The sorry tale of Slater and Gordon has brought the debate over publicly listed law firms to the fore once again, with the opposition from some private firms suggesting a reluctance to acknowledge the business side of the law.
Andrew Grech stepped down as managing director of Slater and Gordon on 29 June 2017. It was the end of a wild decade for the head of the world’s first publicly listed law firm, which seemed like it could do no wrong until its systemic accounting issues came to light following the acquisition of Quindell in the UK.
Slaters reported massive losses, many of its shareholders commenced legal action and the firm’s lenders swooped in and claimed 95 per cent of its equity under the recapitalisation plan.
Slater and Gordon is so synonymous with the ‘listed law firm’ that many perceive its issues to be characteristic of this new breed of legal services provider. But is this really the case?
Fellow personal injury firm Shine Corporate suffered a similarly catastrophic share price drop in 2016 after downgrading its earnings guidance. Meanwhile, the several intellectual property firms that have listed on the ASX operate within their own niche and seem to have avoided the woes of Slaters and Shine so far.
In this cover story, Lawyers Weekly investigates whether the publicly listed model can ever truly work for law firms, as well as why some traditional lawyers can’t bear the idea.
Lawyers Weekly approached Slater and Gordon and Shine Corporate but the firms declined to comment.
Listed firms slated to fail?
Slater and Gordon’s accounting practices came into question after the firm announced negative cash flow and a net loss of $958.3 million in the second half of 2015.
Similarly, Shine Corporate’s share price dropped 75 per cent overnight in January 2016 when it downgraded its EBITDA forecast for that year by almost $30 million.
Their share price crashed and the massive losses these entailed for shareholders did some damage to the market confidence in listed law firms, making it difficult to see how many more could feasibly list in the near future.
Australian corporate law firm Thomson Geer announced in late 2015 that it was considering listing. Chief executive partner Adrian Tembel still hopes to take the firm public, although he says it would be a mistake to rush the process.
Mr Tembel tells Lawyers Weekly that Slater and Gordon’s failings have made the environment more challenging for law firms considering listing, but says others are not bound to the same fate.
“I think it's well understood that Slater and Gordon had two unique issues,” Mr Tembel says.
“One was that they were a ‘no win, no fee’ law firm, and so it was very capital-intensive. That's very different to a commercial law firm, which doesn't carry that level of work in progress and therefore capital requirements.
“The other issue was, of course, a very aggressive offshore acquisition. Many [Australian companies] have made strategic acquisitions in foreign markets and failed, so it's not just Slater and Gordon. However, this was dramatic and it's sad. And it is a setback [to other firms that are considering listing] but it's not fatal.”
Ultimately, Slater and Gordon’s aggressive acquisition strategy brought it undone. But is there a more sustainable way for a listed law firm to generate value?
UNSW associate professor of finance Mark Humphery-Jenner*, who has followed the Slater and Gordon story closely, says other law firms considering listing would do well to pursue a more level-headed growth plan.
“Slater and Gordon's acquisition strategy almost, on reflection, appears to be a textbook situation where firms will engage in an acquisition strategy and eventually destroy value,” he says.
“For a firm to list on the market and maintain a more sustainable growth strategy, I think it would need to do at least two things: firstly, it would need to ensure that its internal growth is continuing. A firm that is just acquiring to grow, without internal growth, will eventually run into challenges.
“By having internal growth, that will enable the firm to grow going forward when the number of acquisition targets perhaps declines, or they don't see quite as many attractive acquisition targets in the future.
“The second thing that it will want to do is ensure that those additional acquisitions have a clear business purpose that generates synergies for the firm.
“The third thing they might want to do is ensure that the acquisitions they do aren’t too large for the firm. Integration-type issues can arise when the firm does mega-acquisitions. What constitutes a mega-acquisition depends on how big the acquirer is, but Quindell was quite large for Slater and Gordon.”
Mr Tembel says rapid growth by acquisitions is not Thomson Geer’s plan. He feels a more circumspect approach will still be attractive to potential shareholders.
“It's not just a listed law firm that has growth pressure on the Australian stock exchange,” he says.
“Any stock which has a growth component to it, which most do, will feel the pressure to deliver growth outcomes for their shareholders. It's for management and their boards to decide what level of growth they're going to pursue, and therefore what type of share price target they're going to pursue.
“We would never pitch ourselves as a high-growth opportunity. We will always pitch ourselves as a diversified, capital-light, strong cash flow, moderate growth opportunity. That might have a share price [or] price earnings impact, but we're very comfortable with that.”
What’s the attraction?
The most significant benefit of listing is the extra capital it provides. Mr Tembel says going public would help Thomson Geer fund further national growth and diversification beyond legal services.
“Our long-term plan is to develop into a modern, transparent professional services firm, and so we see a transformation into a corporate structure with third-party capital as consistent with that objective. It's not essential, but it's consistent,” he says.
“The evolution now is that we're a little more open to organic or acquisition growth, not just in pure legal services but very supporting and consistent services, whether it's patent services, corporate governance advisory, government relations: services that we think are complementary and that our clients would appreciate being offered under the same roof.”
Mr Tembel adds that the capacity to offer equity to employees other than partners could be a great mechanism to boost engagement and staff retention.
“We think that short-term cash objectives, which are common and popular in law firms, whether it's just through salary increases or short-term bonuses, are short-term incentives,” he says.
“It's inherent in great businesses that there is long-term thinking, long-term planning, and to make that work you need long-term incentives. So the idea of creating capital gain opportunities for all of our people – not just our partners or our up-and-comers – over the longer term, we think, would drive optimal behaviours and give us competitive advantage.
“One of the great aspirations of our plan is that we would open up equity ownership way beyond our traditional partners to a broad range of our people, with the capacity to invest, stay invested, stay longer [and] build true capital value, which would be a reflection of a stronger law firm.”
However, not everyone in the legal profession shares Mr Tembel’s outlook. Robert Pierce, the CEO of unlisted IP firm Wrays, says the loss of the traditional equity model could disenfranchise lawyers who are working towards partnership.
“If you look at the traditional model of legal services, the model is one where professional staff work towards equity in the firm and the value that it brings from a financial point of view as well as a professional point of view,” he says.
“I'm not sure that the listed model offers that same trajectory for professional staff, so there could be some rising stars out there, particularly in the IP field, who may feel that their route to equity has been blocked in the traditional sense.
“We've seen a lot of movement in the market at staff and partner levels. There are some lateral movements occurring as a result of staff and partners not seeing a route through to equity that they once had.”
Mr Pierce says one of the main benefits of the traditional partnership model is that the firm’s shareholders – the partners – work directly with its clients.
“It's no secret that companies are required to generate returns for their shareholders. That's the case for both public and private companies,” he says.
“I would say that shareholders of a private firm are actively engaged with clients and closely involved with the day-to-day running of the business, and that builds that connection to the client. I think advisers at private firms have an ability to perhaps focus more on the longer-term client experience.
“A publicly listed firm will certainly have different stakeholders to manage and expectations to manage, not least with share price fluctuations and what the market is doing, whereas potentially a non-listed firm can concentrate on its long-term strategic objectives and therefore the needs of its clients and people.
“If the shareholders are directly involved in managing the business and setting the business up to enable it to deliver the service that the clients require, and they have an intimate knowledge of that service because they're actually dealing with the clients on a day-to-day basis, I think a private firm has an agility that potentially a listed firm loses.”
Mr Pierce puts forward what seems to be one of the biggest criticisms of listed law firms: that their focus on generating profit for external shareholders could detract from their client service.
However, no one can deny that profit generation is one of the main objectives of any law firm, with the obvious exception of not-for-profits. A law firm is as much a business as an accounting firm, a bank or a kebab shop is.
The opposition to publicly listed law firms seems to be based on the perception that law is a higher calling than other professions – one where the best interests of the client somehow supersede the profit motive. Hence the preference among many for the term ‘profession’ over ‘business’.
This is not to say that lawyers don’t care about their clients. In fact, it’s quite the opposite. Good client service is how any law firm generates profits, particularly in terms of attracting return business and referrals. These profits then benefit shareholders, whether they are partners of the firm or faceless investors.
Stuart Smith, managing director of listed IP group Xenith, says it is “nonsensical” to think that listed law firms serve shareholders above clients.
“All law firms have shareholders, whether they be partners or shareholders on the ASX,” he says.
“I’m yet to see a commercial law firm that isn’t run with a profit motive, regardless of its ownership or capital structure.
“The best way to serve our shareholders is to run our business in an efficient, effective and sustainable manner. The best way to do that is to deliver impeccable service to our clients so they remain with us, and to find new ways to add value to their businesses.”
Mr Tembel says that in all law firms, the profit motive coexists with professional duties to clients. What is really taking place, he says, is a shift in the way lawyers perceive their profession.
“All [large] law firms in Australia are businesses that have strong financial incentives for their people, so that's old news,” he says.
“But it's the coexistence between the profit motive and professional duties that exists today, and will always be there.
“The great future law firms will continue to ensure that their professional standards are absolutely untouchable … But that's secondary to whether you're in a corporate structure or a private structure. Both are driven by the profit motive.
“We've got a cultural standard that is a product of deep regulation that goes back over a century, so it's not surprising that lawyers in this country have a particular cultural norm. That's entirely understandable. It takes time for that to change.”
Mr Humphery-Jenner agrees that there is a stigma associated with the notion of a law firm being a business. He notes that, in fact, a publicly listed law firm is exposed to much greater scrutiny regarding its profits and corporate governance.
“The resistance seems to have been, from what I've observed, mainly the historical assumption that law firms are acting in clients' best interests, over and above any other profit motivation,” he says.
“When you really drill down into it, law firms are all already profit-focused, in that law firms all want to make profits for partners or for whoever else is accruing those profits at the firm.
“The main difference with a listed law firm is there are now shareholders who might get profits in the form of, say, capital gains or dividends, so the real difference is where the profits are going.
“In reality, for publicly listed law firms, there's actually much more scrutiny about what they're doing with respect of charging clients or with respect of whether they perhaps violate their duties to courts or whether they engage in poor corporate governance.”
Mr Humphery-Jenner adds that the increased disclosure requirements that come with listing on the ASX can give lenders confidence that a firm is being run well.
“By being listed, [law firms] are clearly undergoing all of the disclosure requirements of the ASX and they have additional public scrutiny. That gives lenders additional confidence lending to the firm because there's more scrutiny of the firm going forward,” he said.
“For example, Slater and Gordon had a large amount of debt, but the reason they could get a large amount of debt, at least in part, comes down to their disclosure. So disclosure will give better access to capital.”
Although Slater and Gordon declined to provide commentary for this story, the following is an excerpt from a comment left on the Lawyers Weekly website in January 2016, attributed to Andrew Grech, group managing director, Slater and Gordon:
"When Slater and Gordon listed in 2007, a hierarchy of duties was clearly outlined in the prospectus and constituent documents clearing stating that the company's obligations to the courts and clients remain paramount, as follows:
"The company and the directors must procure that, where possible, the company fulfils its duty to the shareholders, to the clients of the company and to the court. In the case of an inconsistency or conflict between those duties of the company, that conflict or inconsistency shall be resolved as follows:
(a) the duty to the court will prevail over all other duties; and
(b) the duty to the client will prevail over the duty to shareholders.
"Without stating the obvious, this means that any person who invests or provides debt financing in Slater and Gordon does so on the basis that they understand this hierarchy and the importance that we place on our professional obligations."
The IP niche
ASX-listed intellectual property firms Xenith IP Group, QANTM Intellectual Property and IPH Limited seem to have taken to the public model more easily than the personal injury firms. Xenith’s Mr Smith says this is because IP firms differ greatly from traditional law firms in terms of both their service offering and cash flow.
“The nature of our intellectual property practice is fundamentally different to other listed legal services businesses,” he says.
“Xenith IP Group’s revenue is derived from professional service fees from its multinational client base, which is highly diversified by industry sector, geography and service line.
“The nature of the IP life cycle means individual IP matters can continue to generate revenue for up to 10 years for registered designs, 20 years for standard patents and indefinitely for trademarks. This contributes to a relatively consistent, predictable and sustainable annuity-style earnings profile.”
He notes that the structured nature of IP work makes cash flow faster and earnings easier to predict.
“We do not work on a contingency basis, so work in progress (WIP) never builds up to a material degree, which makes the business relatively capital-light,” Mr Smith says.
“A key aspect of the IP industry is that it’s highly process-oriented, with a myriad of discrete steps and actions throughout the IP life cycle, many of which are deadline-driven. That means we tend to issue large numbers of invoices for relatively smaller amounts, on a monthly basis and/or as various stages of the process are completed.
“The commercial law firms running large numbers of litigation matters on a contingency basis might have to wait several years to invoice each client at the end of each matter, and even then, only if they win.
“Their accumulated WIP can be measured in terms of years, not days, and the levels of write-offs may be both significant and difficult to predict. High levels of WIP also arguably increase exposure to adverse regulatory changes. These factors may all be manageable with adequate capitalisation, but they are nevertheless indicative of a fundamentally different business model, with a different risk profile.”
QANTM managing director and CEO Leon Allen says that while the company does own a law firm that provides IP services, most of the businesses it owns are patent and trademark attorney firms. While this makes it significantly different to law firms in other areas, Mr Allen says there is no reason why other firms should be prohibited from listing.
“The challenges in running an efficient listed business or large private intellectual property practice are not dissimilar,” he says.
“What is different in being listed is that your actions and your financial results are much more visible and open to scrutiny. It is a key requirement of my role that I need to manage an additional interface, if you like. Apart from employees and clients, there is now a relationship with shareholders and the associated regulatory requirements that are part of being a publicly listed company.
“Clearly, this imposes challenges in terms of allocation of time and areas of focus, but also in ensuring that the fundamental basis of success is based on the quality and the competitiveness of the professional service offered. As such, I don’t see a contradiction with the purpose of an IP company related to the nature of its ownership.
“There are many forms of listed companies across industry sectors that operate in highly competitive environments. I think you would find that most, if not all, would say they have a responsibility to their shareholders but also to their customers or clients.
“I do not see any inherent contradiction in running a business or a practice which serves the interests of multiple stakeholders, and in this I would include employees.”
However, it can be difficult for firms to gain the trust of their clients before going public.
Wrays CEO Mr Pierce points to a report from Beaton Research + Consulting earlier this year that surveyed the clients of listed IP firms. The report found that nearly 80 per cent of the clients surveyed either agreed or strongly agreed that the reduction in the number of privately owned IP firms was against clients’ interests.
Two-thirds of respondents either agreed or strongly agreed that firms owned by ASX-listed companies must put the interests of shareholders above those of clients.
However, it is worth noting that many international clients are based in jurisdictions where law firms are still prohibited from listing, such as the US, and may find the concept hard to come to grips with.
Mr Tembel says Thomson Geer’s clients may be more receptive to an IPO.
“Very early in our project, we did a strategic sampling of our client base and external referral sources. There were very strong levels of support for the firm contemplating anything that would make us more transparent, for example,” he says.
“Of course, clients will always want to understand that any transformation would not prejudice them in any way, and I think we'll always be able to convince them of that because we think that the benefits are huge for clients if we are in that transparent, stable, best-practice environment.”
‘A metaphor for modernisation’
Mr Tembel acknowledges, however, that listed law firms still face a significant challenge due to the perception that they serve shareholders above clients.
“If there are appropriate declarations to shareholders before they invest that professional duties are paramount, then there's no legal issue,” he says.
“But is there a perception that somehow a public corporation will be more motivated by profit than a private enterprise? Big question mark.
“I don't agree that just because you're in a corporate environment you've somehow given up some degree of professionalism.
“With the absolutely embedded culture in law firms of financial performance being the criteria for progression, I don't think anyone who's a sophisticated legal buyer will mistake that for anything other than the profit motive being alive and well in private law firms for decades.”
Like any of the other metamorphoses taking place in the legal profession at the moment, if listed law firms are really going to take hold it won’t happen overnight. All the professionals Lawyers Weekly spoke to agree that Australia is unlikely to see many more listed law firms in the near future – Slater and Gordon has made sure of that.
“This is a metaphor for modernisation,” Mr Tembel says.
“You're not going to have 20 listed [law firms] in five years' time, but it's a metaphor for the changes that are occurring and the way the profession is being restructured.”
There would still need to be a significant cultural change in law before listed law firms could become more common, let alone the norm.
Another firm will need to fill the void left by Slater and Gordon to prove to the profession and the market that listed law firms can generate profits in a sustainable, client-focused way.
The only question is: who will it be?
*Disclosure statement: Mark Humphery-Jenner was a shareholder in Slater and Gordon and lost money on these shares. He elected not to participate in a class action against the firm.
A GUIDE TO LISTING YOUR LAW FIRM
Lawyers Weekly asked what law firms should consider before they make the jump into the public sphere.
Mark Humphery-Jenner, associate professor of finance, UNSW:
“If a law firms wants to list on the market and establish its credibility with investors, it will want to ensure that its corporate governance is strong and that it has people with the requisite experience. That would obviously involve the legal experience that's required for them to continue as a law firm, but it's also going to involve having the experience [of] making acquisitions or investing. These are the types of corporate governance characteristics that all listed firms will want in order to maximise growth.
“The second thing is they'll want to ensure they have a clear growth strategy that they communicate effectively to the market. That growth strategy can involve acquisitions if there's a clear way they will add value, but they would also want to ensure the market that they will have an internal growth strategy that will help the firm continue to go forward if the acquisition targets perhaps aren't quite as promising as they were hoping.
“The third thing is when they are making acquisitions, given the experience that Slater and Gordon has had with its overseas acquisitions, it would be wise for a law firm to clearly communicate to the market that they have people on board [who] can do the due diligence that is required.
“And then fourthly, if the firm is going to undertake these acquisitions, they're going to want to ensure that they perhaps aren't quite as rapid-fire and there's enough time to fully integrate these firms and extract as much synergy as possible from them so that they can continue to maximise internal growth in addition to growth through acquisitions.”
Adrian Tembel, chief executive partner, Thomson Geer:
“It starts with their strategy, and if that strategy can be accelerated and strengthened or turbo-boosted by becoming a transparent corporation with access to capital, with capital incentives: tick.
“Then it's about having a realistic time frame to transform the organisation and have it ready and match-fit for the scrutiny. It can take years.
“And the other key point is you can't view it as an exit. It's got to be viewed as a nation-building exercise, and an exercise to create further commitment from its people, to take the firm from here and transform it to there.
“Having access to capital for appropriate strategic investments and acquisitions is a really big plus in a fast-moving environment like ours, particularly when you've got a strategy which is to appropriately invest in allied services.
“But it's the capital incentives that motivate your people: the fact that if they nation-build for the next five years and build value in the organisation, they could be rewarded with share allocations and share growth. We think that's a really exciting motivation for our people.”