Amy Kolz wonders what would happen if a private equity fund invested in an Am Law 100 firm

A little before 10:30am on 3 June 2020, Derek Boone took a deep breath and swung open the glass doors of his law firm's 49th floor conference room. As the managing partner of Chicago-based Trale Blaser & Stern, Boone had conducted hundreds of meetings in this room, but today was different.

Private equity firm SilverKnight Partners had made an unprecedented $200m (£124m) investment in Trale Blaser the day before, transforming the law firm from a traditional partnership into a privately-held corporation with an equity value of $600m (£373m). Boone had just become the chief executive and in a few minutes would lead the inaugural board meeting.

This moment had been years in the making. The American Bar Association (ABA), along with the state Bar associations, had changed the rules of professional conduct to allow non-lawyers to invest in law firms in the autumn of 2018.

The following spring, Henry Abrams, the co-founder of SilverKnight Partners, a $10bn (£6bn) buyout shop, had approached Boone about a deal with the firm. It had taken then 48-year-old Boone several months to persuade his eight-member management committee to explore the option. Another six months were spent undergoing a gruelling due diligence process, negotiating terms and obtaining the support of Trale Blaser's partnership.

Now, as Boone surveyed the six other board members seated around the mahogany conference table, he felt a mix of excitement and trepidation. The 900-lawyer firm's new equity structure, along with SilverKnight's access to capital and expertise in growing professional services businesses, could vault Trale Blaser to a new level of profitability.

But the risks were substantial: would the firm's top rainmakers chafe against the corporate-style management and compensation structure? Would Abrams and the two other SilverKnight partners on the board focus on high-level decisions as promised, or would they enmesh themselves in day-to-day operations? As head of the first US firm to sell an equity stake, Boone couldn't be certain.

As 2010 draws to a close, the rules prohibiting outside ownership in law firms are still firmly in place in the US. But there are good reasons to believe that Trale Blaser's story, or a version of it, could become a reality for some Am Law 200 firms in the not-too-distant future. Australian plaintiffs firm Slater & Gordon sold shares in an initial public offering (IPO) in 2007. Non-lawyers will be able to invest in law firms in the UK from next October, and a bevy of private equity firms have already proclaimed their interest. In a porous, global legal market, such investments, along with the extra capital and expertise that they might bring, will only add to the pressure on US law firms to re-examine the status quo.

Traditional law firms, with their annual distribution of profits and a capital base constrained by the size of their partnership and perhaps a bank loan, may find themselves at a disadvantage when investing in talent, geographic expansion and technology. Clients pushing for efficiency and value, and the continued rise of alternative legal providers such as outsourcers and virtual law firms, could likewise challenge the rationale for the insular law firm model of today. One day, not so far from now, a few law firm leaders might decide that it's time for a new business model.

So what might happen to a law firm that became a private equity target? We asked 14 private equity professionals and investors, along with several consultants, investment bankers and business and law professors, to contemplate that question. Their answers helped shape our story.

The experts suggested a future for our model firm that was more evolutionary than revolutionary: a relentless and granular focus on revenues and costs; a willingness to make large but carefully calculated investments in people and new technology – and the discipline to measure those efforts; and flexibility in testing new models of staffing and pricing.

As the law firm partners of Trale Blaser learn, a private equity investment entails the most and least attractive aspects of corporate capitalism: innovation and efficiency along with ruthless accountability.

The courtship

When Henry Abrams first asked Boone for a meeting in May 2019, the managing partner expected that Abrams would want to talk about rates. Abrams, as the head of SilverKnight Partners, was a growing client of Trale Blaser: the private equity shop had generated $6m (£3.7m) in legal fees for the Chicago-based firm just the year before. Instead, over breakfast at New York's Regency Hotel, Abrams pitched the idea of SilverKnight acquiring a substantial minority interest in the law firm.

Abrams had done his homework. Trale Blaser was in the middle of the Am Law 100 with $850m (£529m) in gross revenue, but it was closer to the bottom quartile in profitability, Abrams said. The firm generated a $250m (£155m) net profit, or $1.1m (£685,000) in profits per equity partner (PEP). That annual pay cheque might have enticed talented laterals to join the firm 10 years ago, Abrams speculated, but not today.

The Midwestern firm was falling into the disappearing middle of US law firms: with just three international offices, it couldn't be called global, but it also lacked the profitability or narrow focus of a high-end boutique. The firm had a solid brand name and a few marquee practices – intellectual property (IP) litigation, private equity and energy among them – but a group of middling practices kept it out of the elite ranks. Trale Blaser & Stern needed a better strategy, and it needed the capital and corporate structure to carry out that plan. SilverKnight could help with both, Abrams said.

Boone was intrigued. Two years into his tenure as managing partner, he was frustrated with his inability to meaningfully increase the 100-year-old firm's revenues and profits. Clients were hell-bent on ever-increasing discounts. Partners, still feeling the aftershocks of the last recession, were reluctant to commit resources toward new international offices, expensive laterals, or new technology. Boone knew that SilverKnight had jump-started other professional services businesses in the consulting and advertising industries, but what kind of control would the law firm have to give up? And in the near term, were the firm's 225 partners even willing to discuss their business at the level of detail SilverKnight would demand to explore a transaction?

Thankfully, Boone found an ally that summer in Kevin Makerain. The firm's IP star, Makerain had a $25m (£15.5m) book of business and a prominent role in some of the highest-profile entertainment IP cases, but he was frustrated with Trale Blaser's recent results and his partners' stinginess in recruiting other IP laterals. Makerain had been tempted recently by lucrative offers from Am Law 100 firms with deeper litigation benches. As one of the firm's top rainmakers, he was able to persuade the rest of the management committee that with a tight non-disclosure agreement, there was little risk in letting SilverKnight peer in.

The diligence

Makerain and Boone, however, never imagined just how intrusive SilverKnight's due diligence would be. In late 2019, the private equity shop sent in a team of analysts to pore over the firm's financials, billing history and timesheets for the previous five years. Partners had to submit detailed, client-by-client revenue and cost estimates as well as endure probing interviews about their professional and personal relationships to find out whether any looming family or medical problems would interfere with their billings.

SilverKnight debriefed close to 30 clients to sanity-check the projections and assess Trale Blaser's market share and reputation. Over the course of the autumn, the private equity shop constructed a comprehensive financial model that calculated a baseline set of five-year projections and then ran a dozen scenarios with different assumptions about the economy and the performance of different practice areas. SilverKnight needed to know that its investment in Trale Blaser's business could deliver a return of at least 20% under all reasonable scenarios.

The proposal

For the previous 100 years, the partners of Trale Blaser & Stern had split all of the firm's profits at the end of each year and voted on all major decisions. Though PEP had been stagnant for the last five years, partners liked feeling in control of the firm's destiny and the yearly large cash payouts.

In contrast, a SilverKnight deal meant selling a 33% stake to the private equity firm and agreeing to a multitude of heavily-negotiated covenants and rights that would give the buyout firm a significant say in the future of the law firm. The recapitalisation also entailed taking on approximately $400m (£249m) in debt, a frightening number to leverage-phobic lawyers who could easily recite the list of Am Law 200 firms that had crumbled under large bank loans.

Still, SilverKnight's proposed $600m (£373m) equity valuation of Trale Blaser's business would generate a handsome one-time payout at the time of the investment: a partner who had earned $1.1m (£685,000) in the most recent year would get $3.3m-$4.4m (£2m-£2.7m); those with earnings of $2m (£1.2m) would get $6m-$8m (£3.7m-£5m).

But for most partners, only 35%-40% of that payout would be in cash; the remainder would be equity in the new Trale Blaser company that would vest over the next five or more years, keeping those partners tied to the business.

Going forward, the partners would earn salaries that would equal roughly half of their previous compensation, and an opportunity to earn additional equity from a $80m (£50m) incentive pool, if they hit certain performance hurdles. That earned equity would also vest over time; but the unvested portion would be destroyed if a partner chose to leave. Each year, in effect, the most senior partners would re-up their individual investment in the firm. Together the law firm partners would own 67% of the new company's equity, a stake initially worth $400m (£249m). If the value of Trale Blaser equity increased, or even stayed the same, partners would profit from this deal.

The true riches of the deal, however, depended on the successful performance and future equity value of Trale Blaser. If SilverKnight helped the firm increase profitability through operational improvements and strategic investments while the firm paid down some of the debt, then a later sale of Trale Blaser's stock to another buyer or the public markets could generate a handsome return – SilverKnight believed that it would be at least 20%-25% over five years – for all equity holders. So Trale Blaser partners would be giving up half of their annual cash compensation in exchange for a $400m (£249m) equity stake that could more than double in value. That outcome, however, was far from certain in many lawyers' eyes and a poor trade compared to the current system.

"Why would we ever accept this deal?" asked Joseph Luddith, co-head of the regulatory practice and a 25-year veteran of the firm. It was a scepticism expressed by many in the partnership until Abrams made a rousing speech at a tense partnership meeting in early December, two months after the due diligence began.

"Many of you will spend your careers creating value at this fine firm: bringing in new clients, bolstering Trale Blaser's reputation, attracting legal talent," said Abrams. "And yet your cash-based compensation pushes you to have a one-year view of your practice and the firm's health, not a five or 10-year view. You get no reward for building the firm's long-term value as an institution. You get a portion of the profits you help generate and when you retire, you get your capital account back, a modest unfunded pension and, if you're really talented, maybe a portrait in the conference room.

"Your so-called autonomy is a myth," Abrams went on. "Your management committee drives the firm's strategy today; partnership votes only constrain your leaders from effectively implementing it. Yes, you can leave to join a competitor without penalty, but your colleagues can do the same, leaving this partnership vulnerable to a run-on-the-bank-style exodus like your peers at Coudert Brothers or Heller Ehrman."

Abrams continued: "We want to work together to transform Trale Blaser into the powerhouse law firm that our diligence tells us it can be. Yes, your compensation will be tied to the long-term performance of this great firm; yes, each of you will be accountable for contributing to the profits and franchise of the firm; yes, those who go will leave money behind. But those of you who stay and build will have real equity – a stake in the ongoing business. You will own stock that could triple or quadruple in value over the next decade."

Closing the deal

A bloody battle ensued among the partnership in the months following Abrams' speech. Makerain and a significant group of the firm's most profitable and youngest rainmakers quickly saw the advantage of an outside investor and a corporate equity structure. Other partners were adamantly against such corporatisation, arguing that they didn't attend law school to answer to number-crunchers. Ten partners, including Luddith, left for competitors in January 2020, taking roughly $25m (£15.5m) in revenues with them.

Also, certain partners and practices didn't fit into what SilverKnight and its raft of consultants argued was the optimal growth strategy for Trale Blaser & Stern. SilverKnight's diligence identified 40 veteran partners, for instance, as having consistently depressed billings and profits over the past five years relative to their share of firm profits. And the firm's 20-partner real estate department was also relative deadweight, the private equity firm argued.

The 60 partners targeted for exit, as well as a large group of sympathetic colleagues, were initially outraged. But accusations of cold-blooded capitalism died down as partners contemplated the terms under which the underperforming partners would be trimmed. The veteran partners would get a one-time payment equal to six times their most recent year's compensation, and it would be entirely in cash. The departing senior partners would have to agree to multi-year non-competition agreements, but for partners who had been making $1m-$2m (£622,000-£1.2m) per year, many of whom were in the twilight of their career, $6m-$12m (£3.7m-£7.5m) in cash was ultimately difficult to turn down.

The real estate partners would get much smaller cash payouts – equal to their 2019 compensation – but they could join competitors six months later, as long as they agreed not to solicit other law firm employees: for partners who were no longer part of the firm's core strategy, it seemed a reasonable trade. On 2 April 2020, the Trale Blaser partnership voted to accept the SilverKnight investment. Exactly two months later, Trale Blaser became the first privately-held corporation in the Am Law 100.

The first three months

As Boone dialled into the third Trale Blaser board call that September, he mused about the many changes at the firm during the last three months. As chief executive, Boone was responsible for executing the detailed 'value enhancement plan' developed by both Trale Blaser's management committee and SilverKnight. Abrams, two other managing directors at SilverKnight – Steven Philtech and Michael Magnus – and Ralph Schroeder, former chief executive of business consulting behemoth Carson Consulting, had joined a reconstituted board that included Boone and two other Trale Blaser partners.

Boone had agreed to work closely with two SilverKnight-appointed corporate executives to streamline the law firm's operations and finances. A 15-year veteran of McKenney & Company became the chief operating officer, and SilverKnight lured a chief financial officer from a boutique investment bank. The deal terms allowed Boone to select a new chief marketing officer (CMO), but the private equity shop exercised its contractual veto rights when Boone originally chose a CMO with a CV littered with law firms.

Boone and his new executives set up a flurry of new initiatives in the first 12 weeks post-acquisition. The new CMO, a veteran of accounting giant Grant Bolton, hired a team of former consultants to conduct in-depth client interviews every six months to a year. The feedback was analysed in a report shared with the partners and Trale Blaser's business development executive and quantified on a 1-10 scale. That rating would be one factor in determining lawyers' compensation, the board decided.

SilverKnight, like Makerain, thought that the IP group could vastly increase its profitability if the right laterals were hired in pharma and life sciences. The deal terms had set aside $70m (£43.5m) in equity and $15m (£9m) in cash to entice a handful of star rainmakers in IP, as well as five to 10 other partners to fill in the firm's solid energy and restructuring groups. In the first three months after SilverKnight's investment, rainmakers in all three groups worked to formulate a top 20 list of laterals to approach.

Eighteen months later

As Boone looked over Trale Blaser's preliminary year end 2021 results before departing for his New Year's Eve holiday, he smiled faintly. The new Trale Blaser & Stern had increased its earnings before interest, taxes, depreciation and amortisation (EBITDA) by almost 10% in 2021 alone. Five-star pharma laterals had already brought in a combined $55m (£34m) in revenue, significantly exceeding their first-year projected revenue of $35m (£22m), and Boone saw a marked increase in partners cross-selling across practices.

Commercial litigators who had once focused only on a client's civil docket now regularly introduced their contacts to their corporate colleagues. And clients were naming a larger group of Trale Blaser lawyers as key relationship contacts in their feedback interviews. With the new equity and compensation structure, partners were more likely to promote their colleagues and focus on long-term results, instead of devoting every last billing hour to maximising their annual cash pay cheque.

Boone and his COO had already spent $9m (£5.6m) of the $25m (£15.5m) originally allocated toward investments in pricing analysis and knowledge and process management. The SilverKnight investment terms had also specified the creation and implementation of alternative fee pricing software by the end of 2021.

Even the launch of Trale Blaser's Knowledge Share programme had gone smoothly. Partners had submitted to tediously long interviews about their expertise, best practices and lessons learned in each transaction or matter. A knowledge management team was working to develop a comprehensive firm database and a set of matter checklists to be rolled out in early 2022.

Not everything had worked. An early programme encouraging top rainmakers to spend up to 90% of their time generating business had backfired when several large clients complained that they wanted to see more of their relationship lawyer. Boone shelved the programme.

One critical deal term had been support of the firm's expansion into Asia. Like many other firms with solid private equity practices, Trale Blaser wanted to take advantage of the region's transactional growth. But SilverKnight board members thought that a new private equity and capital markets practice was too risky, given that other Am Law 100 firms had saturated the market.

After a three-month debate involving outside consultants, several financial models and a few heated exchanges, Boone and the board resolved to hire a litigator to run the Hong Kong office: the data showed that the firm's return on a litigation and regulatory compliance practice would be higher.

Five years later

Boone straightened his tie and walked out onto the balcony overlooking the trading floor of the New York Stock Exchange (NYSE). Abrams and Philtech were at his side, along with Makerain, the CFO and COO and six other Trale Blaser partners. It was 9:28am, two minutes until the opening bell, and the chief executive couldn't stop smiling. Five years after SilverKnight's initial investment, Trale Blaser had increased its gross revenue by 38% and its EBITDA by 61%.

Now Boone and his partners were rich. The IPO price of $15 (£9.33) per share gave the firm a market capitalisation of $1.8bn (£1.1bn): the partners' original equity had tripled to more than $1.2bn (£747m).

Trale Blaser now had six international offices and a slew of promising laterals looking to come on board: it had become the law firm of choice for ambitious lawyers. The NYSE representative gave Boone the signal: it was 9:30am. Boone rang the opening bell as the crowd clapped and cheered. The TBS ticker crossed the tape, the first sale. It was only the beginning.

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Our fake maths

The SilverKnight Partners investment in Trale Blaser & Stern is fictional, but we based the structure and dollar values on a series of assumptions suggested by private equity professionals. Law firms don't report earnings before interest, taxes, depreciation and amortisation (EBITDA)