In this blog, we feature insights into the significant impact private equity investment is having in the legal industry.

The legal industry has long been perceived as a bastion of tradition, resistant to change and innovation. However, in recent years, this perception has begun to shift as private equity (PE) firms have increasingly turned their attention to the sector, bringing with them a wealth of capital, expertise, and a fresh perspective. This influx of private equity investment has had a significant impact on the legal industry, particularly in the realm of alternative business structures (ABS) and the potential for nonlawyer ownership of law firms.

The Rise of Alternative Business Structures (ABS)

The legal landscape has historically been dominated by the traditional partnership model, where lawyers hold ownership and management positions, perpetuating a culture of exclusivity and self-governance. However, in recent years, there has been a growing movement towards alternative business structures (ABS), which allow for nonlawyers to hold ownership and management positions. This trend has been driven by several factors, including the increasing demand for legal services, the need for greater efficiency and cost-effectiveness, and the desire to offer more diverse and innovative service models.

The Impact of PE Investment on Partner Capital

Private equity investment has also had a significant impact on how law firms traditionally fund themselves. In the past, law firms have primarily relied on a partnership model, where the partners invest their own capital to fund the firm’s operations. With private equity investment, law firms can reduce or even eliminate reliance on partner capital. This can free up partners’ capital for other investment opportunities or personal needs. However, private equity investment can result in law firms losing some control over their operations. PE firms may appoint their own representatives to the law firm’s board of directors, and they may have a say in major strategic decisions.

The Emergence of Nonlawyer Ownership

PE firms have played a significant role in the rise of ABS and nonlawyer ownership. These firms have been attracted to the legal industry by its potential for growth and profitability, and they have been willing to invest in innovative business models that challenge the traditional paradigm. As a result, PE firms have been at the forefront of the development of ABS and nonlawyer ownership in the legal industry.

As of October 2023, 32 states allow for ABS and nonlawyer ownership of law firms, although the specific requirements for ABS and nonlawyer ownership vary from state to state. In some states, there are very few restrictions on ABS ownership, while other states have more stringent requirements. This is a significant change from just a few years ago, when only a handful of states permitted such structures. Of the top ten GDP states in the US, five allow for ABS and nonlawyer ownership of law firms. This suggests that there is a growing trend among high-GDP states to embrace these alternative business models.

Some specific examples of how PE firms have been investing in ABS are:

• In 2018, Advent International acquired Axiom, a leading provider of legal talent management services.¹
• In 2019, Permira acquired Quistel, a leading provider of legal technology solutions.²
• In 2020, Clayton, Dubilier & Rice acquired LegalZoom, a leading online legal services provider.³

The impact of private equity investment on ABS and nonlawyer ownership has been complex and multifaceted. On the one hand, PE firms have brought significant resources, expertise, and a focus on innovation to the legal industry. This has led to the development of new business models, the adoption of new technologies, and the expansion of legal services to underserved markets.

On the other hand, private equity investment has also raised concerns about potential conflicts of interest, short-term profit maximization, and changes to the traditional law firm culture. PE firms often have a short-term investment horizon and prioritize profit maximization, which can lead to pressure on law firms to cut costs, increase billable hours, and prioritize high-volume, high-margin work. One of the tools most leveraged by PE firms to increase efficiency is cutting costs, which can lead to job losses in law firms. Additionally, the involvement of PE firms in law firms can raise concerns about conflicts of interest, as PE investors may prioritize their financial interests over the best interests of clients which could lead to ethical breaches. This could also have an impact on overall access to justice. Private equity investment in law firms could lead to increased costs for clients, which could make it more difficult for people to access legal services.

Taking Pause to Consider the Impact

As the legal industry continues to evolve under the influence of private equity investment, it is crucial to carefully consider the implications of this trend and ensure that it aligns with the profession’s ethical principles and the best interests of clients. Law firms considering private equity investment need to carefully evaluate the potential risks and benefits to ensure that they have a clear understanding of the investor’s expectations and goals.

Regulators and professional bodies also have a role to play in ensuring that PE investment does not undermine the ethical standards and professional obligations of the legal profession. They need to develop clear guidelines and regulations that address the potential conflicts of interest and ethical concerns that arise from PE investment in law firms.

The influx of private equity investment into the legal industry marks a new era for the legal profession. It is a time of both challenge and opportunity. PE firms can bring significant resources and expertise to the table, but it is essential to ensure that their involvement does not come at the expense of the profession’s ethical standards and the best interests of clients. By carefully considering the implications of PE investment, adopting responsible practices, and fostering a culture of transparency and accountability, the legal profession can harness the transformative power of PE while safeguarding its core values and ensuring that the pursuit of innovation aligns with the fundamental principles of justice and ethical practice. Taking steps to mitigate potential risks and accounting for the challenges that can arise with PE investment will help the legal profession navigate this new landscape and emerge stronger and more resilient.

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Sources

1. https://www.reuters.com/technology/legalzoom-eyes-over-5-billion-valuation-second-attempt-us-ipo-2021-06-21/
2. https://www.businesswire.com/news/home/20190905005709/en/Axiom-Announces-Strategic-Investment-from-the-Permira-Funds
3. https://www.burfordcapital.com/insights-news-events/insights-research/lawcom-equity-investments/

The information provided in this blog is provided for general informational purposes only. Some of the information may not be applicable or appropriate for all law firms.