The Business Of Law

As has been widely reported, the third quarter of 2009 saw 13 mergers among law firms, bringing the total number so far in 2009 to 45.  There were 25 in Q1 2009 and 7 in Q2 2009.  In 2008 there were 70 mergers among law firms.

These figures might lead an outside observer to ask: Why the merger mania?  To be sure, there is much about the legal industry that is changing.  Many of these changes are outlined in an excellent article over at law.com (subscription required).

The article reports on a recent panel discussion at the ALI-ABA ACLEA 2009 Summit in Arizona held yesterday.

The panelists outlined a series of external forces—namely globalization, changing regulations, and evolving demands of clients, and they talked about the dramatic changes those forces could bring to the education of law students, the practice of law, and the business model of running a law practice or firm.

Here’s a brief excerpt:

The globalization of clients will continue to force even small firms to deal with matters abroad or represent foreign clients in the United States. Large and quick law firms will have the competitive advantage, he said, but smaller firms can compete with the use of technology.

Another big change that is already in the works is the switch to a buyer’s market. Law firms used to be the ones dictating how matters would be staffed and priced, but that is no longer, Bower said. Sophisticated clients are demanding that first- and second-year associates stay off their matters. They are also off-shoring work themselves or demanding their law firms do it, Bower said.

Perhaps the most dramatic change that is further down the road is one Bower called the “ticking time bomb” overseas. That is the Legal Services Act of 2007, which when it takes effect will allow law firms to raise capital like a public company.

Now I’ve talked about the Legal Services Act quite a bit and here’s how it relates to the merger mania that we’re seeing.  Law firms currently have limited ability to raise capital.  To innovate or expand the business, firms can either borrow money from a bank, raise capital from existing partners, or merge.

As you might imagine mergers often look like the easiest route to partners who don’t want to saddle the firm with debt, and certainly don’t want to dig into their own pockets to provide growth capital.

Of course the obvious question is why can’t firms raise outside capital to fund expansion like any other business.  The answer is that the rules of professional responsibility prohibit it.  That’s where the LSA comes in.

In the U.K. the LSA would allow firms to raise outside capital by selling shares in the firm.  Of course there are safeguards in place to prevent conflicts of interest, or lawyers putting the interests of shareholders ahead of their clients.

The net effect of the LSA though is that firms headquartered overseas will now be able to raise outside capital to grow and expand, and as U.S. law firms continue to compete in a increasingly global legal marketplace, the pressure of this outside capital will be enormous.

Will U.S. firms survive, will we change the rules to allow U.S. firms to raise outside funds to compete with their brethren across the pond.  As always, we’ll be staying tuned…