First Contact - Rules of Engagement in M&A

Some three and a half years after the debt markets got paralysed - that's 15 quarters now - there is a realistic chance now that the raft of VCs running around - especially in UK legal services markets - can finally stop "fishing without hooks". Trade buyers have been trundling along at a tick over level, but largely unchallenged, until now. So if a deal flow is to re-emerge, a reminder of the rules of first contact would be timely:

The problem with "first contact" is that it is usually botched, so here are some lessons from an old soak who's seen most of them (and been guilty of quite a few).

1. Do the homework first. Deals do come out of the blue, unsolicited, or from a chance meeting, but they usually only show that you don't know as much as you need to. These are the deals which typically result in "impairment reviews" a year or two post completion. If you don't know the firms you would like to acquire or be acquired by, you are effectively abdicating your strategy and enterprise valuation to strangers (to you and the market). Know what is known as your "addressable market", your role in it, and why you are better/different - and have the numbers to prove it.

2. Advisers advise, principals decide. The corporate finance world is full of experienced deal makers, rain makers, thought leaders and assorted other grand terms for commission junkies. Unless you are in the business of making dozens of deals a year, however, you are simply the next burger to them, so be realistic. These "escorts" through the maze can be charming and cost effective, but they probably won't even recognise you, let alone respect you in the morning. Its your baby, its your cash, it's your call.

3. "Who" makes the first approach is important. Everyone likes to keep their big guns until the last stages, so the initial contacts from trade players will often be from other directors. The best (and the worst) of these are line directors with a "real" job, not group special projects or business development roles. They're best when they have some humility and know what they don't know. They're worst when they are simply too rough and think running a big established business model is the same thing as entrepreneurial ability. Precisely what makes them a great executive director can make them a very poor M&A leader, especially when looking at competitor deals. Group directors and VC introducers can be good, but there is still a stage to be gone through after this where you get to know the real culture of the contacts.

4. Talking at all shouts loudest. Letting the VC telemarketer in or agreeing to a first meeting offsite, is not non-committal; it says your hat is in the ring. If you are not for sale, don't take the first step. If you are - do your homework on who buys what, how often and why. (Some smaller firms use this process as a cheap valuation exercise. It has repercussions though, as you will be seen as damaged goods or unreliable thereafter. Dabble if you must, but crying wolf cuts your multiples and/or serious bidder list when you do get serious.)

5. Mind the gap. Owner managers are usually living in the numbers for the 12 months ahead - the last set of published accounts are ancient history. For buyers the last 2 or 3 years of numbers gives a hunch of what's where, but if these are abbreviated balance sheet reports, they really are guessing. The difference can be significant, especially in growing companies in growing markets - usually the ones you try to buy into. Be patient with what is effectively a 3 year data gap. What looks like a £1m business to the researching buyer, can turn out to be a £3-4m one by the time you get there (and vice versa). It matters. Disappointment is as easy to display as excitement.

6. Forget the fag packets. The headline deal numbers of the latest super deal are almost always an irrelevance. VCs tend to forget that even if they don't use DCF valuation approaches, vendors certainly do when calculating the cash impact on their lifestyle post deal. The multiples issues is not that secret (See RBP's Briefing Note: VCs - What Are They Good For (and how much)?). So stick to realistic numbers and aim for a win/win deal. Simple really.

To see exactly the sort of information VCs and trade buyers use in assessing the M&A landscape of the Legal IT market, see RBP's "Legal IT: M&A Perspectives 2011 Q1 report

http://www.rbponline.co.uk/rbpsectors.asp?sector=LTS

Legal Qualification – Protectionism or Standards Maintenance?

Some legal services background to the new reviews in legal education may help. Three areas of statistical development are not well monitored.

First, lawyers feel they are better trained and intellectually equipped than in the past. Decades of 3A’s, A* grades, etc at primary degree entrance level, selection by 2:1 or firsts only thereafter should ensure that only the cream is selected. So it is assumed that lawyers are brighter and better than ever before. Judges may have opinions here, but no-one seems to be willing to ask the clients if they value this intellectual investment. The Chambers, Legal 500, IFLR and LBR directories provide rankings, but on no empirical benchmark. If anything the rhetoric from lawyers is that “no-one does any law anymore” and the clients are expecting a progressive dumbing down of the legal service.

Secondly, “lawyers” broadly described, ie those who have not taken pupillage, training contracts or qualified can only be guessed at, but it is clear that the output from law faculties has for some time now been generating large and increasing numbers of "lawyers" who go nowhere near the mainstream professions.

Thirdly, a number of “grey” areas are emerging in the definitions of “lawyer”. Overseas lawyers converting to UK practice are tracked, and have had a significant role especially recently in keeping numbers up in large firms, but in-company lawyers are only tracked in so far as they need to maintain a practising certificate – which increasingly many won’t.

Without an understanding of how these three issues are developing, the professions are effectively walking blindly into the future.

If clients do not want super qualified egg heads, but would be happier with process policemen tooled up with software – why is the training route into the profession so limited? And sadly in recessionary times, even more so?

Over the long term, statistics from the Law Society Annual Statistical Reviews show solicitor training contracts commenced remains broadly flat. Since 1995 trainees commencing contracts has risen 16.9% in an industry which has grown by 153% from £9.4bn to £23.7bn. The gap has been filled by significant increases in the number of admissions of lawyers from other professions and overseas.

Whereas in 1995, 8576 law graduates equated to 4170 training contracts (48%), by 2009 the percentage has fallen to 36-42%. Looked at another way – the lawyer production line has been producing as many lawyers for areas outside the professions as inside and is now consistently producing many more lawyers for roles outside the profession.

Combine this with the strongest growth in lawyer numbers being consistently within the in-company market and the profession could find that it is shooting itself in foot.

Protecting the quality of entrants to the profession, whether or not the profession’s clients require this particular type of quality, is certainly not “joined-up” thinking and could be construed as more like protectionism than unfettered supply and demand.

Supplying the market with fewer chances for equity participation makes a growth in the number of GCs and in-house lawyers no surprise.

To cap this with a ready supply of legally competent talent for firms seeking alternatives to costly legal practitioners is economically illiterate in the extreme.

Increasing prices and/or eschewing fixed fees while stubbornly putting doctoral brains on scuffed knee problems simply exacerbates this miss match. It is a miss match which has been going on since well before 2003 and for which disillusioned GCs and consumers alike are only symptoms.

See RBP's Legal Services White Paper on Legal Services Reform - White Heat or White Noise? at www.rbponline.co.uk

Legal Services - Going off the Reservation?

At the core of the debate is the concept of “reserved activities”, or activities which only a properly trained, qualified, and regulated person can be permitted to do. Only lawyers can be trusted to “do” certain things. In any other industry or process this would be seen quite simply as a restrictive trade practice, but where it is essential to the administration of justice, it is seen as a tolerable lesser of two evils.

Few would contest that a judicial system needs a process whereby the quality of advocates, the process of case management and the veracity of the testimony and documentation is kept as high as possible. The concept of being an “officer of the court” in the UK is an important one in terms of the independence of the legal system. Historically barristers were the advocate specialists and solicitors the conduct of litigation specialists, regulated by the Bar Council and Law Society respectively.

Reserved activities were extended, however, to include the conveyancing of property and the administration of probate, and on these two pillars rest much of the history and growth of the legal professions.

Conveyancing and Probate are two areas where individuals are most likely to face contentious disputes. There is, however, no commensurate need for a regulated person to be involved in buying a billion dollar warplane or buying a multi-billion pound company. Section 14 of the Stamp Act 1804 was a rather ungentlemanly compromise giving solicitors a conveyancing monopoly which is now routinely conflated with attacks on access to justice.

While defending the maintenance of historically anachronistic anomalies, the legal profession is currently uniquely slow to consider even modest extensions of legal professional privilege. The Prudential case in the Court of Appeal was an opportunity to extend officer of the court status to some types of accountant in some circumstances, but no, parliament must decide. The elision of “justice” with protectionist measures is mendacious and all too common and frankly unhelpful.

Clementi did not propose a change to the reserved activities. He could have extended them or curtailed them – he did neither. Arguably the Clementi terms of reference put the burden of proof firmly on the restrictive provision to prove its value. By the time the Legal Services Act arrived, however, it included provisions which enabled the industry regulator (LSC) to oversee insurance claims management and immigration.

The core issue is clearly closer to the one that drove Pitt in Napoleonic times – trade and taxes. Immigration is currently (erroneously) seen as one of the most volatile claims on the Legal Aid budget, and claims management is a pivotal process whereby vast calls on the public purse are in effect outsourced to the insurance industry.

The legal regulators may well see the maintenance of some reservations as an essential platform from which to ensure a viable profession. That, frankly is not their call. Any issues necessary to ensure the proper conduct of litigation - are, but they are currently insisting that only parliament can deal with these. By this logic, any extensions of protectionist reservations would require the same rigor. It is hard, however, to see how and why a £25bn industry needs protection. Perhaps it is time to remember that it was the OFT reviews in 2001 that started the whole ball rolling.

If the new regulatory regime empowers law firms to compete head to head with legal services firms from other regulatory regimes - all well and good. If they simply ramp up protectionist measures - this is predictable, but it is also highly likely to be self delusional and self defeating in the medium and long term.

(See RBP's White Paper for a fuller exploration of these issues with references at www.rbponline.co.uk)

Legal Services Reform - In Whose Name?

The theory goes that “consumers” were badly served by the professional regulation systems of the past. To keep the legal services sector fit for purpose it had to be reformed and competition introduced both at regulatory and practitioner level. The bogey man of Tesco law was promoted – interestingly not by Tesco – but the scare tactics to justify changes introduced have been relentless.

Way back in 2003 – the Clementi brief was “To consider what regulatory framework would best promote competition, innovation and the public and consumer interest in an efficient, effective and independent legal sector. To recommend a framework which will be independent in representing the public and consumer interest, comprehensive, accountable, consistent, flexible, transparent, and no more restrictive or burdensome than is clearly justified”[Our emphasis]. Taking a dispassionate view of the events over the last decade, both driven by the regulatory changes, and the market itself, it is hard to conclude that the interests of consumers have always remained at the forefront of every ones thoughts and actions.

Very few detailed analyses of the economic implications of the changes to the legal services market overall have been undertaken. Among those that have, they have identified, for example, disaggregation of legal services as a major theme. That a sea of change is happening with or without the intervention of the regulators and the esteemed Reviews and reviewers is evident.

So we have set out in this series of blogs to run through the discrete issues in turn and put the numbers and facts relevant to them in plain view. A clearer understanding of the vested interests and the directions in which they steer the debate can only help. We have no axe to grind here, and hope to present a dispassionate and independent view of the landscape. We are also prepared to say what others are not.

It may well be, for example, that some would conclude the Jackson Review is essentially about keeping big risk items off the Legal Aid and NHS budgets; that Legal Aid in the UK is probably at least twice as expensive as it should be, and that the Legal Services Act is all about tooling up to defend protectionism and established monopolies and oligopolies, not increasing competition for legal services.

That no-one is candid about these positions is a testament to the strength of the legal professional lobby. For good or bad – it is an exceptionally pervasive and effective one. It could also be that some would conclude the real money has already disintermediated the legal profession which is increasingly seen by the deeper, cannier commercial pockets as simply a cost of failure – and one that they are increasingly reluctant to pay.

Legal Services Reform - White Heat or White Noise

This is the first of a series of posts on the plethora of events in the legal services arena currently. There is a lot of hype and misinformation - having reviewed the numbers - the following (in no particular order of priority) are the headline (for some - uncomfortable) findings:

1. October 2011 will be a whimper, not a bang. The bag was 10 years ago but just as GCs are not fussed about the Legal Services Act now, no private practice lawyers were listening then. The latest reforms aim to empower solicitors to compete in a wider legal services market at the cost of minimal concessions to other professional interest bodies.
2. Personal injury work will not become legally aided, but when an access to justice issue is side tracked into automated cost arbitraging, even the MoJ has to act. Jackson reforms are a lamppost that generates more support than light in terms of the access to justice high ground.
3. Competition between regulators is unlikely to reduce the costs of regulation on qualified lawyers. It could even increase it. Forcing other legal services providers to take on the overheads of lawyers in the name of competition – levelling costs up in effect – is nonsensical. They will find other ways to disintermediate or marginalise the “reserved” lawyers, who will simply get more uneconomic.
4. As long as non-lawyer entrants to the market are forced to first get a licence through one of their competitors’ regulators, the impact of deregulation will be essentially protectionist rather than deregulatory. This allows legal lobbyists to claim increased competition and economic forces on prices, etc while delivering anything but.
5. Direct access to the Bar is a tipping point for commercial work. Barristers approving ABS’, and especially Licensed conveyancers offering this will be seminal moves, but restricted rights to conduct litigation are typical of the noise without substance that characterises this debate. Had the Bar Standards Board allowed commercial barristers rights of conduct, tanks would have been parking on lawns, but access to pupillage remains heavily constrained.
6. ABS’ from outside the profession are already thriving - not “in waiting”. Rights of audience are not as precious as lawyers think. Lawyers will not become ABS empowered entrepreneurs overnight.
7. Legal Aid is structurally unsound. 17% cuts are unlikely to fix the core problem: the £2bn budget is twice as large or half as effective as it should be. This source of legal work will not increase and will be forced to consolidate and improve efficiencies.
8. Better training, higher entry restrictions and continuous professional education – in effect all the core activities of the regulatory bodies have been ineffective in either building “consumer” confidence or equipping lawyers to deal with “unreserved” legal services competitors. Increasing the costs of being a lawyer is not synonymous with being a “good” lawyer.
9. Some firms will see listing as a viable route, but this it is not likely to come from the most lucrative end of the legal market which has no need of external equity. The track record of listed consolidators in professional services in the UK is not good.
10. Most law firms are simply not much greater than the sum of their parts (or partners). The fact that key partners can and do move firm is both a strength and a weakness. It means establishing an equity value in any given agglomeration of partners is elusive – a weakness. It also means acquiring firms is largely unnecessary when acquiring their key partners or fee earners can be a cheaper, simpler route. By now it should be clear that VCs will not be beationg a path to equity partners’ doors.
11. A mid-market consolidator is not contingent on ABS’ to emerge, although one may yet see this as a reason to try. They are much more likely to fail than to make any serious dent in the magic circle global positions.
12. ABS’ may be a useful route for firms hedging consumer focused legal services risk. Competing within a fickle government regulator environment, while relying heavily on automated scale based systems and self interested insurance drivers makes limited liability and speed of decision making essential.
13. The real debate should be the sustainability, pace and scale of fewer partners using technology and increased fee earner support ratios to maintain or enhance profits per partner.
14. A protectionist approach to restricted entry to the professions is economically illiterate and achieving the exact opposite of the intended preservation of exclusivity. Global firms circumvent it, mid-market firms are weighed down by the cost of it, and clients have access to a growing pool of talent with which they can devise their own cheaper solutions.
15. There is no shortage of entrepreneurial and clever lawyers – industry internal rivalry is keen and focused. Lawyers are not good at inter-industry rivalry and are being progressively disintermediated – cut “out of the money”.
16. Talk about the reforms being for the benefit of “consumers” is disingenuous. Legal lobbyists who do not differentiate between solutions for consumer and commercial clients, but persist with an “us” and “them” view lose the trust and confidence of both constituencies.

Private practice lawyers risk putting themselves deeper into the position of claiming to be the protector of consumers who resent being protected in that way or even by them at all – and certainly not at that cost.

Data behind the above will be spelt out in forthcoming blogs covering:
- Change in In Who’s Name?
- Reserved Activities and Restrictive Practices
- Access to Justice and Legal Aid
- Consumers, Confidence and LeO
- Jackson & Insurance Costs
- Regulatory Competition
- Consolidation
- The Problem with VCs and Listing
- Fixed Fees and Disintermediation