How Nonlawyer Ownership Abroad May Affect U.S. Firms

This commentary provides some preliminary thoughts on how equity investments in non-U.S. law firms may change how U.S. law firms do business.

Impact on U.S. Market Generally

U.S. firms are being shortsighted if they assume that there will be no competitive impact in the United States just because equity investments as such are still contrary to (what some will argue are anticompetitive) U.S. bar regulations. Certainly those U.S. firms competing for international work inside the United States or those U.S. firms already operating or contemplating operating in international markets should seek to understand now how they will compete against firms that are ' pursuant to their jurisdiction's bar rules ' able to obtain external equity financing. For example, how will an AmLaw 50 firm compete in London, Europe, or Asia with a UK firm that has access to a significant war chest to hire talent and acquire local firms that provide expertise in focus areas? Or, an example that may be closer to home: Until now, UK firms (with a few exceptions at the top end of the market) have been too mismatched financially to enter the U.S. market on a large scale; this may change as UK firms gain access to outside capital, enabling UK firms to compete with U.S. firms in their own market, and this outlook will magnify if the current trend away from U.S. capital markets
continues.

Outside Investments: What For?

In the UK, there are already quite a few law firms that are working to prepare for outside investment. These are not just firms on the commodities end, such as real estate conveyance shops, plaintiffs firms, will generators, and the like; these are also growing mid-market firms. These firms will use investor money to finance expansion, including into international markets, and to finance large-scale capital investments in systems that improve work processes and client relationship management ' both long overdue in the legal industry globally. They will also put competitors who remain 'professional' partnerships under pressure by offering large golden handshakes (part equity, part cash) to attract talented lawyers and non-legal staff. By the acquisition of several focused firms, they will create specialized powerhouses that compete internationally.

These are not crystal-ball predictions. Several UK mid-market firms are currently considering these among other options. Some pioneering U.S. firms are also beginning to explore using equity tie-ups creatively for strategic talent and business acquisition.

Structural Changes

Clearly, fundamental structural changes are required before a 'professional' firm is ready to be acceptable to an outside equity investor. Once firm management has agreed on a strategic growth path (a process that itself often is a significant achievement), structural changes must follow in the form of robust management structures. In particular, ways to manage professionals must be introduced, accepted, and lived by. On the firm management side, effective governance and communications structures need to drive the agreed strategy. This is true at all functional levels. Sound financial practices will no longer be optional measures to maximize profit per partner; they will constitute non-negotiable investment conditions that will be monitored tightly and managed rigorously with little sympathy for individual partner idiosyncrasies. Even those firms that choose not to seek outside investment will adopt some of these practices in order to remain financially competitive. A good portion of these practices will spill over across the Atlantic into the United States, where even leading firms, while highly profitable, still are often managed on a cash basis, and partners still enjoy far greater independence in how they manage their practices.

Changes in Financial Management Function

The financial management function has been transformed significantly during the last 10 years, and we expect this transformation to continue ' accelerated by the potential of outside capital raising. The role of the CFO also will see significant change for several reasons. First, current CFOs of many AmLaw 100/200 firms are retiring members of the baby boomer generation. Most have a financial accounting background and carry a CPA qualification, and they have been invaluable in helping their firms grow exponentially from sometimes modest beginnings through several business cycles. In my organization's work with law firms, we have noticed a change in this profile. CFOs who are now entering law firms often have a background that is rooted much more in finance than in accounting; these people are likely to have a strong banking or industry background. This generally implies people who are even more analytically but less debit-credit minded, who use systemic data to back up business decisions and who are more willing to penetrate partner sensibilities on the independence of their practice. They are adamant about long-term performance and are not afraid to help the managing partner manage out unprofitable or unfitting practices, clients, and partners ' irrespective of whether these provide large amounts of revenue to the top line of the firm or otherwise carry a big stick.

Second, technology will be on the side of these financial managers. Outside investments will help, in particular, undercapitalized firms invest in systems that allow professionals (I purposely use this term instead of partners) to make real-time pricing decisions, staff matters at optimum levels, and use technology to generate those parts of a lawyer's work product that are no longer deserving of the expenditure of human energy.

Third, the increase in professionalism of the law firm finance function might mean that a CFO who is looking for a new challenge has the option of joining a different management function in the law firm ' instead of, as often is the case, seeing a similar CFO position in a different firm as the only next step. This will make the position of law firm CFO more attractive to financial professionals who come from outside the legal industry ' which in turn will only help increase the overall effectiveness of professional law firm management.

Michael Roch is the lead author of Financial Management for Law Firms. He advises firms on finance and capitalization issues, competitive positioning, mergers, and alliances. Based in London and Denver as a partner of Kerma Partners, he can be reached at [email protected] or 720-937-6101. ' 2007 by Kerma Partners.

This commentary provides some preliminary thoughts on how equity investments in non-U.S. law firms may change how U.S. law firms do business.

Impact on U.S. Market Generally

U.S. firms are being shortsighted if they assume that there will be no competitive impact in the United States just because equity investments as such are still contrary to (what some will argue are anticompetitive) U.S. bar regulations. Certainly those U.S. firms competing for international work inside the United States or those U.S. firms already operating or contemplating operating in international markets should seek to understand now how they will compete against firms that are ' pursuant to their jurisdiction's bar rules ' able to obtain external equity financing. For example, how will an AmLaw 50 firm compete in London, Europe, or Asia with a UK firm that has access to a significant war chest to hire talent and acquire local firms that provide expertise in focus areas? Or, an example that may be closer to home: Until now, UK firms (with a few exceptions at the top end of the market) have been too mismatched financially to enter the U.S. market on a large scale; this may change as UK firms gain access to outside capital, enabling UK firms to compete with U.S. firms in their own market, and this outlook will magnify if the current trend away from U.S. capital markets
continues.

Outside Investments: What For?

In the UK, there are already quite a few law firms that are working to prepare for outside investment. These are not just firms on the commodities end, such as real estate conveyance shops, plaintiffs firms, will generators, and the like; these are also growing mid-market firms. These firms will use investor money to finance expansion, including into international markets, and to finance large-scale capital investments in systems that improve work processes and client relationship management ' both long overdue in the legal industry globally. They will also put competitors who remain 'professional' partnerships under pressure by offering large golden handshakes (part equity, part cash) to attract talented lawyers and non-legal staff. By the acquisition of several focused firms, they will create specialized powerhouses that compete internationally.

These are not crystal-ball predictions. Several UK mid-market firms are currently considering these among other options. Some pioneering U.S. firms are also beginning to explore using equity tie-ups creatively for strategic talent and business acquisition.

Structural Changes

Clearly, fundamental structural changes are required before a 'professional' firm is ready to be acceptable to an outside equity investor. Once firm management has agreed on a strategic growth path (a process that itself often is a significant achievement), structural changes must follow in the form of robust management structures. In particular, ways to manage professionals must be introduced, accepted, and lived by. On the firm management side, effective governance and communications structures need to drive the agreed strategy. This is true at all functional levels. Sound financial practices will no longer be optional measures to maximize profit per partner; they will constitute non-negotiable investment conditions that will be monitored tightly and managed rigorously with little sympathy for individual partner idiosyncrasies. Even those firms that choose not to seek outside investment will adopt some of these practices in order to remain financially competitive. A good portion of these practices will spill over across the Atlantic into the United States, where even leading firms, while highly profitable, still are often managed on a cash basis, and partners still enjoy far greater independence in how they manage their practices.

Changes in Financial Management Function

The financial management function has been transformed significantly during the last 10 years, and we expect this transformation to continue ' accelerated by the potential of outside capital raising. The role of the CFO also will see significant change for several reasons. First, current CFOs of many AmLaw 100/200 firms are retiring members of the baby boomer generation. Most have a financial accounting background and carry a CPA qualification, and they have been invaluable in helping their firms grow exponentially from sometimes modest beginnings through several business cycles. In my organization's work with law firms, we have noticed a change in this profile. CFOs who are now entering law firms often have a background that is rooted much more in finance than in accounting; these people are likely to have a strong banking or industry background. This generally implies people who are even more analytically but less debit-credit minded, who use systemic data to back up business decisions and who are more willing to penetrate partner sensibilities on the independence of their practice. They are adamant about long-term performance and are not afraid to help the managing partner manage out unprofitable or unfitting practices, clients, and partners ' irrespective of whether these provide large amounts of revenue to the top line of the firm or otherwise carry a big stick.

Second, technology will be on the side of these financial managers. Outside investments will help, in particular, undercapitalized firms invest in systems that allow professionals (I purposely use this term instead of partners) to make real-time pricing decisions, staff matters at optimum levels, and use technology to generate those parts of a lawyer's work product that are no longer deserving of the expenditure of human energy.

Third, the increase in professionalism of the law firm finance function might mean that a CFO who is looking for a new challenge has the option of joining a different management function in the law firm ' instead of, as often is the case, seeing a similar CFO position in a different firm as the only next step. This will make the position of law firm CFO more attractive to financial professionals who come from outside the legal industry ' which in turn will only help increase the overall effectiveness of professional law firm management.

Michael Roch is the lead author of Financial Management for Law Firms. He advises firms on finance and capitalization issues, competitive positioning, mergers, and alliances. Based in London and Denver as a partner of Kerma Partners, he can be reached at [email protected] or 720-937-6101. ' 2007 by Kerma Partners.