Kitchen: We see ourselves as growth investors
Maintaining a route to the equity for salaried partners and senior associates is key to the smooth acceptance of private equity (PE) money at law firms, an investor has argued.
Tom Kitchen, an investment manager at Horizon Capital, said there was “a large pool of acquisition targets” in the legal market.
Last autumn, Horizon entered the law by acquiring Midlands firm FBC Manby Bowdler as the first member of its Adeptio group as part of a ‘buy and build’ strategy that will see it snap up other firms around the country and support them to grow both organically and through their own, smaller acquisitions.
Speaking at a recent event organised by leading solicitors’ insurance brokers Lockton, Mr Kitchen explained that the resilience of the legal market made it “really attractive from a PE perspective”. A mix of services across multiple practice areas meant law firms were able to absorb ups and downs and maintain “sustainable growth”.
Further, smaller law firms were “struggling” with both the increased compliance burden and need to invest in technology.
And then there was succession: “A growing trend is that, for whatever reason, the generation coming up are less likely to want to be equity partners than the past generation. People are quite happy with a market-rate salary, a good bonus, and less risk and less pressure than being an owner of a business.”
In any case, the nature of partnerships, and particularly the demands of senior partners close to retirement, made longer-term investment difficult.
PE investors also see the opportunity for “back-office synergies and leveraging technology and data” to improve efficiency.
There was real potential for a buy and build strategy given the “large pool of acquisition targets that we think are available in the market today”. Mr Kitchen said consolidation “has commenced and will accelerate – the opportunity now is to be part of the leadership of that”.
The dynamics of the legal market were similar to those of accountancy five years ago, he went on – Horizon was also one of the first investors there, back in 2021, by buying Midlands firm Dains, which it sold at the end of last year, 10 acquisitions by the group later, for a return of eight times the invested capital. This showed they could create “a lot of value”.
Horizon structures its deals as some cash upfront “in a tax-efficient manner” but then the partners reinvesting in the business, holding a minority share of the new group and earning a salary, ahead of another “liquidity event” when it ultimately exits.
“One of the things that we really focused on before making an investment in this space was staff retention,” Mr Kitchen explained. “Without oversimplifying it too much, the one thing that would worry me about this market is if you bought a business, you didn’t get the culture piece right and the staff left – you haven’t got a business left.”
That meant both communicating clearly to all staff and also focusing on the more senior people who were not in the equity and may be disincentivised by the transaction, thinking their partnership ambitions have been curtailed.
“How we’ve addressed that is through ‘sweet equity’. So in each of the businesses that we buy, we create a new class of equity that’s solely reserved for the salaried partners, senior associates, people coming through the ranks to apply for and still have an equity stake in the business.”
Addressing fears that PE just wanted to squeeze businesses to maximise a future sale, Mr Kitchen said that this was not how it worked at this level.
Those kind of deals, among big companies and big PE houses, were about “financial engineering and margin efficiency and a bit more organic growth”, he explained. “We’re trying to take a business which is doing £15m, make some acquisitions and get that up to near £100m.”
Horizon has committed capital to fund acquisitions – which FBC has yet to do – but also organic initiatives, with a new office in Solihull and a second office in Wolverhampton in recent months.
Mr Kitchen said: “There are operational improvements you can make, but we’re typically putting more money in and seeing actually profit margins decline for initial period – we’ve made more hires in FBC in the last six months than it had in the previous three years. We see ourselves as growth investors.”
He argued that scale supported staff retention – because of more training and development, as well as career opportunities – and reducing risk, with a positive knock-on for the cost of insurance.
“What we’re trying to build is a scaled national provider of legal services to the UK mid-market. And that’s across a full-service offering, a balance between both private client and corporate work…
“The ability to serve clients over multiple service lines over multiple years really builds a repeatable revenue profile… [This] places a premium on your business.
“We’re also naturally keen to avoid long working capital tie-ups and that comes down to a focus on more mid-value transactions. Rather than one huge corporate deal being the boom or bust for the year, having a more repeatable base of smaller or medium-sized engagements can help you from a working capital perspective.”
Individual firms within the Adeptio group will retain “a significant amount of autonomy over their client delivery and culture and brand,” Mr Kitchen went on.
“In this market there’s a lot of brand equity and we want them to retain the partners and them to continue managing the business as they were before, but just with a bit more support and capital and expertise in growing businesses to a much larger scale.”
Over time, Horizon would look to build out a central compliance, finance and M&A function to service the group.
Mr Kitchen said the valuation range for law firms was currently around 5-8x EBITDA, similar to accountancy five years ago.
But accountants were now worth “significantly more” – Horizon bought Dains for less than 7x but sold it for 14x.
He added: “Accountancy tends to trade a slightly higher premium to legal because you have the recurring revenue element of the audit and tax.”
Horizon’s typically exits after four to five years and Mr Kitchen said the next owner would probably be another PE firm.
“The only other potential of the scenario I could see is that the US regulatory landscape around private equity ownership of law firms changes, which it might do. And a US private equity-backed law firm may look to acquire in the UK, but I think that might be the turn after us, to be honest.”
Tomorrow we will report on the perspective of Neil Lloyd, managing director of FBC Manby Bowdler, who also spoke at the event.
