At Gateley, Law Firm Sees IPO as Salve for Legal Industry’s Woes

On the morning of June 8, Nick Smith checked in at his London office around 7:30 a.m., where he met some of his law partners and then walked across Paternoster Square to the stock exchange.

At 8 a.m., while drinking his first glass of champagne, Smith watched GTLY, the ticker for his law firm Gateley PLC, scroll across a giant screen amid a fantastic display of graphics designed to mark the occasion: That morning, his law firm became the first in the U.K. to hold an initial public offering.

For Smith, the rest of the day blurred into a series of champagne toasts and celebrations until the market closed, by which point Gateley had raised around $45 million, and sold 30 percent of its equity to outside investors on the London Stock Exchange’s Alternative Investment Market. The firm retained the other 70 percent of its equity.

“It was never our objective to be the first full-service law firm to float,” he said.

[caption id="attachment_3782" align="alignleft” width="314"][Image “Pedestrians walk past the London Stock Exchange Group Plc’s offices, right, in Paternoster Square in this view from St. Pauls Cathedral in London, U.K., on Monday, June 8, 2015. Photo by Jason Alden/Bloomberg” (src=https://bol.bna.com/wp-content/uploads/2015/08/223614818-e1438981483702.jpg)]Pedestrians walk past the London Stock Exchange Group Plc’s offices, right, in Paternoster Square in this view from St. Pauls Cathedral in London, U.K., on Monday, June 8, 2015. Photo by Jason Alden/Bloomberg[/caption]

Smith explained that the 350-lawyer, mid-market U.K. firm, which represents a mix of modestly sized institutions and privately held companies, had emerged from the credit crisis and discovered a highly competitive business environment that seemed unlikely to change. Clients were applying greater pressure to cut fees, which was eating into profit margins; meanwhile, fewer young people seemed to be interested in pursuing a career in law and recruiting talented young lawyers into the firm had grown more difficult, Smith said.

Switching from a partnership structure to a corporation that has access to public market financing seemed like it could provide an answer to some of these problems, he said. It could provide a way for new lawyers joining the firm to gain ownership from day one and for partners to monetize their sweat equity investment, Smith explained.

Indeed, according to one news report , Gateley partners took home 83 percent of the roughly $45 million raised in the IPO while the firm itself kept just more than 12 percent, or about $5.9 million. Smith did not respond to requests to confirm these figures.

Gateley is not the only firm to take note that the outlook for law firms looks less bright today: In the U.S., many law firm chairs have looked to chart a path through similarly rocky waters. But U.S. rules still largely prohibit non-lawyer ownership of law firms, although such restrictions no longer exist in the U.K., Australia and many other parts of the world.

For firms in those countries, Gateley’s IPO raised the question of whether the firm is plotting an anomalous, ill-considered strategy, or if the legal industry is poised to enter a new era when partnerships give way to corporate structure and law firms cede a measure of control to outside investors.

Like any company, it is now subject to the whims of the market. After reaching a high of 103 pounds in June, Gateley’s stock is now down to 97 pounds. The firm has also had to open up its books: In mid-July, it said its fee income growth has been strong and expects its revenue for the year to be at least 60 million pounds, up 10% year-on-year .

According to the firm’s Admission Document, it intends to adopt a “progressive dividend policy” with the first dividend payment expected to be announced with the interim results for the year ending April 30, 2016.

“We do understand it’s a bold business decision, but we’ve done these in the past,” said Gordon Poole, an outside consultant to the firm.

[caption id="attachment_3774" align="alignleft” width="273"][Image “Inside The London Stock Exchange. Photo by Chris Ratcliffe/Bloomberg” (src=https://bol.bna.com/wp-content/uploads/2015/08/215297556.jpg)]Inside The London Stock Exchange. Photo by Chris Ratcliffe/Bloomberg[/caption]

Few lawyers have heard of Gateley PLC outside of the U.K., but the firm traces its roots back to firms founded more than 200 years ago. In 1974, Stephen Gateley & Sons and Bernard Wareing merged to form Gateley Wareing, which grew from 12 people to over 200 by the late 1990s.

In 2006, it became one of largest firms with lawyers in both Scotland and England when it merged with Henderson Boyd Jackson. Since that time, it’s opened offices in London, Leeds and Manchester, and one in Dubai — the only one outside the U.K.

Today, the firm’s lawyers focus on real estate, employment and pensions, banking and finance, corporate law and a number of other areas. The firm advises on transactions with value that ranges from $20 to $150 million, according to Smith, who added that this has become a highly competitive space.

“Increasingly, the conversations we have with clients about billing and fees are uninspiring,” he said. “That’s because the negotiations are always about our margins.”

The partnership model also felt ill-suited to the current era when tech companies, consultancies and other lucrative job opportunities that never existed in the past now abound: The partnership model requires young lawyers to spend years, working long hours under the long odds that they will someday make partner and then be able to share in any profits that can be derived from younger lawyers’ toil. Whatever the downsides, it’s a model that is not easily abandoned at firms such as Gateley, where the existing partners are necessarily invested in a partnership track, having started off as young lawyers themselves.

In 2013, after a broker approached Gateley about joining an international law firm in a three-way merger that the firm ultimately rebuffed, Smith said he and other partners at Gateley started to seriously consider an IPO: The Legal Services Act of 2011 had made it possible for a U.K. law firm to register for an IPO by removing the restrictions on non-lawyer ownership of a law firm.

Access to the public markets could resolve certain problems that Smith saw: The firm could use the markets to raise money if it wanted to entice a rainmaker to join Gateley, acquire another law firm or acquire another non-legal service firm that complemented their offerings. It also meant that young lawyers who joined the firm could immediately gain an ownership in the firm by purchasing shares, whereas joining any other firm would mean accepting the odds and betting on the partnership track.

[caption id="attachment_3761" align="alignleft” width="300"][Image “Nick Smith (Courtesy)” (src=https://bol.bna.com/wp-content/uploads/2015/08/Nick-Smith-e1438923358168.jpg)]Nick Smith (Courtesy)[/caption]

“This was about giving people that understanding of why they’re sitting at their desk at 11 o’clock at night,” said Smith. “It’s: ‘Well I’ve got a client and this is going to make them happy and drive the share price’ — not: ‘I’m going to line the pockets of the senior partners’.”

“You could argue everyone is aligned now,” added Gordon Poole, Gateley’s outside consultant, “which is something that can’t be said at other law firms. It’s actually quite a nice statement.”

Still, taking outside investment also means giving up equity ownership, and it carried other risks, including that no U.K. firm had ever tried it. It required changing from a partnership to a corporate structure, giving over a measure of control to outside investors, and likely sharing earnings with them too.

The closest example was Australia’s Slater + Gordon, a consumer law firm that specializes in personal injury, which had gone public in 2007.

Several legal consultants said there was an easy argument for why a firm that works on a contingency fee basis would want to go public: Such firms never receive a steady stream of payments to work on a case, and only receive payment if their case reaches a successful resolution. That creates obvious cash flow problems, which having ready access to public markets to raise funds helps resolve.

But law firms like Gateley do not face such cash flow problems, since most of its work is not taken on a contingency basis.

Peter Zeughauser, a law firm consultant based in California, said many law firms have been aggressively deleveraging since the financial crisis, and added there are litigation finance firms that are willing to lend millions of dollars. Such firms, along with many banks, have provided financing for law firms with less strings attached than actually giving up ownership in the firm, Zeughauser said.

“I think it’s quite a ways off before it makes sense,” he said, adding that day will come “when the need for capital becomes so great that law firm partners have to give up ownership.”

At the moment, there are cheaper ways to raise capital than holding an IPO, Zeughauser said.

Smith, who said he worked at Kirkland & Ellis in the 1990s, noted the U.S. legal market is somewhat different than the U.K. where all but one of Gateley’s offices is based, and that he’d never assume that what made sense for Gateley would work at another firm.

The firm has long had a corporate board to guide its strategy, Smith said, and after considering the idea of an IPO, it appointed a working focus group of about a dozen people who were tasked with considering the idea on a confidential basis, including whether it could be done and if it made sense. Over the course of about a year and a half, the firm looked at it and four times voted to move ahead with the process, according to Smith.

In the end, 93 percent of the partnership voted to move forward with merger, he said.

The idea was to differentiate the firm, so it could attract more talent, and also to use the access to public funds to diversify some of its revenue streams: for instance, it could hire non-legal consultants, such as health and safety and planning experts to complement its real estate and construction practice. That would allow the firm flexibility in negotiating with clients, Smith said.

And the Gateley partners were not alone in seeing the IPO as a possible answer to their problems: This February, Jonathan Molot, a law professor at Georgetown University and a founder of the litigation finance company Burford Capital, wrote an article in the Southern California Law Review urging law firms to abandon the partnership model in favor of a public structure.

Molot believes that law firms are destabilized by the fact that they rely on partners to provide capital, which they can withdraw when they retire or leave the firm. Under the partnership model, he said, “there’s no permanent equity, no incentive to build long-term loyalty to the firm.”

Smith said the lawyers who were partners at Gateley all agreed to stay at the firm for five years. He added that now, everyone from staff to new lawyers to senior lawyers can receive ownership in the firm, which will build loyalty.

Zeughauser also acknowledged that the U.S. tax structure is set up so that law firms are taxed on earnings before they are distributed to partners, which creates a disincentive for them to reinvest their own capital back into the firm, and provides an incentive to seek other forms of financing. However, he said there are less onerous, and cheaper ways to obtain outside investment than selling equity in an IPO.

Even Molot acknowledged that $45 million was within the range of what Burford Capital lends to its clients.

Smith said that many of the critiques of going public are off-base: While other firms wouldn’t want to give up control of the firm, Gateley, in contrast, is pleased that it has access to seasoned investors giving input on its business strategy.

And clients loved the idea, he said: “When we sent out our notice of our intention to float, we were deluged by letters from clients who want to invest,” said Smith, adding that clients were the third biggest investors — with Gateley holding 70 percent of its equity, and investor funds holding the second most.

Being publicly traded is s a big shift, Smith acknowledged, and while the firm hasn’t announced any plans or big moves that would require raising capital on the market, there’s already a major change: “What pays me now is the share price and the dividend,” he said.

(UPDATED: This article has been clarified to reflect the fact that Gateley has said that it expects to issue a dividend.)