Features & Analysis

A burgeoning earthquake in the UK legal services sector

The pandemic has increased pressure to invest in IT infrastructure and reduce back-office costs, but most firms are facing historic lows in available cash, with partners generally reluctant to commit additional capital

When FTSE 100 wealth management giant St James’s Place (SJP) burst onto the scene, it completely disrupted its market. SJP was the second fastest entrant into the FTSE100 at the time and used a scalable platform to draw in over 4,000 financial advisers, roughly 12% of the entire UK market, all of whom are self-employed.

In the early part of this century, we saw a similar shift in the opticians’ market. Deregulation of the industry allowed opticians to advertise their services, which provided customers with better choice and more cost-efficient access to services. Relatively quickly, two-thirds of the market was dominated by a small number of national chains (Boots, Specsavers and Vision Express), all using a franchise model to consolidate the smaller practices.

I believe a similar earthquake is taking place in the UK legal services market and that we will see large scale consolidation of high street and lower mid-market firms in the coming years.

This segment of the UK legal services market is highly fragmented. There are several thousand small firms, many of whom have under-invested in back-office infrastructure and who have an ageing equity partner group and limited capital reserves. Covid has highlighted these weaknesses and shone a light on the poor management and outdated operating models that are so commonplace in this sector.

The pandemic has increased pressure to invest in IT infrastructure and reduce back-office costs, but most firms are facing historic lows in available cash, with partners generally reluctant to commit additional capital.

Covid isn’t the only source of pressure. A recent market report suggested that Professional Indemnity Insurance premiums have increased by an average of 30% amongst SME firms, with two-thirds of them claiming this was among the biggest threats to their firm.

In this environment, consolidation of the sector is inevitable. But who will be the chief consolidators?

In the changing mid-market, the winning models will be those that generate efficiency from scale and investment; that invest in central management; and brands that will enhance their “customerisation”, providing competitively priced, client-focused services.

Efficient corporate consolidators with a well-defined M&A strategy and an ability to execute on it against clear parameters should do well. Firms such as Knights, which does not pay over the odds and which has the advantage of being able to issue listed equity in consideration, should benefit.

The hub and spoke model used by Shakespeare Martineau whereby central costs and infrastructure are consolidated around a core hub, allowing practices to join and benefit from scale and shared costs but retain their identity, may be another winner.

But the operating model most likely to dominate this consolidation of the high street and lower mid-market is the legal consultant model.

The model, which offers lawyers a central service platform, brand and management infrastructure from which to operate, in return for an average of 30% of the lawyer’s revenue, relies on the lawyers themselves operating as self-employed consultants. Over recent years it has become more and more accepted by lawyers, investors and clients, and even more so since the pandemic. Suddenly working remotely has become viable and appealing.

The signs are that the main protagonists in the legal consultancy space are going to overtake many firms currently above them in the league tables.

Since its IPO in 2017, Keystone Law has continued to grow quickly and now has 479 fee earners, compared to 267 at IPO. Its revenue growth has continued apace, demonstrating its ability to win and retain clients under this model, and its share price has consistently risen.

Another protagonist in this space, Taylor Rose MW, has doubled the number of consultants on its books in the past year alone, adding 15-20 new recruits every month and now taking four times the revenue from its consultancy practice than it did in the financial year pre-pandemic. It also has the advantage of operating a traditional practice alongside its consultant division, and as a practiced consolidator through M&A it should be in a good position to benefit from both models.

These businesses are growing at a rate that significantly exceeds that of their traditional competitors, and there is every indicator that this trend is set to continue.

The UK smaller mid-market legal sector is exceptionally fragmented, and I believe it is these consultancy-based businesses that are in the strongest position to take advantage of it. They have the highest quality infrastructure for managing and delivering legal services; they are much better placed to recruit lawyers directly; and the recent rapid adoption of home working has accelerated the appeal of ‘officeless’ legal advice to lawyers and clients.

This is not a flash in a pan but a long-term, genuine story of market disruption.

John Llewellyn-Lloyd, head of Business Services, Arden Partners

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