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Will private equity solutions become commonplace for firms amid recession?

A year on from selling a 30 per cent stake of its business to a private equity firm, Wotton + Kearney has experienced numerous benefits. So, with a potential recession looming, will more firms look to alternative funding solutions for increased cash flow?

user iconLauren Croft 04 August 2023 Big Law
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In June last year, international law firm Wotton + Kearney entered into a partnership with private equity firm Straight Bat, which took a 30 per cent stake in the legal practice.

The partnership, W+K said in a statement at the time, meant that Straight Bat would assist the firm in delivering on client solutions and growth objectives, as well as bolstering the firm’s position in the insurance market.

Then, earlier this year, national plaintiff law firm Slater & Gordon officially delisted from the ASX following a compulsory acquisition of its remaining securities by private equity firm Allegro Funds.

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On 24 February, Slaters confirmed that the company had signed a bid implementation agreement (BIA) with a subsidiary of Allegro Funds, providing for a recommended off-market takeover for 100 per cent of the listed company shares at $0.55 per share, with unanimous support from the directors of the law firm. As of mid-April, Allegro Funds had acquired more than 97 per cent of Slaters.

Speaking to Lawyers Weekly at the time, Slater & Gordon chief executive John Somerville said that the day-to-day of the legal practice would continue.

“This is not about turnaround, this is not about restructure. This is about investment for growth,” he said.

One year on for W+K

When the sale originally went through last year, Straight Bat’s minority stake in the firm was at 30 per cent, with the 70 per cent balance to remain with partners/shareholders. However, W+K said at the time that the private equity firm’s stake would be “dilutive over time” as the legal practice looks to allocate more shares to new partners.

Speaking to Lawyers Weekly recently, Wotton + Kearney chief executive partner David Kearney said he has been “delighted with the contribution Straight Bat has made in the first year of our partnership”.

“Over the course of the past 12 months, our revenue has grown by approximately 25 per cent. We’ve also seen a material rise in operating profit. Straight Bat has assisted our leadership team with our growth strategy and supported us every step of the way. Looking forward, like most law firm leaders, I am very conscious that legal businesses will need to transform their operating model to remain competitive. Our Straight Bat board members are both ex-McKinsey, skilled in achieving lasting and positive change, and I am confident that they will bring these skills to the fore as we aim to become an even better business partner for our clients,” he said.

“I am also delighted that Straight Bat’s investment in our legal business has resulted in our ownership group building an even greater focus on growing a legal business of value in a collaborative way. In my view, this is very different to the siloed, ‘eat what you kill’ culture that prevails in some legal businesses.”

Since last June, W+K has poached an insurance team from Sparke Helmore to open its eighth office across the country, acquired boutique firm Ball + Partners, taken teams from Corrs Chambers Westgarth and MinterEllison, appointed a partner from King & Wood Mallesons, as well as promoted five to the ownership group.

Straight Bat recognises that our ownership group is not stagnant and that lawyers who are making long-term, lasting contributions to the value of our business should be entitled to join our ownership group,” Mr Kearney added.

“Since Straight Bat invested in our business, we have promoted five lawyers to our ownership group consistent with the agreed model. This has resulted in a dilution of Straight Bat’s 30 per cent stake.”

PE investments ‘not without cautionary tales’

Taylor Root director Brad Booth was unsure that PE solutions were currently a trend for law firms, but he said it could be the answer for firms with cash flow and funding issues.

“The history of private equity in the legal industry is very mixed and not without cautionary tales, particularly overseas. Law firms looking to innovate and grow might see PE as being a more appealing option. PE funds have raised significant cash over recent years, and those chasing ‘buy and build’ deals might see the legal industry as an option,” he explained.

“Like any business, law firms have growth plans and funding needs, [and] PE funds might just provide the right mix of investment and expertise to fuel the growth trajectory that’s not necessarily provided by traditional funding models. The injection of capital used to invest in technology and strategic acquisitions are likely to be some key factors. For some firms, there will also be the added benefit that PE teams can provide with expertise in business operations and strategy. The potential networks that law firms could tap into via their PE partners are also likely to be a consideration.”

In terms of why firms may look into private equity options, BBB Capital managing director Adrian Bouris said it has a lot to do with funding lines, particularly for firms with larger cases and longer lead times.

“If you’re an insurance litigation firm and you’re one of the panels for insurance companies, you get a high volume of small margin but very strong matters,” he explained.

“And therefore, on the defendant’s side – and those sorts of businesses, I think, are strongly attractive to a private equity firm because the earnings leverage with more junior staff is very high. And the predictability is quite strong, and there’s not a lot of risk in the business.”

Plaintiff law firms, however, can be more of a “contingency risk” – and Mr Bouris said that typically, private equity firms are looking to get an internal return rate of more than 20 per cent over time – the peak of which is generally at three to four years.

And compared to traditional bank funds, PE funds are more likely to take a longer-term view on their investment, which Mr Booth said is “often more aligned with a firm’s long-term growth plan”.

The other benefit is that the investment by the PE fund is probably going be non-recourse; that is, if the growth plans don’t materialise as they expect, the law firm (or its partners) may not be required to repay the investment. This will obviously alleviate some of the financial risk with large debt via traditional bank loans, but importantly, firms partnering with PE funds will also have to hand over a degree of ownership and control,” he posited.

“My view is that technology has the potential to dramatically change the world of work; law firms are no exception, and those that can get ahead or at least stay with the tech innovation curve will be very well placed. PE might be the answer to access what is likely to require a large investment in technology.”

PE investments a ‘good thing’ amid economic turbulence

The question of whether PE firms will begin to invest in law firms more moving forward, Mr Bouris said, depends on two things.

“One, what sort of private group it is, and to have a specialty going and doing turnarounds from stress companies or admin companies. Or two: more general, looking at commercial litigation and insurance dependent litigation,” he added.

“There’ll always be some commercial litigation happening, plaintiff or defendant side that doesn’t matter. And then you also might have an insurance mediation site, and that is very strong and dependable.”

This kind of investment from PE firms could also be needed for law firms amid a recession, should one happen.

“Borrowing funds to assist operating expenses is normal, and a non-recourse PE investment model might be more appealing as the ‘borrower’, but PE funds invest money on the basis of getting a return. It’s unlikely to be an option for firms that simply have issues juggling cash flow,” Mr Booth added.

“Like any industry, global turbulence and a potential recession will expose firms whose business models are struggling. This might create opportunity for acquisitions, and perhaps access to PE funds might be the answer for firms that are positioned for growth. The market conditions might be the catalyst for good firms that need an injection of funds to upgrade or implement technology to consider PE.

“The business of law continues to evolve; for some, it will be critical to implement innovative legal tech, streamline operations and look at acquisitions to keep growing (if that is the strategy). Having more funding options available for law firms to consider is a good thing, and PE is just one.”

Looking outside the usual scope for additional funding is also something W+K has had a positive experience with, although Mr Kearney admitted that it wasn’t too common – yet.

“Private equity is a source of capital, and capital is required to fund the growth [that] most firms desire to reward senior legal talent. Of course, it is one of a number of different sources of capital open to any firm where the relevant business structure allows for external ownership,” he said.

“Whether private equity solutions become common is likely to depend on the extent to which private equity is prepared to commit to long-term partnerships with legal businesses and move away from the traditional ‘buy, build, sell’ model, which underpins the majority of private equity investments. Pleasingly, W+K has partnered with a private equity firm committed to our long-term vision and determined to play a part in assisting us achieve that.”

Lauren Croft

Lauren Croft

Lauren is a journalist at Lawyers Weekly and graduated with a Bachelor of Journalism from Macleay College. Prior to joining Lawyers Weekly, she worked as a trade journalist for media and travel industry publications and Travel Weekly. Originally born in England, Lauren enjoys trying new bars and restaurants, attending music festivals and travelling. She is also a keen snowboarder and pre-pandemic, spent a season living in a French ski resort.

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