Law firms are listing on the stockmarket. That makes sense for them, but investors should steer clear, says Matthew Lynn.
Tech start-ups that have cracked artificial intelligence. Engineers who can make household robots. Internet-based banks or smartphone app developers. There are all sorts of high-growth, emerging industries that you might expect to fuel the next boom in listings on the London market. As it turns out, however, the market is seeing the most action in a business that has been around for hundreds of years, and doesn’t seem to have changed very much over that time. Law firms. There have already been a handful of floats on the stockmarket, and this week we learned that Mishcon de Reya is lining up what would be the biggest and most prestigious legal initial public offering (IPO) yet. The firm could be worth hundreds of millions. It is easy to see why that is a good deal for the partners. The problem is that it isn’t likely to be a very good deal for investors.
The law firm gets access to cheap capital – the equity raised will almost certainly be cheaper than borrowing from the bank. The partners get the chance to cash in on some of the equity that has been built up in the business, which should pay for some nice houses in the Home Counties. And offering junior lawyers share options might be a more attractive way of keeping them happy than the promise of a partnership in the future. Investors might think they’re getting a good deal too. According to the Law Society, the total value of legal services came to £25bn in the last year and grew by a healthy £1.9bn. Globally, legal services have an estimated value of $1trn, and the UK is carving out a role for itself as a legal centre where disputes from around the world can be settled. It makes sense for investors to want a share of that.
And yet there are two big problems. First, the business model of the law firm has worked perfectly well for a long time, but it might be about to change. Law is one of the industries most vulnerable to the rise of artificial intelligence. After all, it is a hugely expensive service – you have probably never met anyone who thinks their lawyer is value for money – and yet one that can also be relatively easily systematised.
Robots often find small physical tasks in the real world hugely challenging, but big mental computational tasks far simpler – this is why they are better than humans at chess, for example, but not as good as we are at sweeping the floor. If AI takes over huge chunks of legal work, it might be the law firms that lead that, and make a fortune from it. Then again, it might be software companies, or app start-ups, or the accounting firms, or someone else entirely. When an industry gets disrupted, there is no way of know how it will work out – but it often isn’t good for the incumbents.
Next, law firms are likely to suffer from the superstar problem. Like investment banks, or film studios, the profits at a law firm are generated by a few talented staff. But they end up taking almost all the earnings, leaving nothing for shareholders. After all, it is relatively easy to find another shareholder, or some more capital. It is a lot harder to find a private-equity lawyer with 30 years’ worth of experience and a lifetime of knowledge and contacts. There isn’t much reason for that partner to share his earnings with shareholders who aren’t very useful and who can easily be replaced. The result? The firm may grow, but the senior staff will simply demand to be paid more, or walk out the door, leaving very little left over for the owners of the business.
A disappointing record
The record of the firms that have listed so far is not very encouraging. DWF has done nothing since its IPO earlier this year, and Ince Gordon Dadds has seen its shares fall. Slater and Gordon, an Australian firm that listed in 2007, saw its shares soar for a few years, and then fall back sharply. There is no sign that any of them are about to turn into the new Netflix or Apple. In truth, investors should be very, very careful before investing in law firms as they come to the market. At the very least, you should proceed only with due care and attention, as their lawyer would probably put it.