Five partners at a niche Mayfair law firm have become instant millionaires. The lawyers in question have not struck it lucky on a winning lottery ticket, nor have they received an early Christmas present from one of their wealthy rock star clients.

In fact, they have done something that was considered equally unlikely by most in the legal profession — they have sold their law firm to a financial services group for £7m.

The sale of Statham Gill & Davies (SGD) to AIM-listed Tenon Group – the first time a UK law firm has been bought by an incorporated company — is a landmark in the deregulation of legal services.

The deal has provided partnerships up and down the country with an unchartered opportunity to raise capital for future expansion by cashing in on the value of their firms.

And it has ignited regulatory, financial and philosophical arguments regarding the future of the legal profession in this country.

"Law firms everywhere are watching this deal like hawks," says George Bull, head of professional practices at Baker Tilly.

"This is an absolute landmark in professional services."

In a Legal Week news analysis published three months ago, the experts — without exception — said that such transactions would not happen here for years, such is the regulatory minefield.

So how did SGD pull off such a deal?

Until now, Tenon, which listed in March 2000, has been buying up accountancy firms in order to create a national business advisory company.

So far it has snapped up more than a dozen medium-sized to small accountancy firms up and down the country.

But it never intended limiting itself to accountancy firms in its drive to create a one-stop business advisory shop.

Talks between SGD and Tenon began in May, just days after Tenon had acquired Godfrey Allan, an entertainment and media tax specialist which had close ties to SGD.

Tenon was encouraged by the similar client base and good working relationship that the two firms possessed.

"The driver for us was the clear similarity between the profiles of both firms," says Tenon chief
executive officer Ian Buckley. "It fell perfectly into our philosophy of offering an integrated business advisory service."

While initial meetings went well, both sides were aware of the regulatory pitfalls such a deal would entail, particularly with regard to the rules against outside equity investment and the status of reserved activities such as litigation.

Nonetheless, according to insiders, The Law Society was highly co-operative during negotiations although it became clear early on that some major concessions would have to be made on behalf of SGD.

Due to the ban on fee sharing, the firm's lawyers would have to give up their practising certificates and join Tenon as advisers.

Moreover, the firm's contentious lawyers would be barred from joining Tenon completely as litigation is a reserved activity.

"The issue of litigation was not crucial to completion of the deal," Buckley says.

"Tenon wants to offer a business advisory service and regulatory arguments regarding reserved practice areas are not something we are interested in pursuing."

In the light of this, the litigation team has decided to set up as a two-partner firm – Andersen Forbes – which will run as a separate unrelated business taking certain administrative services from Tenon under a separate agreement.

Nonetheless, while the issue of litigation was dealt with swiftly, negotiations over the financial aspects of the deal became more protracted.

SGD – which advises music-related corporate entities and major rock groups such as Oasis and Radiohead – has seen its turnover grow by 15% a year since it was founded in 1991.

The firm advised around 350 clients last year with fee income totalling £2.5m and profits standing at £1.3m.

It became clear early on that the partners at SGD were not going to give up their practising certificates cheaply.

The £7m package – half of which was paid in Tenon shares – involves a three-year lock in with the former partners of SGD dissolving the firm to become directors of Tenon Statham Gill.

The view in the market is that in current economic conditions, SGD has negotiated shrewdly, extracting a very generous price from Tenon, which was advised by Macfarlanes.

"I am surprised that Tenon paid that much when it was effectively creating its own market in law firms," says one management consultant who operates in the legal arena.

"I know of a number of similar firms who would have sold out a lot cheaper than £7m."

But with Tenon looking to acquire several more businesses this year in order to achieve a turnover target of £100m, potential targets will be monitoring its bottom line profitability closely to see whether selling out is a good long-term bet.

In fact, interesting parallels can be drawn with a similar deal that occurred two years ago.

In 1999, South Africa's leading commercial firm, Edward Nathan Friedland (ENF), turned its back on plans to merge with a UK law firm and decided to sell its business to the Nedcor Investment Bank for £40m.

In a joint statement released at the time, the two parties said they had concluded a 'unique agreement in South African history'.

When another South African commercial law firm, Rabin Van Den Berg & Pelkowitz, sold its corporate advisory business to the investment bank Brait shortly afterwards, many thought the floodgates had been firmly wedged open.

However, no further deals have been announced.
One problem – eerily similar to current global economic conditions – is that the South African markets became volatile shortly after the ENF deal, with the share prices of the financial institutions facing sustained pressure.

This will have diluted the value of the deal to the law firm partners who cashed in their partnership status because of the drop in the value of their share options.

The partners are also believed to have signed a five-year lock in – depriving them of the option to defect back into a partnership.

The generosity of the SGD deal with Tenon hinges on how well its shares perform.

Although the AIM market is holding its own at the moment compared with other European junior exchanges, the quality of the paper will have a huge bearing on Tenon's future success.

"It is doubtful whether a large law firm would be tempted by an AIM-listed company in current conditions," Bull says.

"In tough economic times most firms would feel more comfortable with a larger institution that can offer better quality paper and more investment potential."

But Tenon remains unfazed about its long-term prospects.

"We are always subject to volatile markets, but we intend to deliver a profitable business and let the share price take care of itself," Buckley says.

The next three years are likely to prove critical to Tenon as it strives to improve margins and implement integrated management structures.

Tenon's strategy is to concentrate on smaller niche business firms with highly specific expertise that matches other aspects of its business.
Further law firm acquisitions are definitely on the agenda.

"The business case is whatever suits the client and that will always be sector or niche driven," Buckley says. "Technology is an obvious sector for us and, eventually, we hope to have IP lawyers working alongside our patent agents and other tech specialists."

This obviously points towards smaller profitable partnerships with a clear industry focus as likely targets.

Niche IP firms such as Roiter Zucker, Willoughby & Partners and Manchester firm Kuit Steinhart Levy would be potential targets.

With Tenon's strategy so dependent on its share price. It is likely to be younger, more entrepreneurial partnerships that it covets as a means of driving its business forward.

Tenon is adamant that large law firms, particularly in the regions, are not on its shopping list. This is due to concerns about business conflicts and the potential loss of referrals such deals may lead to.

Tenon says it is also keen to bed down the SGD deal before making any further forays into the legal market.

The challenge for the management is its ability to integrate its disparate acquisitions into a single unit which is worth more than the sum of its parts.

With the winds of change blowing firmly in the direction of MDPs and equity sharing arrangements, it is clear consolidators like Tenon are here to stay.

For example, Numerica – another business advisory group – recently signalled its ambitions by buying the non-audit businesses of three accountancy firms including City-based Levy Gee.

Intriguingly, Levy Gee has close ties with Howard Kennedy with which it has a joint venture, Kennedy Gee Corporate Finance.

Howard Kennedy may well be tempted to jump into bed with Numerica, although it would have to hive off its litigation department, which amounts to 20% of the practice.

After all, if it negotiated a similar deal to SGD, its partners would be sharing out £57m.

Such is the rapidly changing nature of global legal services that nothing can be ruled out.

Especially as, soon, lawyers may not have to sacrifice their solicitor status in order to throw in their lot with a company like Tenon.

In its report Competition in Professions, which was published in the spring, the Office of Fair Trading argued that companies should be able to offer legal advice to their clients in the same way that they offer financial advice.

The Director General of Fair Trading, John Vickers, is yet to make up his mind on the matter.

Meanwhile, an initiative underway at The Law Society may make it easier for firms to raise money without selling themselves to another business in their entirety.

Current rules against outside equity investment prevent law firms from selling a stake in their business without dissolving the partnership.

But a Law Society working party is looking into ways of introducing a halfway house – whereby firms can sell a minority stake to a financial conglomerate.

This could avoid the serious issue of conflicts because it would maintain the firm's independence.

The working party is currently looking at the mechanics of outside investment deals and is understood to be in favour of allowing such arrangements in the future.

At a recent UIA conference in Turin, Law Society president David McIntosh said: "I can think of many law firms which, if fee sharing, including co-ownership, were permitted, would attract an abundance of non-lawyer investors. And I know there are lawyers who would welcome having the large investments they make to their firm returned to them because of outside money coming in."

Ian Mouland, head of EJ Legal's management consultancy arm, says: "Law firms are cracking businesses and a damn sight better risk than some of the rubbish that banks put their money into these days. It is an absolute crime that law firms struggle to gain decent facilities from banks while flimsy companies have money thrown at them."

Legal Week understands that leading UK law firms are already lobbying The Law Society to change the rules in order that they might sell minority stakes in their firms to global financial institutions.

For most firms this would prove a more attractive option than being bought out completely.

During the 1980s – buoyed by the Financial Services Act 1986 -deal-hungry financial conglomerates refused to restrict themselves to one area of expertise. The result was that UK banks and brokers capitulated to foreign entities.

Who would doubt that the legal profession has embarked upon the same journey?