Doing it [the outside investment] way…

What do you see as the benefits for law firms of outside investment, and what can private equity firms bring to a legal services business?

There are three areas I would point to, the first being the capital itself, which is self-evident. If you are growing fast, you soak up cash that you might want to otherwise distribute. Significant investment in infrastructure, off-shoring, branding or restructuring can be highly capital intensive. In the brave new world, law firms will be competing with well-funded companies such as Capita, for example, whose ability to draw on a heavyweight balance sheet presents a new set of challenges for the traditional partnership. If you want to out-compete Capita, you will probably need access to capital.

Second is the cultural change that I think an outside investor can bring. I am told by many law-firm partners that rigorous business discipline and the traditional partnership model are not always comfortable bedfellows. But looking forwards, bold decisions are likely to be needed in the face of stiff competition and a prolonged recession. If you talk to other professional services firms that have converted and brought in outside capital, they will point to cultural change as being one of the most important benefits of an outside investment partner.

The third reason would be the value that I think a decent private-equity partner brings to the table. We are experts, not at delivering legal services (or the services of any other segment we invest in), but in the business of helping growing companies fast, mitigating risk and driving value in so doing. So whether it’s professionalisation, profit and cash flow improvement, strategic innovation or M&A, I think we can make a very good partner for a firm on the move.

What areas of the legal market would you potentially be looking to invest in and why?

There are two broad areas of interest for us. One is somewhat complex but nevertheless routine, repetitive work. At the moment, probate, personal injury, aspects of patents (patent renewals in particular), some financial services work and commercial advice for SME’s stand out. Those are services that are buried within a traditional law firm and often provided in the traditional manner, but that we believe could be better undertaken at a cheaper cost by a dedicated, focused business with great IT and really good processes. A consolidation play in one or more of these areas interests us.

Second, taking a slice through the whole market, we are interested in the services provided to law firms and the outsourcing that many law firms are likely to want to consider – for example, legal-process outsourcing of document review for litigation or sale and purchase, back office services, technology services, knowledge management and so on. Unless firms have scale and expertise, they are unlikely to be able to compete in these areas on either cost or service grounds. Those sorts of possibilities are of great interest to us.

Despite the rumours, we’ve never said that we are interested in taking a direct stake in a mid-market law firm. There may well be some very good investment opportunities out there, but it’s still tricky to structure something that works in that area at the moment. We want to invest in the here and now – not just in three (plus) years time.

We are not really keen either in the cultural turnaround of a traditional firm unless that firm is particularly well positioned – but we do think dedicated carve-outs and newer entrants, or entrants with a very focused growth strategy, are attractive and are more likely to entertain us as a partner.

What are the perceived benefits for those investing?

It is an unusual sector in that there has been little external investment, and I think for well-positioned, well-run companies with access to capital, the opportunity to grow really fast and maintain profitability and margins is very real.

Currently, the share of the legal market being delivered by traditional law firms is a huge proportion of a total market of some £25bn. My expectation is that in 20 years time, a much higher proportion will be delivered by non-law firms – possibly a majority. And over this period, many law firms will break up and undergo restructuring. There will be a lot of corporate acquisitions, spin-offs and the like – there will be lots of new entrants and a much more active M&A market than many currently envisage.

The opportunity to invest behind a good management team and a good business in a segment that is likely to win as the market restructures is compelling to us. And we believe that, as the market develops, there will be future opportunities to capitalise on investments made today.

What has the response been from law firms towards investment, particularly in the current economic climate?

We have had conversations with over 100 managing partners or senior partners since we first started thinking about the sector carefully, and we have noted a definite change in attitude very recently. I think people have realised that if they carry on doing the same things the same way, then margin erosion and loss of market share is inevitable. People are thinking quite carefully about how they deliver and how they go to market. These thought processes are much more active now than even six months ago.

What types of firm do you see thinking of outside investment and why?

I think everybody is.

At one end of the market, on the high street, you’ve seen conveyancing disappear and lots of other classes of work come under significant pressure. Firms are having to think very carefully about how to capture new customers and how to deliver services cost effectively.

At the other end of the market, the Magic Circle are also thinking very carefully about their technology, offshoring and other innovative ways of holding market share and sustaining margins.

What advice would you give to firms gearing up for 2011?

Focus on what makes your firm competitive.

Do you truly offer a world class service? Are you industry experts not just legal specialists – business partners for your customers – so that people will go out of their way to use you? How can you be the lowest cost provider? Do you have a special relationship with your customer driven by brand or a contractual ‘sticky’ relationship?

For many, we don’t believe that the traditional model – whether that is the way that customers are attracted or how service is delivered – will stand the test of time. Right now there are literally hundreds of non-traditional firms looking at this market place saying, ‘we can do it differently’, ‘we can do it better’ and ‘we can do it cheaper’. We believe that the impact of these players, the recession, technology, outsourcing, the Legal Services Act 2007 and so on will combine to have a dramatic effect on this marketplace.

Jeremy Hand is the co-founder and managing partner of Lyceum Capital and current chairman of BVCA. He can be contacted at jhand@lyceumcapital.co.uk