The SMB M&A landscape is in a state of constant evolution, with specific sectors occasionally rising to prominence, sparking increased activity and leading to higher valuation multiples. Recently, sectors such as dental offices, accounting firms, and home service companies have become hot, characterized by increased searcher interest and rising purchase multiples.
In the 26th episode of Private Market Insights, we turn our attention to an industry with the potential to hit similar levels of prominence in the next few years thanks to a changing regulatory framework. Tom Lenfestey, the Founder of the Law Practice Exchange spoke to us about law firm M&A and how the industry has changed in recent years. If you are intrigued by the prospect of diving into the legal M&A space, this episode offers a comprehensive overview of the opportunities and challenges that lie ahead, so make sure to watch the full conversation:
“There’s so much shared knowledge in the business world that could be applied to law to make it better. I think that’ll be an exciting opportunity.”
Tom Lenfestey
Regulatory Barriers in Law Firm Acquisitions
The American Bar Association’s (ABA) Model Rule 5.4 has historically set significant barriers for law firm M&A, mandating that law firms be entirely lawyer-owned to preserve their independence. This rule, aimed at ensuring lawyers can provide independent and unbiased advice, distinctly separates the legal industry from other professional fields in terms of ownership and acquisition possibilities. As a result, the landscape of law firm M&A has been restricted to acquirers with law degrees, limiting the access of non-lawyer investors and influencing the overall dynamics of acquisitions within the legal sector.
Law Firm Ownership Evolution
However, this regulatory framework is slowly starting to change. The transformation of law firm ownership rules in Utah, Arizona, and Washington D.C. reflects a shifting mindset, that law firms owned by non-lawyers can be ethical industry actors and can even help expand access to justice. For example, this regulatory change in these jurisdictions has allowed alternative business structures to flourish. Law firms with business models designed to provide low cost services can generate significant profits while simultaneously bridging gaps in legal assets for lower income individuals. This approach is not only about introducing capital and competitive models into the legal industry but also about leveraging technology and outside expertise to optimize service delivery and minimize costs.
Revolutionizing Legal Services with Non-Lawyer Ownership
Law firm M&A is more common outside of the US in places such as the UK and Australia. In these regions, firms owned by non-lawyers benefit from professional management and external investments, leading to improved client service and firm growth. This model enables significant advancements in technology and service delivery, meeting modern consumer expectations more effectively than traditional law-owned firms.
The Effect of Practice Area on Valuations
In evaluating law firms for acquisition, a firm’s practice area of focus significantly affects the firm’s business model, marketing approaches, and profitability margins. Personal injury law, for instance, operates distinctly compared to estate planning or other legal practices. Understanding the nuances of each practice area is crucial for buyers to align investments with their business objectives.
Challenges of Non-Attorney Law Firm Ownership
For non-attorneys entering the law firm acquisition space, the primary hurdles include navigating strict ethics and regulatory landscapes, notably in limited markets like Arizona and Utah. Other significant challenges are overcoming inexperience in the nuances of the legal sector and ensuring a smooth transition that respects the legacy and operational dynamics of traditionally lawyer-owned firms.
SBA Rule Changes: A Boost for Law Firm M&A
Recent SBA lending rule modifications, especially regarding partnership structures and partial buyouts, could significantly ease the process of law firm M&A going forward. These changes allow sellers to remain involved for introductions and networking, crucial for maintaining client relationships and firm revenue, thus offering more flexibility and opportunities for both traditional and non-attorney buyers to engage in law firm acquisitions.
Enhancing Law Firm Margins Through Acquisition
Acquiring law firms often leads to improved margins, with buyers introducing strategies like increased digital marketing and leveraging technology, which significantly enhance the firm’s profitability and operational efficiency.
According to Tom, “the value of a law firm is typically made up of the business value or entity value plus that personal goodwill value that the lawyer has. Social capital, those are the referrals they have, the brand they have in the community. Knowing how to deal with those under a transition plan is huge.”
In Conclusion
Tom Lenfestey champions the potential within law firm acquisitions, emphasizing that success hinges on understanding regulations and specialized practice areas. These evolving changes promise to bring benefits for investors, legal professionals, and the broader public.