How exactly do you determine which is the most “valuable” law firm in the world?
Where do you start and upon what stats do you base your decision? And who would do it? Silly question the last one because who else by The American Lawyer, who have determined that?
While law firms have permitted outside investment in Australia for some time and in the UK since last year when the ‘alternative business structure’ (ABA) was introduced, in the US the firms have kept appropriately quiet about matters like revenues and profits.
The American Lawyer analysis took an investment bankers approach to the topic. As they say:
Our procedure is based on the classic investment-banking technique of developing cash flow multiples to value companies. We started with each firm’s net, made deductions by assigning equity partners with a notional salary, then applied a multiple that varied depending on the firm’s size, its average growth rates in revenue and profits, and its brand strength. We then used this formula to calculate values for our Global 100 list of the world’s highest-grossing law firms.
So who’s top of the AL list?
Number 1 is Kirkland & Ellis, with a $3.95 valuation.
The numbers thereafter for the top five are:
2) Latham & Watkins LLP ($3.8 billion); 3) Skadden, Arps, Slate, Meagher & Flom LLP ($3.34 billion); 4) Allen & Overy ($2.71 billion); 5) Gibson Dunn & Crutcher LLP ($2.71 billion).
But what’s really interesting is when the firms are ranked by total value per partner the results are wildly different.
At the head of this group is the relative newcomer Quinn Emanuel Urquhart & Sullivan LLP, whose “value per partner” is about $17.7 million. That’s nearly $5 million-per-partner more than Kirkland, which finished in that ranking’s number two slot.
As American Lawyer reports:
Part of the challenge in appraising law firms is the lack of existing investment deals to use as a benchmark. In two of the first post–ABS acquisitions of U.K. law firms by professional investors, for example, the apparent valuations differed wildly. In January technology and outsourcing company Quindell Portfolio acquired Liverpool-based personal injury law firm Silverbeck Rymer for £19.3 million ($30.7 million)—a multiple of less than four times the profit that firm accrues each year. Then, just a few days later, Australia’s Slater & Gordon—which in 2007 became the world’s first publicly listed law firm—bought another U.K. personal injury specialist, Russell Jones & Walker. Slater paid £53.8 million ($85 million) for RJW—more than 11 times the target firm’s annual net profits.
Complicating the process further is the fact that law firms have little in the way of hard assets. A firm’s chief revenue generators can leave at any time, potentially taking clients—and revenue—with them. (However, this is also true of other professional services businesses, many of which are publicly listed and have been valued and traded successfully for years.)
Then there is the issue of how a firm’s owners—its equity partners—are compensated. The way that most partnerships are structured means that they are effectively unable to retain any earnings at the end of each fiscal year. Except for any planned investments, all remaining profit—what the Am Law 200 and Global 100 surveys refer to as “net income”—is distributed among the equity partners in full. Compared to companies in other industries, this gives law firms an artificially high profit margin, since from an accounting perspective, equity partners receive no above-the-line salary and therefore represent no cost to the business. This arrangement precludes the calculation of almost any recognized valuation metric, such as EBITDA (earnings before interest, taxes, depreciation, and amortization), which is the favored tool for private equity investors.
“Partner remuneration is reported as one figure, but really it’s two things—it’s a payment for a day job and payment for putting capital into the business as a proprietor,” says legal consultant and former Clifford Chance managing partner Tony Williams. “Firms have never really looked at it that way before, but that’s exactly what [external investors] would do.”
Before a traditionally structured firm could attract outside investment, then, it would need to fundamentally change the way it compensates its equity partners. The firm would need to determine how much of an equity partner’s total compensation is essentially a salary paid to an employee and how much is profit returned to a shareholder. One of the first hurdles we faced in our analysis—and the first of many assumptions we had to make—involved this issue.”
The American Lawyer valuation of law firms is an interesting and ambitious study on an industry that is increasingly less able to hide its light under a bushel and is increasingly being held up to a scrutiny it will need to get used to.