The ABS triangle – regulators, consumers and investors

Baker Tilly’s George Bull analyses the changing market.

The recent initial public offering (IPO) of full-service English law firm Gateley and its admission to AIM mark another significant step in the evolution of alternative business structures (ABSs) in England and Wales. While Gateley is the first UK law firm to achieve a public listing, it is not the world’s first listed law firm. That accolade belongs to Slater and Gordon, the Australian consumer law firm, which listed on the Australian stock exchange in May 2007.

Once the regulatory regime for law firms is relaxed, it’s only a matter of time before law firms turn to the capital markets to raise money to fund growth or acquisitions. Flotation is well-suited to consumer law businesses, which are by their very nature readily scalable, relying on smart systems, high leverage and little or no partner input to client matters. Hub-and-spoke outsourcing models also lend themselves to this, as do portal-type referral businesses, such as National Accident Helpline. However, the fortunes of Australian Integrated Legal Holdings, which listed in August 2007 and went into voluntary administration in December 2014, illustrate the perils.

For traditional law firms, listing brings further challenges. For example, lower leverage and a greater reliance on contact between partners and clients require care to avoid stalling partner succession by creating a ‘marzipan layer’ of individuals who would have become partners in the old firm but stand little chance (even with carefully drafted long-term incentive plans and share option schemes) of ever acquiring a measurable stake in the company. The risk is that, by the time senior equity partners leave (typically three to five years after the IPO), the firm may have been hollowed out as senior employees depart to pursue their careers elsewhere. That in turn raises difficult questions for investors.

As most ABSs are concerned with consumer law, it will be interesting to see how Gateley rises to the challenge of building a successful traditional law firm business in a listed environment. Equally, of course, it is possible that over the next five years, Gateley will transition into an entirely different type of law firm.

Subject to the usual investment warning that past performance is no guide to the future, a well-executed growth strategy could deliver market share of 30% for a single consumer law firm. Regulators encourage a competitive market, so it’s unlikely that any jurisdiction will contemplate fewer than three or four major players. The market place can also support medium and smaller ABSs appealing to different client types and offering services in different ways.

All this suggests that, once a consumer ABS has maximised its market share in a jurisdiction, it will strive to repeat that success in other liberalised regimes.

Attention has focused on the arrival of ABSs. It is now more instructive to consider the evolution of ABSs within the triangle, defined by three main participants: regulators, consumers and investors. The key questions relate to who is ‘winning’ and what impact ABSs will have on all three sides of the triangle, as well as on the size and shape of the legal services market in England and Wales.

Regulatory reform is fundamental, so it’s important to track the development of ABSs after the Legal Services Act came into force. This must be viewed in the global context. How do the English reforms compare with trends in legal services regulation in other key markets? Is the UK benefiting economically from its reforms?

Of greatest significance is the likelihood of further reforms. These include not only the adoption of similar changes elsewhere, but the potential for further regulatory changes in countries such as Australia and England, where national and state regulators may take the view that the regulatory framework is an evolving organism, not an ossified structure. That reflects the regulatory experience along with the appetite and parliamentary time for more change.

Moving around the triangle to purchasers of ABS services, it’s worth asking in whose interest were the reforms undertaken? In England and Wales, the initial reform agenda was underpinned by the public interest. This was quickly replaced by an overriding emphasis on the consumer interest. Has this worked? Is there a price/quality trade-off? As major consumer law brands emerge, it is arguable that reform has achieved many of its objectives through greater consumer choice, better value for money, improved transparency and fewer complaints.

Government-led changes in relation to legal aid and court procedures render debate about access to justice more complex. On balance, it seems that more consumers are accessing legal services and are beginning to show signs of responding to ABS’ endeavours to develop repeat relationships, but the picture is by no means clear. A degree of murkiness continues to surround the ‘claims culture’. Is there a claims culture in the UK? If so, is this beneficial or damaging for the public interest?

Then we come to the position of the investors. As foreseen when the reform process began, potential investors take many forms. For most, the prospect of a share in significant profits is tempered by recognition that they lack detailed understanding of how law firms work. While robust due diligence will provide greater confidence, some ABS propositions are simply too innovative to be fundable at an early stage. And then there is the question of investor exit, which is substantially uncharted water for all but listed ABSs.