A blog by Joel Barolsky of Barolsky Advisors

Strategies for whatever future holds

In Articles, Commentary on 6 July 2018 at 7:43 am

First published in the Australian Financial Review, 6 July 2018

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The opposite of a ‘perfect storm’ is what BigLaw is enjoying right now. The combination of the Banking Royal Commission, strong corporate deal flow, numerous class action defence cases, regulatory change, major infrastructure projects and general economic growth has seen many of the nation’s top law firms enjoy double-digit profit growth over the past year.

The key strategic question is whether these firms treat this as a one-off, or see it as the start of a new era of prosperity?

Both scenarios are worth exploring.

The One-Off Wonder Scenario

If firms predict a return to a shrinking market with a looming threat of disruption, then conventional wisdom would suggest retaining some of the current surpluses to make themselves ‘future-proof’. A war chest could be used over the next few years to transform culture, invest in adjacencies, craft new business models, acquire game-changing technology, recruit superstars and build relationship capital. It could also be used to introduce a more consistent dividend policy.

While this all makes perfect sense none of the major firms will do it.

Current tax law requires each partner to declare their individual share of the partnership’s net income in their individual tax return, whether or not they actually received the income.

It follows that most firms will distribute all F18 supernormal profits to avoid the partners paying tax on income they don’t immediately receive. This payout will be accompanied by a communal prayer session that the second scenario comes to fruition.

While this tax issue does provide some constraints to reinvestment, there’s nothing stopping firms setting up new investment vehicles outside of the partnership in which partners acquire a stake in their personal capacity. Gilbert + Tobin partners’ collective investment in LegalVision is a good example of this. This strategy may be useful for taking a stake in new discrete businesses, but it could get messy if only a subset of partners elect to invest and the new ventures were directly involved in co-creating the legal service.

The Glory Days Scenario

If firms are more bullish and expect the good times to continue, then maybe some really interesting strategic choices on the cards.

With a higher risk-tolerance, firms may elect to do some or all of the following:

  • Take the opportunity to incorporate and create the capital base and balance sheet to innovate that is not possible within the partnership model. With more money to play with, firms will be in a better position to compensate partners for any one-off capital gain issues.
  • Double their investment in developing the skillset, toolset and mindset to compete in the digital age. Within four to five years, the firm will experience a step-improvement in its capability to harness the power of new technology, but more importantly the willingness to embrace change.
  • Double the intake of legal graduates and make the life for junior lawyers more bearable. Creating more system capacity and having a bigger pool of talented happier people will make the firm mentally stronger and healthier.
  • Acquire a boutique management consulting firm will the express aim of accelerating lawyers’ abilities as holistic strategic business advisers.
  • Split the firm into two: one part that can command super-premium value-based pricing, and the other housing those practices that require market-leading operational excellence to thrive.
  • Create an internal ‘risk enterprise’ modelled on the litigation funding business model. This new business will enable the firm to enter more innovative gain-sharing pricing arrangements with clients and bring more creative value-building opportunities to the table.
  • Make an aggressive play in the compliance market. Over the years, the Big 4 accountants and other providers have controlled this market and reaped millions of dollars from it. The Royal Commission has essentially revealed that these incumbents have failed and it’s time for legally-trained risk experts to return.

So which one?

So which is more likely to eventuate: the one-off wonder or glory days?

My best guess is that it will be somewhere in-between. Yes, the Commission will end but there is a lot of underlying demand driving growth in top-end legal work. The broader economic outlook is okay to good, slated infrastructure spend is massive, in- and outbound capital flows will remain strong and post-Commission restructuring will keep the corporate lawyers busy for quite a while.

The perfect storm has become the perfect calm. The open question is just for how long?

Screen Shot 2018-07-05 at 6.00.43 pm

Source: strikingly.com

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