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In recent years, law firms and accountancy firms have experienced significant expansion. In the last 12 months, over 120 recorded acquisitions and mergers took place.

Whether expanding your current business, acquiring or merging with other firms, funding of these transactions and structuring the new transaction is at the forefront of everyone’s mind.

In this 3-part series, we will discuss alternative funding, different business structures, and everything a firm needs to understand regarding mergers and acquisitions, including due diligence procedures.

Firstly, we will discuss alternative funding available to professional firms.

Initial public offering, listing

Although rare, there are some professional practices that have found success in listing either on the main market (i.e. the London Stock Exchange) or AIM.

Advantages	Disadvantages
Funding: the possibility of raising capital can be endless and fairly quick once the company is officially listed on an exchange. Firms can then easily exchange their shares for cash which they can use to fund future expansion (whether for opening/acquiring businesses in new jurisdictions or acquiring competition etc).	Costs: the costs associated with “going public” can be very excessive and can easily run into the millions of Pounds. On average, the initial costs of listing could cost up to £25,000 per member. Even after those costs, there are no guarantees that the listing will be successful. This is why this option of raising funds is not accessible to most professional practices.
	Regulation: the lists of rules that govern listed entities are excessive. From adopting a more complex accounting standard, governance codes that force firms to appoint independent directors, and comprehensive social and sustainability policies just to mention a few.

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On average, the initial costs of listing could cost up to £25,000 per member. Even after those costs, there are no guarantees that the listing will be successful.

Reinhardt van der Merwe Senior Manager

Private equity

In recent years, we have seen a significant increase in the number of private equity firms acquiring professional practices. Moore Kingston Smith is the recent success story in which an accounting firm was acquired by a private equity firm.

Earlier this year, the Guardian reported that over 60% of all veterinary practices are now owned by large corporations rather than the standard local practice firm. Most of whom are backed by private equity. Law and accountancy firms have seen similar shifts as well in recent years.

The recent success can be attributed to the fact that professional practices have a unique position in which most of the revenue generated is annuity by nature. This realisation has attracted many private equity investors who are looking for alternative ways to invest in businesses, without having to deal with the fees and metaphorical “red tape” that comes from investing in the stock market.

Private firms would often establish an alternative business structure (ABS) in which you will ordinarily see a holding company that will acquire the professional practice. Within this new structure, the private equity firm would set up a board of directors which will oversee the day-to-day operations of the firm. The board will consist of existing members (often the managing partner and some of the senior partners), and some of the Private Equity firm’s own team to at least have influence on the board.

Advantages

Disadvantages

Gearing and risk: unlike applying for a large loan which will attract interest and have terms attached to repay it, receiving funding from private equity will have no direct impact on the firm’s gearing as private equity firms will affectively become shareholders (i.e. equity holders). It also gives firms relatively quick access to what can be significant funding.

Control and culture shift: these structures often fail due to control, and changes in culture. Professional practices are unique in that the members can effectively run the business how they see fit. From decisions surrounding their own clients, the fees to bill, hours they work etc.

However, with a new structure, in which they have to report to a private equity firm, these members/partners may have to follow strict corporate policies and be limited in the way they manage their own client portfolio which they have worked hard to build over the years.

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Credit facilities

The most common option is to raise funding by means of a credit facility with a reputable financial institution. Often, firms will enter into a bi-lateral agreement in which it secures funds from multiple financial institutions. Financial institutions may prefer bi-lateral agreements as it spreads the risk between them.

Advantages

Disadvantages

Costs: the transaction costs associated with applying for a credit facility are minimal in the initial stage. The real consideration should be given to the monthly transaction cost associated with the facility and the interest attached to it.

Cashflow and gearing: unlike the first options which are mostly “equity-based transactions”, obtaining external financing will significantly weaken your gearing ratio as a firm will be assigning a significant loan to their balance sheet.

The loan will attract interest which can become expensive and will follow strict terms in which companies will have to pay specific instalments.

Failing to pay a single instalment can have real ramifications for the firm. This new obligation on the firm’s balance sheet will significantly impact its ability to raise funding in the future if the firm is heavily geared already (i.e. a high level of debt vs equity).

Control: this facility often provides the members with access to capital with very little change in the structure in the firm. Meaning members will still control the firm and the firm will be relatively unchanged.

Financial covenants: unfortunately, it is not as simple as filling out an application and receiving a big lump sum in your bank account. Entering into a credit facility will have many terms and conditions attached to them which firms need to follow carefully.

For example, often financial institutions will mandate the need for an audit being carried out on the financials even if the company is below the statutory threshold (i.e. is seen as a small company) further increasing the real costs associated with raising capital.

Other financial covenants may require a firm to closely monitor some key ratios throughout the term of the loan (often needing to report to the bank quarterly). In recent years, with the sharp increase in interest rates, firms have had difficult conversations with their lenders after they have failed their interest cover ratio and have effectively forced them into a refinancing situation.

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Restructuring & Recovery

Internal fund raising

Last, and probably the least favourite option, is raising funding internally from its existing members. Many existing partners can be reluctant to invest further capital into the practice. To generate partner capital investment firms can look to bring a fresh wave of new partners into the practice but with succession being an ever present issue this is not always a viable option.

Assuming a firm can make its way through the mountain of internal politics and secure the required approval, there are still some advantages and disadvantages to consider.

Advantages	Disadvantages
Little downside: as all of the costs sit with the members, there is very little risk to the firm itself as it has no obligation to pay any of the fees nor is obligated to settle any capital loans if the member fails to make the payment.	The ability to raise funds: currently, there is an increase in young junior partners who are struggling to raise the funds to invest in the firm. Most resort to obtaining a loan from a financial institution, but they are not always successful and in fact there is a growing trend of disinterest in stepping up to the partner plate in the first place.
	Dilution: just like issuing more shares in a standard limited company, raising more capital may dilute existing members rights to future profit share.

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Conclusion

Deciding what option works best for you and your practice is a deeply personal one. Every firm will have to consider its situation carefully, its financial requirements, the balance between growing the firm and protecting the culture and structure which has made it successful thus far.

We encourage firms to truly explore every option, and most importantly, be transparent with all members regarding the risks associated with each option.

So, how will you be funding your firm’s future?

Contact us For more information Contact the team