IPO’s in Professional Services – a growing trend?
The professional services industry is attracting a lot of interest from investors and deal activity has been on the rise in recent years. There is also increasing talk of potential IPO’s and rumours about a handful of law firms considering a float. To find out more, we interviewed James Allen, Equity Research Analyst, from Liberum to explore the professional services capital market.
James Allen, Equity Research Analyst, Liberum
Liberum is an independent Investment Bank with a desire to offer original thinking and a high quality of service. Our Investment Banking division provides advice and execution services to UK PLCs, including corporate broking, equity capital markets and M&A. Our Equities division provides sales, research and trading services to institutional investors, specialising in all-cap pan-European equity research across twelve pillars with deep sector knowledge.
1. What is your overall impression of the Professional Services capital market?
There is strong institutional appetite to invest in the professional services space. This is evidenced by the strong demand from investors when DWF, Gateley, Keystone and Knights have chosen to sell down internally held capital over the last 18 months in the legal services space. There has also been strong institutional demand when money has been raised as part of an acquisition, such as the £10m capital raise for K3 Capital’s acquisition of Knight Corporate Finance Group and Knight R&D, as well as Begbies Traynor’s £22m raise, in part to pay for its David Rubin & Partners acquisition in March last year, but also to fund pipeline opportunities.
In terms of sector performance, most firms have performed well since coming to market. Of the firms that have listed in the last five years or so, success stories include Alpha Financial, Elixirr, FRP, Gateley, K3 Capital and Keystone. Of the firms that have not performed quite as well, RBG Holdings’ share price has remained broadly flat since listing in 2018, DWF is currently trading below its 2019 IPO price but is now trading well after a period of significant restructuring, while Knights is now below its 2018 IPO price after a profit warning at the end of March 2022.
2. What do you think will happen in the next 12 months?
There is clearly an unusually high degree of uncertainty at the moment. However, we expect to see more professional services firms coming to market in the UK. We believe one barrier to listing in the past has been around managing the transition from an LLP, where partners have limited liabilities and which is a common ownership structure in the non-listed professional services market, to a PLC, where external institutional ownership is introduced into the capital structure. However, firms such as Gateley and FRP have provided proof of concept since listing, having converted from a traditional LLP to a PLC themselves as part of the IPO process, and so we expect more professional firms will begin to explore this route.
3. From a Professional Services firm perspective, why would a firm consider a listing and what are the benefits?
We believe many of the benefits of an IPO apply equally to both professional services firms and firms in other sectors. However, the benefits of an IPO can vary from company to company depending on company strategy, how much money is raised and, ultimately, what investors want the company to do with the money raised post-IPO.
Benefits to the firm may include:
- Improved visibility of a company’s brand;
- Increased access to finance through public markets;
- Scope to accelerate growth plans, including both organically and through acquisitions; and
- Potential to diversify ownership and increase incentives.
Not only does an IPO provide a growth opportunity for the company, but it also provides existing shareholders with an exit opportunity to take some money off the table.
4. In your opinion, what is driving a growing interest in IPO’s in the legal industry?
We believe the proof of concept provided by the current listed peer group has shown the legal services industry that there is an alternative to the traditional LLP ownership structure.
Benefits of conversion from an LLP to a PLC in the legal service industry include:
- Employees below partner level can partake in share ownership schemes, such as LTIPs;
- Partners are not tied to a ‘lock-step’ model where the right to share in the profits of the business is directly linked to the length of tenure of a partner, rather than productivity or profitability;
- Increased access to funds that allows the business to make investment choices that may be more limited in a traditionally funded LLP business;
- No personal liabilities should the firm become insolvent;
- Increased ease in extracting capital in order to leave/retire, which reduces the likelihood of a succession crisis;
- Financial security as salaried partners are no longer remunerated through profit shares, which can fluctuate;
- Access to capital should allow partners to grow their practice faster than under the traditional LLP model;
- Capital investment allows firms in more traditional industries, such as legal services, to modernise back-office structures and to promote greater use of technology; and
- Even where an LLP is maintained under a PLC structure, capital buy-ins tend to be much more modest.
As a result of the strong performance of the listed legal services peer group, we expect more firms will want to join the listed peer group. This is supported by a survey of 200 law partners performed by litigation funder Harbour which found that 31% mentioned that their firm was considering an IPO in the next 12-18 months.
5. Why is the professional services market so attractive to investment?
We believe the professional services market provides exposure to specific end markets that investors should find attractive.
For example, in the advisory market Begbies Traynor, FRP and K3 Capital provide exposure to the insolvency and restructuring sector which has historically performed well after a recession. These firms also provide corporate finance services, which is an area of the market that has been very busy post-COVID. In terms of financial metrics, these businesses offer strong growth, high margins and, in FRP’s case, an attractive quarterly dividend pay-out which is appealing to income investors.
In legal services, the sector is reasonably defensive and client relationships are sticky, which means revenues are quite predictable. This is evidenced by how well the sector performed during COVID. The sector offers an attractive mix of growth, such as Keystone, and income, such as DWF, which means the sector is investable for most investors and investment strategies.
6. What’s the international picture of capital market activity in the professional services industry?
In terms of the advisory market, there are some very large international players with a strong brand, such as FTI Consulting and Accenture in the US, which have both performed very well in the long run.
However, in the legal services sector of the market, capital market activity has been limited outside of the UK. This is because, other than in England and Wales, only Australia and the UAE permit non-lawyers to own and manage legal firms.
7. Who might an IPO not be suitable for and are there any other drawbacks that a business should be aware of?
There are some firms which can support a larger amount of debt than public markets would be comfortable with. Those firms are generally more suited to private markets given the cost of debt is usually cheaper than the cost of equity. However, we do not expect there to be many firms in the professional services sector to whom this applies. People are usually their biggest asset and they typically operate with low levels of leverage.
There are also a number of additional considerations that a firm should be aware of before deciding whether to float. These include an increase in the number of stakeholders, many of whom have competing agendas, the increased possibility of negative trade press, a possible lack of liquidity in the shares once listed, more arduous disclosures and greater accountability. An IPO can also be expensive to achieve.
8. Any other observations or final thoughts for a business considering an IPO?
We believe the single most important point is that any professional services business seeking a listing is differentiated to those firms that have already come to market. This is particularly important in the legal services market where there are already six different legal services firms listed, all of which have a differentiated offering and strategy. Please feel free to contact James who would be happy to discuss your specific situation in more detail.
If you’d like to read more from BDO on whether an IPO could be an option for you and your company, please click here.