Having advised Russell Jones & Walker on its recent merger with Slater & Gordon, Andy Pedrette, Pamela Sayers and Giles Murphy reflect on a ground-breaking deal.
The Legal Services Act has long heralded the start of widely anticipated changes to the UK legal landscape and the Solicitors Regulation Authority (SRA) finally began to issue alternative business structure (ABS) licences in late March 2012. Now, for the first time, licensed UK law firms can accept external equity investment from non-lawyers as part of the financing for their future growth.
One of the first firms out of the blocks has been Russell Jones & Walker (RJW), which has become part of Australian law firm Slater & Gordon, the world's first publicly listed law firm, in a £54m deal. All of RJW's equity partners remain with the business and have become shareholders in Slater & Gordon. RJW now trades as 'Russell Jones & Walker, part of Slater & Gordon Lawyers'.
A natural fit
When Slater & Gordon listed on the Australian Stock Exchange (ASX) in 2007, it set out its aim to become one of the leading consumer law firms in Australia, with ambitions to expand overseas in due course.
Slater & Gordon's shares are traded daily on the ASX and its shareholders include institutions and individual retail investors. Slater & Gordon raised external equity in an initial public offering and then raised a significant further amount to finance a major acquisition in Australia in 2010. New Slater & Gordon shares have also been issued regularly since 2007 to finance smaller Australian acquisitions and to provide shares to staff under the firm's Employee Ownership Plan.
Outside Australia, few jurisdictions allow external investment in law firms, but the advent of the UK Legal Services Act and jurisdictional similarities between the two countries meant the UK was a natural place for Slater & Gordon to explore its international expansion plans. For its part, RJW had been anticipating a changing legal environment in terms of regulation and service delivery, and was looking for the 'right' source of funding to take its business to the next level. The opportunity finally presented itself in early 2011, when RJW and Slater & Gordon first made contact.
Being a listed firm means Slater & Gordon has the ability to raise additional capital on the ASX to fund future acquisition or investment opportunities in the UK. It is also a longer-term funding solution than private equity, where investors may typically seek an exit event in three to five years. There is no such pressure for a single exit event on a publicly quoted company like Slater & Gordon, as investors can increase or decrease their shareholding through daily trading on the public market.
Critical preparation
Any business seeking to attract external equity needs to identify its objectives and to assess the suitability of the various types of funding available. The first obvious question is what will the money invested be spent on?
Investors will expect a firm to prepare financial projections, probably over three years, showing the requirements for capital investment. This may include 'money out' to the current stakeholders, as well as development capital to be injected into the business to accelerate its growth. Investors accept that in reality no business will develop exactly as its business plan predicts. But the financial plan must enable them to understand the main performance drivers of the business and so assess the impact of increased funding.
Investors must see a clear presentation of historical trading to understand what has already been achieved in the business and how this compares to forecast growth. Exceptional items that may have distorted historical results need to be identified, so that investors can appreciate the 'maintainable' performance of the business.
Key to negotiating any investment is to understand how a particular type of investor will look at your business and their likely requirements for financial returns. It's essential to prepare by analysing your underlying financials in the same way that a potential investor will.
Value and structure
In applying 'normal' valuation metrics to a partnership for the purposes of assessing an investment, investors will generally focus on the profitability of the business after payment of market rates to the firm's current partners.
An investor used to corporate transactions involving owner-managed businesses will tend to treat a law firm partner's profit share as comprising two components: a market-rate salary and an additional profit which equates to a corporate dividend. The capital value of the partnership is likely to be discussed as a multiple of the dividend profit (after deducting the base salary from the partnership profits).
However, agreeing the value of a business is a matter of negotiation. The financial projections are crucial, but so too is an understanding of the strategic rationale behind the investment and an understanding of the investor's requirements. In RJW's case, we were delighted to be able to work with both firms to establish that RJW was a substantially more valuable business than Slater & Gordon had initially estimated.
The structuring of any investment is as important as the headline price. In RJW's case, the merger was structured to include cash and deferred cash payments, as well as shares in Slater & Gordon. The balance struck gave the reassurances required to Slater & Gordon's investor community that RJW partners would remain committed to the UK business, while enabling those partners to realise some cash immediately, some over time, and still share in the equity of the business. In addition, a combined business plan was developed with funding available to underpin the enlarged entity's UK growth plans.
There were numerous complex tax issues for both parties and a crucial part of the structuring ensured that RJW partners were taxed on their share of the consideration at 10%, benefiting from entrepreneurs' relief.
Managing the investment process
The RJW transaction took almost 18 months to complete, primarily because of delays in the SRA accepting ABS applications. The proposed transaction was publicly announced in late January, subject to ABS licensing, and completion was not effective until 30 April 2012.
Advice in managing such a lengthy process is critically important, especially as the business seeking investment needs to deliver its projected financial performance in the short term despite any distractions due to the deal process. For RJW, between initial discussions and completion of the deal, the business had to deliver actual results for the last few months of its year to 31 March 2011 and then the whole of its 2011/2012 financial year. So management needed support while also focusing on keeping current trading on track through a prolonged period of scrutiny from Slater & Gordon.
Internal negotiations and communication
In addition to working on external fundraising, firms also need an internal process to plan and implement how current partners' interests will be organised in an ABS structure suited to external equity investment. For existing partners, if a proposed transaction includes a mixture of money-out and equity interest to be rolled forward into a new entity, then the proportions of equity to be sold and ongoing equity interest to be retained by each individual partner will also need to be negotiated.
For the Slater & Gordon transaction, a senior management team was established at RJW that reported on deal progress to the broader equity partner group. It was important for RJW to establish and maintain unanimous and strong support for the transaction within its partner group. Smith & Williamson assisted throughout this internal communications process, reporting on negotiations and as particular issues arose.
Share ownership and incentives
Any capital structure designed to enable external investment to fund additional growth must also cater for a firm's personnel who are key to delivering that future growth. Slater & Gordon is committed to incentivising its legal and non-legal staff. A large part of its incentivisation strategy is the staff ownership plan, whereby staff are issued with shares based on their performance. This strategy has already been implemented in Australia.
Slater & Gordon was originally a tightly held partnership, which became a company in 2001 and then had its shares listed in 2007. A strand of its development has been to widen staff ownership of the firm. At its IPO in 2007, seven former partners were major shareholders and 32 employees were participants in its staff share ownership plan. In its last annual report, 69 employees held over 5 million shares under that plan. Because the firm has publicly quoted shares, staff can see their value every day. Staff with shares also receive dividend income. Slater & Gordon believes that this tangible opportunity for more staff to share in the equity in the firm demonstrates the firm's loyalty to its people and, in turn, encourages staff commitment.
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