The American Lawyer has been reporting on law firm financials for more than 25 years. Through our annual Am Law 200 and Global 100 surveys, we utilize a slew of metrics profit margin, revenue per lawyer, net income, profit per partner, and so on to provide a detailed assessment of the financial health of the world's legal elite. But one area we haven't tackled is how much each firm is actually worth. That is, until now.
After discussions with more than 50 private equity and other investment professionals, merger and strategic consultants, and senior law firm personnel, including managing partners, chief financial officers, and treasurers, we developed a method for valuing a law firm.
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 [see "A Firm Valuation Glossary"]. We then used this formula to calculate values for our Global 100 list of the world's highest-grossing law firms.
So, who's at the top? Baker & McKenzie? Skadden, Arps, Slate, Meagher & Flom? DLA Piper? Perhaps one of the Magic Circle firms? All wrong. It's Kirkland & Ellis. The Chicago-based firm narrowly edges out Latham & Watkins to head the list, with a valuation just shy of $4 billion. The Global 100 as a whole well, the 97 firms for which we have all the required data is worth $97 billion. That's more than the GDP of Slovakia, the world's 62nd-richest country.
The results also show whether the combinations that created DLA, Hogan Lovells, and SNR Denton vereins have actually added any value (two have, one hasn't; see "Adding Muscle Or Fat?"), and reveal the high cost of the recession to the world's leading law firms.
While we stand behind our ranking and our methodology, it's important to recognize their limitations. Valuing any business is as much an art as it is a science. Each investor views things differently. In applying a one-size-fits-all formula to such a range of businesses as the Global 100, we had to make assumptions about their structures, the state of their balance sheets, and the way in which they accrue and distribute profit. Our work is intended to shed light on the issues an investor would face when analyzing a law firm target, and to paint a picture albeit with a relatively broad brush of how the market might be valued today.
Law firm valuation is a relatively new phenomenon. In the past, the legal industry has largely been geared toward delivering short-term profit gains and maximizing partner compensation. Little thought was given to each firm's inherent value.
Following the introduction last December of legislation that allows law firms in the United Kingdom to accept external equity investment through a so-called Alternative Business Structure (ABS), that mind-set is beginning to change. The new law is expected to result in a glut of transactions within the United Kingdom, particularly among commoditized and process-driven practices, such as those dealing with consumer insurance claims, and has brought into focus the need to determine how much law firms are actually worth.
"Investors tend to look at everything through the prism of value that's our stock in trade," says Robert Colthorpe, a financial services expert at London-based corporate finance advisory boutique Europa Partners. "Law firms have never really been subject to that form of analysis before, but they're starting to become more sophisticated and strategic in the ways they are seeking to quantify business value."
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 postABS 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.)