Private Equity Eyes Law Firms

Regulations and ABA rules keep non-attorneys from owning law firms in most states, but that hasn’t kept private equity from noticing that the industry is ripe for investment. Tom Lenfestey, founder and CEO of the Law Practice Exchange, joins the podcast to share what makes the sector a potential hotspot for PE investment, how regulations are evolving and more.

Read a transcript of the podcast below.

Middle Market Growth: Welcome to the Middle Market Growth Conversations podcast, an ACG production, I’m Carolyn Vallejo. Last February we spoke to Allan Koltin of Koltin Consulting Group about the growing trend of private equity firms investing in accounting firms—and it got us thinking which other professional services firms will be targeted by PE. Today we’re joined by Tom Lenfestey of the Law Practice Exchange to talk about what makes law firms attractive targets, how PE navigates legal restrictions around those deals and more. Tom, welcome to the podcast.

Tom Lenfestey: Yeah, thanks for having me, Carolyn. Excited to be here.

MMG: We’re excited you’re here and we have a lot to get into. But first, could you start us off by telling us a little bit about yourself and some of the work that you do with the Law Practice Exchange?

TL: Yeah, absolutely. So, I’m Tom Lenfestey, I’m an attorney-CPA by background and degrees, and I founded the Law Practice Exchange a little over a decade ago, starting with really education for attorneys. And then over the last five plus years, it is the driving marketplace for buying and selling law firms. So at themarketplace.law, we actually have a software-driven buy-sell community, and then our team of brokers and consultants back up that community to really help law firm owners and those looking for growth through acquisition of law firms match and put deals together for succession purposes, for growth, for other strategies. And so our real goal is to disrupt and provide this as a real viable opportunity into the future for the marketplace. So we’re scaling up as we go and helping lawyers and those in the legal profession find that succession or that continuation plan and the growth and consolidation with it.

MMG: Excellent. So you definitely have a front row seat to this space. Can you tell us a little bit about what makes law firms potentially an upcoming hotspot for PE investment?

TL: Yeah, I think it’s one of the few areas you mentioned in the show intro of accounting profession, right? And so as a CPA myself, keeping an eye, as I tell everybody, I don’t know that I have a lot of novel ideas, but I’m a good student of other industries. And so when I started the Law Practice Exchange, I was in a position as a lawyer helping dentists, helping accounting, helping other professional practices on the transactional and planning side as a lawyer-CPA, but they had seemed to have figured out, you know, succession was needed, our aging population of ownership was really coming there. Everything on the law side is, we kind of trail behind these other professional businesses and other professional industries. And so for law, we have our law firm owners that are retiring later than others. Right? I think the last stat was like 400,000 law firm owners at, past or nearing retirement, meaning that baby boomer generation that still has ownership, potentially or most of those without a succession plan. And so I think succession definitely drives that.

I think the other aspect is law’s like a lot of the other professional businesses like accounting; if you had a small accounting practice, good, healthy accounting practice or anything else, if they wanted to invest in technology, it came out of the owner’s funds. If it was partnership funds, right? It just gets hard to really invest into the business platform. There really wasn’t consistency across, you know, what this accounting firm was doing versus this one. And we see that in law, right? We see very novel firms that have invested a lot in technology or marketing or other systems or people, but they’ve done it and it’s very hard to then share those ideas across the industry. So I think with PE of the ability to invest and also help, whether it’s through consolidation and management of groups of firms or otherwise, but to really share what’s been built with others for improvement instead of having this very fragmented or segmented, like, if you want to invest, that’s great, but you have to invest in it yourself. So I think the technology access, the ability to really invest for the greater good of more than just one law firm is an opportunity along with that succession.

And I think the last is the financial. Even though it’s getting harder in law for individual law firm owners because they’re having to invest more in marketing, they’re having to invest more in technology, I think the opportunity for PE is the financial one. Law firms traditionally are run like small businesses and they’re not streamlined on efficiency and profitability. And so I think they still make pretty good money at 25, 30%, some up to 50% plus margins. And so I think for PE to be able to come in to a business that typically—law firms don’t lose money, they’re able to reinvent themselves. They’re pretty durable in good times and in bad times to continue making good dollars, good profitability and high profit margins, but if they can be improved, those profit margins can look even better.

MMG: Now let’s talk more about the sell side. You mentioned 400,000 law firm owners nearing retirement, potentially looking for an exit plan. What would make these kinds of deals attractive to law firms?

TL: Yeah, from the law firm [side], I think succession planning is one of them, right? For so many of these lawyers that are getting to a point, especially of a certain size firm, you know, some of our practice areas or some of our firms get to a certain size that they built into such a large business, their only real candidates would be potentially internal, you know, maybe, candidates or, you know, an outside firm or otherwise, but the values attached to them, you know, if you have a hundred million dollars personal injury firm that’s kicking off, you know, $30 million a year or $25 million a year in profit, the value that’s attached to that on a buyout event is going to have to be private equity either funded or structured in a certain way that’s allowed because, you know, it’s past the SBA limits, it’s past most traditional banking in the field. And so really PE is needed to really help fund these deals as far as succession goes.

I think the other [thing] is lawyers, especially of the next generation, are looking at building better businesses as law firms doing more on marketing, doing more on client service, right? Having responsive platforms and efficient platforms. And I think the opportunity with access to capital that’s not their own capital, like a good young, 5-, 10-year in practitioner that’s really doing all the right things, but really could get into something that has access to capital, access to private equity, knowledge on technology or access to those different providers would be huge. And so overall, I think, again, you’re in an overall industry that hasn’t really changed a lot. You know, there are changes and there’s different pressures coming along, but I think there’s a lot of, as this generational shift comes over, there’s a lot of pressure on, we have to change. And I think PE can be one of those opportunities that they can either provide funding or they can provide the next generation of ownership, or they can provide access to capital to invest in technology that clients and consumers are looking for now. So I think there’s a lot [that’s] attractive for the right situation and structures.

MMG: And we are already seeing some consolidation in this space—is that correct? Can you talk a little bit about the market pressures that are driving that?

TL: Yeah, I think, you know, a lot of the consolidation that you’re seeing now is, again, part of an aging law firm owner population. I think we’re seeing that. I think you’re also seeing pressures on doing more with less, right? As far as more marketing competition, digital marketing, even amongst your everyday law firm, the digital marketing endeavors, the building, the brand, the building, the systems. So I think there is the…how many traditional lawyers that had a door on Main Street who were part of the community and could serve the community and build a good law practice. Now, the business models and law are just different. They are revolving based on consumer demand. Consumers want ease. They want that technology. And so lawyers are having to adapt, invest, and not all law firm owners are up for that. That kind of, historically, if we look back when big changes have come through like financial regulations that require lawyers to modify, like our real estate attorneys a few years ago coming out of 2008, 2009, 2010, a lot of them just said, I don’t want to change. And so they either got out of doing real estate closings because they didn’t want to change their office structure, change their system, start using all of these different things. They just put themselves in a senior position beyond that. And so I think with some of that consolidation that we’re seeing right now, even amongst the small to mid-size practices, that’s part of it, right? It’s getting a little bit tougher. You have to invest a little bit in systems. And overall, you’re seeing now those firms that do invest in systems, do invest in marketing, having the opportunity to go where the consumer is. So a lot of that consolidation being driven by growth through going into these different markets where the consumers are to serve them there under a better hopeful business platform. And then I think the larger firms, you’re seeing that as well. You’re just seeing movement. You’re seeing age transition, you’re seeing new models coming out with the alternative legal service providers or the hybrid versions. So there’s just different pressures that are affecting other industries as well. But I think they’re finally catching up to law and putting some of those pressures, which is motivating consolidation in a good way. And then with some, it’s again, kind of, I don’t want to change, I’m just ready to get out.

MMG: Here in the U.S., PE ownership of law firms is restricted, and of course, potential acquirers will want to be well-versed on some of those restrictions. Tell me a little bit about the current regulations and some ongoing legal challenges that are evolving in this space.

TL: Yeah. So right now, most states have [rules], law firms have to be owned by lawyers. And so that falls under our ABA rules and then the states adopt each of their versions of the ABA model rules or their own, which basically says law firms need to be owned by lawyers. Arizona is the first state to really change that fully and modify in Arizona, which has kind of been the spotlight, at least in the United States. And Utah has a version, DC has kind of a hybrid, a little bit exception for non-attorney ownership, but in Arizona, they call it their ABS, their alternative business structure where you can actually apply to be a non-attorney owned law firm. And so we’ve seen lots of different models evolving out of Arizona, and then many of the other states have looked at it, are looking at it, struggling with it, going through different things. All of these change in regulations, at least in the states, have really been proposed under an access to justice, which at a base level really means legal fees are getting more and more expensive. The everyday consumer can’t get their access, can’t hire an attorney, right? So if you’re in family court and the attorney costs $400 an hour, how do you get good adequate representation? So in Arizona, some of the models that we’ve released, seen, come out as ABS are aimed at serving this, right? So they’re pro bono, they’re nonprofits that are looking at doing that. You also see the alternative legal providers, like the Rocket Lawyers, the Legal Zooms, that are looking at this as an opportunity for having that middle ground, right? Where lawyers haven’t been playing because their fees have been going up, right? Because the cost of people and labor goes up, and so the lawyers just raise their billable rates. And so in Arizona and Utah, you see these alternative business structures being approved and coming out. And that’s where we’re seeing a lot of the attention. It’s moving slowly. I think if you’re in Arizona, it’s moving fast. If you’re outside of Arizona and looking for ABS structure and everything else, it’s moving slowly and cautiously along. Other states are looking at it, Washington state has been trying to evolve and try different things based on access to justice. I think potentially they’d be the next one to do it, but there’s other states as well that are doing this. And I think over time, it’ll be a modified approach [and] will kind of ease into what it’ll be.

MMG: So change is happening, albeit slowly, as you mentioned. But you do seem pretty confident that investors will see at least an easing up of some of these restrictions.

TL: I think so. I think every other industry, every other profession, right? If you look at accounting or CPA firms, if you look at medical…In so many states, medical practices still need to be owned by doctors. But you’ve seen the emergence of the MSO model, the managed service organization, or I would call it under legal an LSO, right? Where you could really have professional management investment in technology systems, you know, to have that hybrid structure. I think there’s ethical questions state by state that have to be answered on that. But I think the biggest thing is when we look at it, you know, right now a lawyer is under pressures to get their law firm as a business running the right way. And not all lawyers are meant to be excellent business owners, like a lot of other professionals. And so being able to bring that knowledge to do more when those pressures build and everything else. And I think the other aspect of it is, these lawyers have to have the capital to invest and to provide these services or to adapt and evolve, and who has that capital right now are some of these alternative providers that have already looked at Arizona for ABS. But if you look, I mean, there’s moves being made by Legal Zoom to be in this alternative…we’re not a law firm, right? And they can play in this space because they’ve kind of fought their fight over the years with state bars and it’s been accepted that, okay, you’re in this space. But now as it opens up more to the in-between, is it a legal service that a law firm offers? Or is it a non-legal, but looks legal, service from an alternative service provider? Is it a technology platform, right, that really just helps with this access to justice problem? And it’s built and reviewed by attorneys and monitored by attorneys, but it’s not delivered. And I think we’ve seen a lot of that in other spaces. If you look at accounting, H&R Block, TurboTax, right? These weren’t around years and years ago, but they’ve evolved to serve a need, to take the lower-income taxpayer and be able to get them through that without having to hire an expensive accountant or CPA to do so. And I think you’ll see the same in law. I think over time it will morph into a place because of these other models, other business structures like the alternative providers coming in, that law will have to adapt, and PE will be part of that.

MMG: You mentioned these less restrictive states, Arizona and Utah. What kind of inroads is private equity making in these states and what kind of transactions are getting done there?

TL: Yeah, I think overall what we saw in Arizona, first and foremost is we had private equity already in law from the lending standpoint, specifically on the plaintiff side. So like personal injury, mass tort, big plaintiff lawsuit type of firms. And these firms, private equity were lending across the country to lawyers for advanced case costs, just to allow them to see these big cases through, or to see all of this growth that personal injury portfolios would need to see. We’ve seen some of those lenders form their own ABS and so now, right, these traditional law firm private equity lenders are in Arizona that can lend, of course, that’s their traditional model, but they could also partner potentially with law firms. And that probably is more on, you know, structuring financials, everything else, than true partnership. But I also think you’re seeing that true partnership slowly evolving. You’re seeing some in Arizona be done where private equity’s going to really come in, whether it’s personal injury or it’s immigration or other spaces where they’re really coming in to take over probably good sizable firms, but to do more and to grow those as part of a succession need or as part of a growth plan overall and partnership as we escalate. Then I think you’re seeing private equity look at Arizona and the ABS as well, you know, for some of those kind of hybrid models, right? That is this legal or is there a technology platform helping to do this? But it is a law firm, it’s just embraced a little bit more to play in that middle road and hopefully expand through that. So we’re seeing that investment, I would tell you, in Arizona, even it’s moving slower than probably some feel like it should. And I think outside of Arizona, for the most part, private equity and non-attorney investors are still slow, are still cautious, the marketplace and the model needs to build for what these funds are going to be, and are they going to be exiting in three to five years once you’ve grown and done all of this, I think that’s going to be really hard because that exit is not yet proven, right? The model’s not there. It may be a buy and hold strategy for certain PE funds. And so I think that’s all of why we’re seeing Arizona move on certain practice areas, certain type of models but maybe not move as fast as some we’re looking at.

MMG: If we do start to see some of these regulatory restrictions getting lifted or eased in multiple states beyond Arizona and Utah, which firms are ripest for private equity investment? I mean, you’ve just made it clear that there are a lot of unknowns here, but are there any types of firms that might be the most attractive targets?

TL: The most we hear about of course, are personal injury or plaintiff firms, because PE’s already been in that space from a lending side. Overall, these are bigger businesses owned by smaller groups of individuals. Maybe one attorney could own a personal injury firm or a plaintiff firm that’s doing $50 million in revenues, right, $100 million in revenues for two partners. Once you get to larger in other practice areas, larger groups of ownership usually come with that. So, if you’re in an M&A corporate practice area that’s doing $20 million, you probably have several if not more partners, equity partners. So those are a little bit slower or harder to do deals when you have so many owners versus personal injury and the profitability, the model is consumer-driven and it’s not typically reliant on the owner attorney based on relationships otherwise. So I definitely think personal injury is that practice area that’s leading the way right now based on conversations. Other ones: Immigration’s a big one because we see that as, there’s always kind of the changing of immigration, but we’re seeing that as a big consolidation and efficiency, just things that were lawyer-driven work in the past are being technology-invested and made into more efficient delivery of those services. I also think immigration’s a federal practice area, so it’s your firm is in Arizona, it doesn’t mean you’re just practicing Arizona immigration. It’s usually you’re helping immigration clients throughout the United States. Other areas would be consumer driven. I truly believe when you look at the different things and the inefficiencies that are probably there in the general everyday consumer practice, whether that’s estate planning, real estate, otherwise, there’s opportunity to really consolidate, make sure you’re in the market where the clients are, but also to use some of that investment and otherwise to really make those practices work for the consumer and for the talent that’s needed really in that place to make it happen.

MMG: Speaking of talent, as private equity does enter this market more deeply, how might that influence how these law firms operate, including things like talent retention or even client services, billing models, things like that?

TL: Yeah, talent retention has been, again, no different probably than other professions, but for law it always seems to be if you have a book of business, you’re looking for that next platform or next law firm to give you the best deal for your book. And so historically, we’ve seen this of lawyers who move and get a good deal, but then there’s another model that emerges. And so, recruiters can stay pretty busy, but overall, I think as the model emerges, the overall goal is to turn client intake and the traditional lawyer book into a business book. And I think that would shift around a lot into, once it becomes part of the business value, you know, the ability to really invest in that, right? Because that is revenue that you can predict going forward. This $1 million, $2 million book of business isn’t going to jump if that attorney leaves. It becomes part of the business model and to try to invest on that. So I think really the shift would be, hopefully, it’s not just about who brings the biggest book of business to join your firm, but really who can be a key advisor, right? I think the biggest thing when we look at AI pressures, especially on attorneys that are in traditional consumer practices or otherwise, you’re not a transactional attorney, you’re not a drafting attorney anymore. Attorneys, in some of these practices, that’s what they’ve done. They draft contracts, they draft wills or anything else. I think the next part is the attorney advisor. And to really move to that, I think that’s a different shift in the hiring policies for the firm or the attorney manager, because now it’s not just serving one client or your clients, it’s really we want you to help manage this team. And I think you’ve probably seen that amongst doctors, right? You know, doctors were used to like patient to patient and now that a lot of primary care physicians and otherwise were put in a position to not one-to-one, but now they’re managing a group of PAs or nurse practitioners and being part of the overall model and process. And I think that’ll change a little bit more for lawyers as well. It’ll be less about hopefully the book and less about just how much can you bill more about really the value that you contribute to the overall business. And I actually think that’s a good thing. I think that so much in the law firm is about the book and the billables moving and being generated that if the focus can really be on knowing the best service to the client, right? And then, efficient delivery of that and good modeling and care along with putting the attorneys that have the right skills in the right places, I think you’ll see attorneys be happier because some aren’t. And then I think overall, hopefully you’ll see better client service and everything come out of it. And I know there’s a lot of fear over, like PE’s all about the dollar, but PE’s also about investing in technology. And I think we’ve seen some of this in the foreign markets as well, which we’ve been able to keep an eye on, which some of the fears I think are just that, they’re fears, but not probably practical fears. Because if you don’t have good clients that love you, you won’t have a business. So, the hope is the focus on the clients and the client service will stay true regardless of who the owner is.

MMG: Now, as you’ve mentioned, there is of course the opportunity here for increased consolidation, but how could private equity involvement in this space also potentially create opportunities for niche law firms to thrive?

TL: Yeah, I think overall, if you’re looking at non-PE firms, there’s going to be those. And again, kind of referencing like the UK, Australia, which have non-attorney and have had non-attorney ownership of firms for a couple decades now, you’ve seen that, you’ve seen consolidation and you’ve seen private equity-owned and backed law firms, but you also see many other firms that haven’t changed and really developed a niche in their area and serving it in a certain model. But I think the nicety of it is you can decide which path, whether PE’s interested in a certain practice area or not, maybe decide that. But I think the other is for the attorneys to really look and say, look, as this evolves, we’ve been holding onto this, we’ve been holding onto this area and fighting it, but it is evolving. So now we have to evolve and let’s pick that niche and really focus on our client as the consumer, the service that we can provide to really grow. So I actually think if you look at the other markets, you’ll have lots of opportunities for lawyers. I don’t think it’s a law firm killer. I actually think it opens up an evolution opportunity for a lot of law firms specifically in those niches that can come out of it and just other adopting certain practice areas or otherwise that may be PE-driven.

MMG: Yeah. Let’s talk a little bit more about places like the U.K. and Australia where private investment in law firms is further along than it is in the U.S. What kind of insights can be gained from those markets?

TL: I think probably the biggest one is, there’s been successes, there’s been failures, but I think overall that the sky hasn’t fallen, right? When you get to a point, there’s always fear over this is going to [make] the law firm owned by a lawyer as obsolete, and that hasn’t happened. Just like what we were talking about earlier on, like these niches and everything else, you get to a point that certain things will change and certain practice areas, but if that’s part of evolution, because we have alternative legal providers, we have AI, it was meant to change. It’s just where these things have kind of shaken out based on non-attorney ownership regulation opening. But I think at the end of it, it’s really, you get to a point, a lot of the pushback has been, now the focus would be if you allow non-attorney ownership, the focus would be on the dollar versus the client care and service. And I think at least some of the stats that I’ve been able to see actually have gone down on client complaints to bars and everything, licensing bars, everything in the UK. And so I don’t think that actually will be the huge impact. I think it’ll be more of, it’ll change in certain practice areas, the traditional model, and it will do different things that lawyers couldn’t do on their own. And an example of this is a PE-owned firm that we’ve had the opportunity to work with from the UK, is just different things that they’ve really come up with is their lawyers don’t actually, directly, right? They’re not the ones managing the client, managing all the tasks, managing all the projects. They actually have a client relationship manager in place just to help to do that. And the lawyer is managing the legal work, the client, they’re of course on the same meetings and teams, but I think it’s a good thing of, you put somebody who’s really good at maybe managing clients, listening to clients, understanding their needs, their expectations, and you put them in that role that traditionally, under most law firm models, now that’s the lawyer, but the lawyer also has to jump over and then go do the work or get the team to do it. So investment really opens up just simple changes that I think can really work for the clients and hopefully work for the lawyers and the law firms that come out of it. But that’s just a process change. I think there’s a lot of other things in just business management, health, culture, other things that will come with that. And I think what we’ve seen in those foreign markets is they’re still evolving, but overall it’s opened up change and more consolidations in certain practice areas. Others haven’t changed that much from that standpoint, but it is an option that they didn’t have previously. They have a new option for these firms that have gotten to a certain size or a new option for this access to justice problem of how to build different models because they have the access to capital through PE or other opportunities.

MMG: So there is so much potential here for growth, for value creation, but right now a lot of private equity firms have to kind of wait on the sidelines for these regulatory roadblocks to be lifted and eased. You did touch on this, but are there some adjacent businesses or services that private equity might want to invest in instead or are already investing in instead?

TL: Yeah, I think absolutely. I think you see the growth of legal software really leading the way, which is where we actually see some of our private equity interested in law firms either in Arizona or these other states or other markets. A lot of them have invested in legal software. And so it’s a software platform to either help lawyers and law firms do that, or it’s a direct to consumer type of model. So software’s one. I do think the alternative legal service provider, right? As far as model, it’s not a law firm, but it’s playing in that space. As that really grows, that opens up a lot of the opportunity. And on that front, what we’re seeing now in that space is actually law firms or lawyers that own those law firms actually get acquired to be part of that. So they’re being pulled from being a lawyer and a law firm owner to, you know, not, you know, no longer doing that, but really come over under this alternative non-law firm structure to do that. Works better for some maybe than others. But really what these alternative providers are looking to do is bring over that legal knowledge, right? If you’re a lawyer and you’ve built a great law firm, you’ve got lots of clients, everything else, and they’ve got great technology, good access to capital, right? They want to invest and grow this, they want to do it with the right expertise and they want to do it with the right team. And so that is what we’re seeing now is some law firms—traditional—go to these alternative legal where they become non-law firms, but they’re part of that advising and overall structure from that. And I actually think that’s where we’ll probably see some of the highest growth. And I think that’s what will ultimately kind of force decisions on these different ownership structures because it’ll get kind of murky, is this a law firm or is this not a law firm? And at a certain point for lawyers, it will be beneficial to have the same opportunities and access to private equity or other non-attorney affiliations as these other alternative providers.

MMG: Okay. Lots of investment potential there and perhaps more than some PE firms might have initially thought. So that’s wonderful. Tom, thank you so much for joining the Conversations podcast.

TL: Yeah, absolutely. Thanks for having me.

This transcript was prepared by a transcription service. This version may not be in its final form and may be updated.

The Middle Market Growth Conversations podcast is produced by the Association for Corporate Growth. To hear more interviews with middle-market influencers, subscribe to the Middle Market Growth Conversations podcast on Apple Podcasts, Spotify and Soundcloud.