Not wanted on the voyage

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From the incumbent’s point of view, the only thing worse than a revolution that topples you is one that renders you irrelevant. You can mount a comeback from exile; you can’t mount a comeback from Nobody Cares. Law firms, pay close attention.

We’re now less than six months away from the implementation of the Alternative Business Structures (ABS) provisions of England & Wales’ Legal Services Act. This event has been forecast as law’s “Big Bang,” the equivalent of financial services deregulation in the UK in the 1980s, although I suspect this will be a long rumble of change rather than a sudden explosion. But as we get closer to October 6, signs are emerging that should be making British firms very uncomfortable and firms elsewhere in the world more than a little uneasy. It’s quite possible that the biggest change in legal marketplace history will pass law firms by.

The Legal Futures website reported last week that English and Welsh law firms are finally starting to take ABSs seriously and are becoming more amenable to external investment. The bad news: the investors may already have lost interest. “City solicitor Paul Harding, who heads ABS Advisory Partners, said he was ‘absolutely convinced’ that private equity firms were getting ‘cold feet’ because of the difficulties they foresaw from investing in partnerships. … Mr Harding said law firms do not really understand what an investor would require of them. ‘They’re thinking about creating capital value that they can buy and sell, and not looking any further than that. They’re in for a shock. If money is made available, they won’t like the terms.’”

Subsequently, at an ABS-themed conference sponsored by Legal Futures, Richard Susskind issued the same warning: most law firms will not be invited to this party. “Law firms hold few attractions to private equity investors because there is no obvious exit route and little profit, he said, predicting that external investment will be made exclusively in new forms of legal business: ‘These are the businesses that are growing; doubling, tripling, quadrupling every year. Of course they’re going to attract investment.'”

When you think about it, the idea that private equity will bypass law firms and roll straight into new business models makes perfect sense. As any managing partner will tell you, running a typical firm is a task that inspires mythic adjectives like Herculean or Sisyphean. Law firms resist corporate management the way cats resist baths. John Wallbillich at The Wired GC illustrates this perfectly by listing five reasons why law firms couldn’t adopt the Goldman Sachs model:

  1. They don’t hire the best and then invest in their development.
  2. They don’t honestly evaluate talent at all levels.
  3. They don’t make people leave who don’t perform.
  4. They don’t directly link pay with performance.
  5. They don’t accept downside risk for upside reward.

Savvy investors would balk at an operation that failed on one of these points; most law firms fail on all five. Why would investment firms take on the headache and heartache of trying to corral hundreds of independent lawyers who each insist on professional autonomy and consistently put their own interests ahead of the firm’s? Many law firm partners, if offered cash for an equity position in their firms, would likely take the money and run. Private investors are fully aware that six months after buying your average law firm, they’d be left with a logo, a lease, and an unfunded pension plan.

Much better, from the investment community’s point of view, to start from scratch. Finance a small greenfield firm where lawyers work efficiently, price by value and are committed to the cause. Alternatively, kick the tires on some of these virtual or distributed firms that deliver results without overhead and attitude. Better yet, never mind the lawyers: go find an LPO the way Thomson Reuters did, inject millions of dollars into its operations, and see what happens. Or throw your weight behind a document service company like LegalZoom or a small-firm franchisor like Quality Solicitors. In all these cases, investors will be looking for private companies that think and behave like private companies, not like country clubs with billable-hour targets.

The threat of irrelevance is not limited to either the UK or the ABS world: it represents a general marketplace shift away from the traditional providers of legal services and their bases. The Daily Business Review recently published an account of a conference where in-house counsel from Microsoft and Hewlett-Packard — not exactly lightweight clients — cheerfully described all the ways in which they were slicing millions of dollars off their annual legal spend.

But the Microsoft lawyer also threw in a statement that should make even the biggest and most “prestigious” firms shiver: “‘When I started,’ he said, ‘everything I did … all the regulatory work … was centered in Washington. Now the centers of power are Asia, Sao Paulo and Moscow. … All the complex legal issues these days are outside the United States.” In other words, complex legal issues — the ones that big firms pursue because they pay off so handsomely in money and prestige — are leaving the building. If you’re a US firm that stretches no farther than the continental 48, that’s a problem.

A year or so ago, I quoted a Seth Godin observation: “When the platform changes, the leaders change.” I think that process is now underway in the law: a shift in the marketplace environment that has a very good chance of deposing incumbents and producing brand new players. Twelve months from now, when the first ABS dollars start circulating through the system worldwide, we should start to see that shift manifest itself.

Law firms that want to survive this change could stand to do a lot of things, but they might be best advised to start with management. Specifically, they could junk a model where the owners manage the business, manage it according to their individual short-term interests, and treat the firm as a means to an end rather than an end in itself. The global legal market is about to hand down a verdict on that model: it doesn’t deliver what we need. It’s irrelevant.

Jordan Furlong speaks to law firms and legal organizations throughout North America on how to survive and profit from the extraordinary changes underway in the legal services marketplace. He is a partner with Edge International and a senior consultant with Stem Legal Web Enterprises.

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3 Responses to “Not wanted on the voyage”

  1. Stephen Lobb

    Thank you for your valuable insights, Mr. Furlong. I am finding your articles, posts, and tweets to be a treasure trove of good information as I prepare to launch my website(s). I am a solo in mid-Michigan. Tell me, are you seeing any decades old big firms engaging in main stream media advertising to try and promote/establish a brand identity that might enhance their value in the eyes of investors? Are any of these old firms doing what Arthur Andersen did in the 90’s after the accounting industry went through a similar upheavel as the legal profession is now?

  2. Jerome Kowalski

    I believe I am with you completely on this topic, Jordan.

    This topic is likely to continue to galvanize the profession’s attention for some time, as we watch events unfold across the pond.

    There are some quite serious business obstacles yet to be adequately addressed, let alone even comprehended.

    As some have noted, the proceeds of capital infusions by outside investors in large law firms will likely be applied to technology and most particularly knowledge management systems, all with a view of lowering costs to consumers of legal services. The result would be increased commoditization and reduced revenues per lawyer. Thus, the consequence of such investments may well be that unless one creates a Goldman Sachs-type leverage ratio (10,000 to 1?), an extremely unlikely result for any law firm, the investor will simply not get the anticipated return.

    The practices which yield the highest return still remain in the plaintiffs’ class action bar and in big stakes high end plaintiffs’ contingency cases. Massive class actions and other high end cases chew up enormous amounts of capital. Law firms which have been active in this world have already amassed substantial capital and have the internal resources to fund these cases. Some still utilize traditional institutional lending from banks at favorable rates. Others utilize litigation funding companies which do tend to charge exorbitant interest rates; but, then again, these funding companies accept all of the risk in making non-recourse loans and at the end of the day, they do not remain partners of the law firm.

    Others have noted that outside investors in a firms would exert some degree of control within a law firm and the danger he highlights is that such investors will impair the independence of the lawyers’ judgments in directing that efficiency, rather than the clients’ best interests will be a driver in handling a client engagement, all in violation of Rule 1.1 of the Model Rules of Professional Conduct.

    But an added impediment is the preservation of client secrets and confidences. Non lawyer investor participation in law firm management necessarily makes non-lawyers privy to such secrets and confidences, with no mechanism to police the maintenance of such confidentiality by these non-lawyers.

    As Yogi Berra said, predictions are hard, particularly about the future, my own humble prediction is that these models won’t work for traditional Big Law. That’s what I said six months ago at http://kowalskiandassociatesblog.com/2010/10/05/will-permitting-equity-investments-in-law-firms-by-non-lawyers-or-allowing-law-firms-to-go-public-have-a-significant-impact-on-corporate-law-firms/ and nothing has yet surfaced to dissuade me.

    The ABS or Tesco models just won’t work for Big Law. But, they may very well for mass market, consumer oriented, commoditized practice, built on a franchise type model, as you suggest. Take something like legalzoom.com and open storefronts across the landscape. The margins may be small, but they are also small at MacDonald’s, KFC and so on.

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