Full text of my opinion piece first published in the Australian Financial Review on 7 February 2020.
Law firm partners focus a lot their profit and loss statements but tend to glance over the asset section of their balance sheets.
This is a missed opportunity.
There are three main reasons assets are largely ignored. Firstly, in ‘zero-in zero-out’ partnerships with 100% dividend payout ratios tracking long-term asset value is relatively less important. Secondly, in some firms, the accountants lump all intangibles into a vague and unhelpful construct called ‘goodwill’. And thirdly, balance sheets tend to list boring things like plant and equipment.
Original AFR article
From a strategic management perspective, there is a significant benefit in framing goals around making the firm more valuable. This means identifying all the assets, both tangible and intangible, that the firm uses to create and sustain value.
A more detailed balance sheet can also be useful when it comes to partner performance management. Growth in asset value should be the heart of what’s expected of partners, especially in regard to their non-financial contribution.
Tangible assets are easy to quantify. The intangibles less so.
Here are five important intangible assets in your firm that are worth measuring, protecting and leveraging.
#1 Relationship capital
Relationship or social capital refers to the strength and stickiness of existing client relationships and, where relevant, referrer and community connections.
While there are no simple measures of relationship capital, good proxies include total client lifetime value, client commitment indices, net promoter scores, client loyalty rates, average service mix per client, share of wallet of platinum and gold clients, social network strength and percentage of sole-sourced work.
#2 Human capital
Human capital refers to the quality, performance and commitment of all partners and staff. Management reports often include data on salaries, recruitment, training and turnover, but these don’t get to the heart of tracking human capital growth or depletion. Additional measures might include:
- Toe-to-toe analysis comparing the quality of key practitioners in the firm versus direct competitors
- Loyalty and career intention indicators
- Succession and talent development pipelines by practice area
- Diversity and inclusion metrics
- Glassdoor, Seek and social media ratings
- Employee net promoter scores
- Leadership capacity and capability
- Culture maps, highlighting hot spots or blind spots
- Real-time measures around staff morale, firm climate, employee experience and discretionary effort.
#3 Brand capital
This refers to the strength of the firm’s brand and reputation in key target markets. Traditional measures include brand awareness, consideration, preference, use, board room impact, recommendation and social media following. An ability to attract star recruits is also an indicator of its brand capital.
One benefit of a strong brand is the ability to command a price premium. By way of example, in 2019, Apple’s brand premium enabled it to capture 66% of smartphone industry profits, 32% of overall market revenue while only selling 13% of total handset units.
Proxy measures around the firm’s pricing clout impact might include the percentage of bids won where the firm was priced higher than competitors, depth of discounting and percentage of matters with supernormal margins.
#4 Data capital
Most firms are sitting on mounds of valuable data with most of it stored on disconnected databases collecting digital dust. The main data islands include:
- client data such as matters delivered, interactions, service feedback, event participation, agreed pricing and billing,
- staff data such demographics, salaries, tenure, engagement, training, feedback and performance records,
- operational data such as time records, matters processed, productivity and utilisation, and
- financial data such as revenue, margins and expenses.
Joining these data sets and applying some smart predictive analytics will allow firms to make much better decisions. For example, the analysis could point to using a specific team with a particular process to do a specific type of matter for a certain client category using a defined pricing model. Each of these choices might mean a 2% improvement, but accumulatively you’re looking at +10% gain without working any harder.
#5 Intellectual capital
The last category is for important bits of firm know-how that don’t neatly fall into one of the other four areas. This might include the proprietary legal products, algorithms, websites, domain names, precedents, templates, applications, patents and trademarks.
Growth in intellectual capital could be assessed by things such as the firm’s investment in research and development and its innovation portfolio. Quantifying the revenue from new products and services can indicate success or otherwise in this asset class.
A call to action…
Take a quick glance over your firm’s strategy papers and board reports over the past 12 months. Is there a way to elevate your firm’s strategic thinking by delving into the intangibles that will sustain your long-term success? I bet there is.
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Many of the professional service firms I work with think they are collaborative, but in reality they’re collegiate. The latter describes a club of friends happy to socialise together. The former describes a one-firm firm where everyone is hardwired to win and deliver together.
business, client loyalty, client relationships, culture, executive leadership team, governance, growth, innovation, Leadership capacity, professional service firms
Is HWL Ebsworth Limited a buy?
In Articles, Commentary on 30 August 2020 at 12:35 pmFull text of my opinion piece first published in the Australian Financial Review on 27 August 2020.
Earlier this week, the Australian Financial Review reported that HWL Ebsworth (HWLE) was preparing to list the firm on the ASX with a $1 Billion-plus valuation.
While details are scant at this stage, it is worth asking whether stockbrokers will recommend a BUY when the HWLE Limited prospectus is issued?
My prediction is they will give this IPO a thumbs down for five main reasons.
#1 Insufficient surplus
As a listed entity, HWLE partners will have to share a portion of the firm’s profits with external shareholders. For the sake of argument assume the current partners enjoy average earnings of $1.5 million per annum. In the future, partner earnings – salary plus bonus minus profit share – might reduce to say $1 million. The incumbent partners will most likely accept a reduced annual income given their significant capital gain upon listing.
This business case seems logical but misses one key point – there is a fiercely competitive market for top talent. Many of the best HWLE partners are proven rainmakers will still be able to command incomes around $1.5 million or more at other non-listed law firms or by setting up their own practice when their employment and escrow handcuffs come off.
At $1 million – the maximum the firm can pay and still maintain dividend payments – HWLE Limited will be way off the mark in attracting any new ‘$1.5 million’ partners.
Over the long term, there’s insufficient surplus to keep both partners and external shareholders happy.
#2 Clients don’t buy the firm
When Shine Justice Limited first listed on the ASX, they presented strong evidence that their personal injury clients chose them because they trusted the firm’s brand and were largely lawyer agnostic. When IPH listed, investors were enticed by a large proportion of annuity income from patent and TM renewals and an ambitious plan to scale.
When it comes to HWLE’s mostly business-to-business relationships, research shows that clients are much more discerning around who does their work.
#3 Vague growth story
External shareholders examining the IPO prospectus will be looking for a compelling growth story. They will want to see how a fresh capital injection will drive shareholder value.
Under Juan Martinez’s leadership, HWLE has a solid track record of acquiring legal practices without the need to splash much cash. Economies of scale work well in mining but less so in premium legal where even boutique firms can generate supernormal profits. Despite all the hype, there’s no legal technology yet available that will create a sustainable cost or client service advantage. Creating a multi-disciplinary practice or moving offshore is fraught with risk.
So, unless I’m missing something, the growth plan beyond more of the same seems less than convincing.
#4 Key person risk
From interviews with former staff, it appears that Juan Martinez has a robust directed leadership style. Overheads are kept to a minimum and all lawyers are encouraged to be on the tools all the time to compensate for below-market pricing.
This is the operating model that has been the bedrock of HWLE’s success to date.
Given Mr Martinez’s tenure and track record, the market will have many questions over the strength of HWLE’s bench. If the proverbial bus had to arrive who will keep the firm together and herd the cats? I’d imagine the firm’s value will be discounted heavily because of this key person risk.
#5 More losses than wins
Future investors in HWLE will have a good look at the investment category and proceed with caution. A 20-year analysis of law and accounting firm IPOs in Australia reveals far more losses than wins, especially for external investors. This includes firms like Stockfords, Harts and Slater & Gordon.
One of the reasons for these failures is the loss of the partnership culture that underpins their initial success. This culture comes from the incumbent partners’ sense of proprietorship, stewardship, collegiality and identity. Shifting from partner to employee is a big shock to many. Financial transparency, share price volatility and an added compliance burden all often have a negative cultural impact.
In conclusion
I have drawn strong conclusions about the potential float of HWLE without access to any specific details. I look forward to reviewing their IPO prospectus and seeing how wrong I am. But if I’m not, buyer beware!
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