and Residential Conveyancing markets where new entrants are using technology and business processes to reduce the cost of handling each assignment. Consolidation in this fragmented sector is likely to be rapid and will be driven by a relatively small number of risk taking entrepreneurial partners doing deals with new entrants. They will become key members of the management teams and shareholders of the new business and expect to be highly rewarded with a capital gain on exit.
In the commercial mid market, occupied by many of the Top 200 law firms, business clients are driving change. In particular they want cheaper, better and quicker legal services. That means law firms need to invest in technology, build a recognisable brand and develop more efficient processes. But they lack the capital and the experience to do this quickly. It is only a matter of time before the most entrepreneurial partners realise things need to change radically. That could mean consolidation but it might well mean doing a deal with a new entrant who has the capital and the experience needed.
Those entrepreneurial partners who understand the need for change may soon begin to think like entrepreneurs in other ways. With income taxed at very high rates their focus may shift from PEP to shareholder value, and converting income into capital gains, taxed at 10%. This could be achieved through incorporation, the creation of an internal market, and the issue of share options. It might also mean an easier and more rewarding exit to a consolidator with external capital.
Is this change in culture and approach likely to be the most important impact of liberalisation? Only time will tell but there is plenty to play for if partners are ready to take the risk.