Private capital investment in professional services firms has surged in recent years.
In the last nine months alone, accountancy firms Grant Thornton (UK), Evelyn Partners, Cooper Parry, Dains and SMH Group and law firms Slater Heelis Solicitors, Beyond Law, Stowe Family Law and FBC Manby Bowdler have all announced private equity investments.
Why have lawyers and accountants become so popular?
Regulatory changes in both the legal and accountancy sectors created initial investment opportunities.
On the accountancy side, the UK Financial Reporting Council (FRC) announced in 2020 a four year transition period for the "Big Four" firms to separate their audit and non-audit operations. A number of the Big Four subsequently sold off non-audit functions, including KPMG’s pensions and wealth advisory practice (now known as Isio, which went on to acquire Deloitte’s UK pensions advisory business), KPMG’s UK restructuring practice (now known as Interpath Advisory) and Deloitte UK’s restructuring services business (which is now part of Teneo).
The Solicitors Regulatory Authority (SRA) in England and Wales first began allowing third-party investment into law firms back in 2012. While there were some early deals, the wave of private equity money into the newly liberalised legal services market didn’t quite materialise in the manner some had predicted.
So what has changed to prompt the recent flurry of deal doing?
A combination of factors seems to be driving the activity:
- Consolidation opportunities in fragmented markets, as firms look to the benefits of scale to drive efficiency and profitability.
- The opportunity to grow non-audit businesses without being restrained by audit conflict rules.
- A requirement for capital to invest in new technology, automation and AI. Funding for international expansion.
- A need for additional working capital funding (particularly in light of recent tax “basis period” reforms, which have accelerated the point at which tax on a partnership’s trading profits is payable, by up to 11 months).
Of course, private equity investment is not the only source of funding open to professional services firms. As well as traditional bank lending, we are seeing credit funds taking an interest in this space and litigation funders expanding their offering to provide firms with broader working capital facilities.
Key areas to consider
For those firms that do choose to go down the private equity investment route, there are lots of things to bear in mind. All deals have their own complexities and challenges - but professional services transactions in particular have some unique features which need careful consideration and navigation.
The journey from a full-distribution partnership model to a corporatised structure or some form of hybrid is not a straightforward one.
Firstly, how the deal will be structured.
Some options include:
- Buyouts – Often executed via a newco stack, with management investing alongside the investor. The existing structure, especially if it includes an LLP, may need to remain for regulatory or tax reasons, but governance typically shifts to the Topco board, changing the firm's culture from a partnership to a more corporate model.
- Carve-outs – Where the target business is sold out of the existing company or partnership and transferred to a new legal entity or integrated into another business. Key issues include identifying personnel and services to be transferred, managing interdependencies, servicing mutual clients, handling non-compete and non-solicitation restrictions and ensuring the continuation of regulatory approvals needed to operate the business.
- Minority investments – The investor may acquire interests in the existing structure alongside management, requiring careful consideration of post-completion governance and the structure of any leverage introduced as part of the deal.
Tax considerations
There are a number of UK tax considerations which are particularly relevant where the target is an LLP (a typical structure for professional services firms):
- Allocation of deal proceeds – Compared to a corporate buyout, there is often greater flexibility to allocate deal proceeds otherwise than pro-rata to the sellers’ existing interests in the LLP. See also the comments below in relation to tax considerations when setting the level of post-deal remuneration.
- Reinvestment – Individuals disposing of an interest in a trading LLP and reinvesting into the buyer’s corporate acquisition stack cannot make that reinvestment on a tax-neutral basis (as is typical on a corporate buyout). As a result, reinvesting partners typically either reinvest on a post-tax basis or retain their interests at the level of the LLP.
- Post-deal integration –
- Typically a target LLP will be retained post-transaction, in part to allow individual members of the LLP to continue to be remunerated free of employer NICs (and the apprenticeship levy) which would otherwise apply (at 15.5% from April 2025).
- Moving assets between the LLP and the Buyer’s corporate group can trigger corporation tax charges (which would generally not be the case where the target is a limited company). There are workarounds to this issue but it can impose constraints on post-deal integration with an existing business of the buyer (or with a subsequent bolt-on acquisition).
- Salaried member considerations for LLP members – The post-deal remuneration and governance arrangements for the LLP will need to take into account the salaried member rules analysis. Where they apply, these rules treat members of LLPs as employees for tax purposes and so (amongst other things) trigger employer NICs and apprenticeship levy on partner remuneration. Managing these rules can for example put constraints around what level of fixed vs variable bonus/profit share is payable to individual members post-transaction.
- HMRC focus on partnership incentivisation – incentivisation of LLP members has been a key area of HMRC focus and litigation in recent years, including challenges to the capital treatment of partner incentivisation structures and challenges under the salaried member rules (most recently, the Court of Appeal decision in BlueCrest from earlier this month). We expect this to remain an area of HMRC interest.
Regulatory issues
Most professional services firms are regulated by one or more authorities and therefore care must be taken to obtain the necessary consents or authorisations in connection with any transaction.
Culture and compensation
The partnership model differs significantly from a private equity leveraged buyout structure. Transitioning to a new structure will require a significant shift in mindset for the firm and its partners, especially regarding profit sharing arrangements. Early considerations should include:
- Partners’ compensation packages – What level of haircut will be applied to partners’ remuneration when the firm moves away from a full-distribution partnership model? Clearly this will drive the pricing of the deal, and part of the equation here is the tax treatment (with ongoing remuneration taxed at up to 47% whereas deal proceeds are generally taxed at 24%).
- Incentivisation, retention and intergenerational fairness – Who is benefitting from the transaction and how are the proceeds of sale being shared amongst key stakeholders? How are any perceptions of unfairness around current partners receiving a windfall at the cost to others being addressed? How is the next generation of talent being incentivised?
- Exit strategy – What is the investor's exit strategy, particularly in the case of a minority investment?
- Governance – How will the firm be run going forward? What impact will having external investment have on the firm's autonomy, decision-making and culture?
Despite these additional layers of complexity, the investment opportunity in professional services is a compelling one and we expect this sector to remain busy throughout 2025.
For more information, please contact one of the listed contacts, or your usual Macfarlanes contact.