Thoughts on ways to improve the management of professional services firms

Monday, October 30, 2006

Corporatisation in Professional Services - Goodwill and Integrated Legal Holdings

"It is something of a misrepresentation to suggest that there is goodwill at all", said one senior Perth barrister. "Who in the legal profession recognises goodwill? The big firms do not recognise goodwill." Quoted in the Australian Financial Review, 27 October 2006, in a response to the proposed float of Integrated Legal Holdings.

To my mind, this is one of the most absurd comments that I have heard. Goodwill is the core asset of most professional services businesses. To say that it has no value is like saying that the practice/business has no value beyond a limited range of tangible assets.

In an earlier post - Professional services : mergers, acquisitions and goodwill - I looked briefly at the goodwill question, suggesting in part that action by partnerships to abolish goodwill opened the way for corporatisation by creating a gap between the partner share as valued by the partnership and the external market value.

This is not rocket science. The key question in buying a business is the level and sustainability of profits. Here it does not matter if the business assets are tangible or intangible. Abolition of goodwill allows an aggregator to get a practice at lower price by offering partners a return for an asset carried in the books at zero value.

We saw this in medicine. Corporatisation and aggregation began with the higher value added areas such as pathology, but then spread into general practice. Doctors, especially the older ones, rushed to sell their practices. The big question was whether or not the profit margins were large enough to support the process. So far the answer appears to be a qualified yes.

Law is far more profitable than medicine. Not only are top partner incomes higher, but so also is profit as a percentage of revenue. To this point law has been protected by regulatory barriers. These barriers are starting to go. As they do, the aggegators will move in.

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