Checkpoint: Private Equity Bought My Lawyer
Gabrielle Henderson
Over the last decade, private equity (PE) firms have become notorious for infiltrating the retail and hospitality sectors, stripping struggling companies of assets, and then running them into the ground. Think Red Lobster, Toys R’ Us, Joann Fabrics, Sears, TGI Fridays, the list goes on. PE firms conduct leveraged buyouts, using borrowed money to buy companies, then saddle the newly-acquired companies with that debt. They sell the companies’ assets and real estate in sale-leasebacks, often selling the real estate back to themselves directly, then charge the now-failing company rent on the lot where it sits. To cut costs and increase efficiency, the PE firms cheapen out on ingredients and materials, lay off workers, and close storefronts. Once acquired by a PE firm, companies are far more likely to go bankrupt. Of the 21 restaurant chains that declared bankruptcy in 2024, 10 of them had recently been acquired by private equity. Red Lobster was already struggling with debt when it was bought by Golden Gate Capital. After the acquisition, the company lost the land that it had previously owned and had rent to pay on top of its debts. PE firms make money by bleeding already-struggling companies dry.
PE’s next victim is the legal sector. The legal field has a large and fragmented market, making it a perfect target for PE firms. There’s plenty of space for trial and error; if a PE firm runs one law firm into the ground, there are more where that one came from. Law firms have a durable demand that’s relatively economic downturn-proof, and they share uniform regulatory structures and benefit from recurring client needs and interactions, so there’s a seemingly endless source of revenue. From the PE firm’s perspective, law firms also present lots of untapped areas for increased profit. They often operate with decentralized billing, limited data analytics, outdated technology, and inconsistent pricing that could all be updated and consolidated to increase efficiency. Law firms also tend to be risk averse, not investing in new technology, personnel, and geographic expansion.
Attorneys are governed by the Bar Association and by state-authorized ethics boards. To be an attorney, you must pass not only the Bar Exam, but also a separate ethics exam called the Multistate Professional Responsibility Examination (MPRE). Every year after an attorney takes the Bar and the MPRE, they must also take Mandatory Continuing Legal Education courses to remain in good standing with their state’s Bar Association. If an attorney acts in violation of the ethical guidelines set forth by the Bar or an ethics board, the attorney can be disciplined and, worst case scenario, disbarred. These bodies and guardrails are in place to protect clients from unethical behavior and to ensure that attorneys conduct their firms in a way that justly upholds the legal system. The American Bar Association (ABA) has extensive professional guidelines that attorneys must follow to remain in good standing. Among them, in the ABA’s Model Rules of Professional Conduct, is Model Rule 5.4, which prohibits the sharing of legal fees with a nonlawyer and limits the ownership of law firms to practicing lawyers only. Model Rule 5.4 makes it tricky for PE firms to infiltrate the legal field the way they did in the retail and hospitality sectors, by buying companies outright. In the last couple of years, however, PE firms have developed a way to skirt protective regulations.
To get around Model Rule 5.4, PE firms have begun pouring investment into Management Service Organizations specifically geared to the legal field. These Legal Service Organizations (LSOs) provide a model for third-party investment in law firms without taking ownership of the firm. The imposition of LSOs separate law firms into two entities. One is the firm proper, which remains owned and operated by licensed attorneys. The other entity, the LSO, owned by the PE firm or affiliated investors, acquires all nonlegal administrative functions like billing, accounting, record keeping, technology, vendor outreach, marketing, data analytics, recruiting, leasing, and cybersecurity. The LSO arranges for a payment structure according to a fixed-fee, revenue percentage, or cost-plus agreement, again to skirt Model Rule 5.4 that prohibits non-lawyers from sharing legal fees. The LSO, once fully integrated into the law firm, handles all the work that would previously have been done by multiple vendors and different in-house departments, and is structured to make the law firm become reliant on it. Attorneys can consolidate and outsource the tedious administrative tasks necessary to running a law firm and spend their time doing actual legal work. It’s an appealing prospect.
There are downsides to the LSO model, though. It’s easy to fire your IT vendor when they become too expensive or aren’t performing as they should. When your IT vendor is instead one part of an investor-backed organization that also runs all your other back-office operations, it becomes much harder to negotiate for a lower rate or better work product. In an LSO scheme, the PE firm owns all the staff, assets, and equipment previously owned by the firm, so the law firm has little leverage to self-advocate. Private equity is investing in the legal field to make money. PE firms have categorized the industry as a new source of revenue. They prioritize efficiency and profit margins, and encourage cost and corner cutting wherever possible. While law firms without the LSO intervention still act as for-profit businesses, lawyers at their own firms operate on reputation and their own names, so they’re more incentivized to do well for their clients. The LSO entity doesn’t have that personal incentive and will always push to keep costs low and profits high with the client experience as an afterthought. When private equity owns the LSO, it’s controlling the firm’s technology, data, brand, and bank accounts and can exert an enormous amount of influence.
The advent of private equity into the legal sector marks a fundamental shift in the way legal services are provided. As Private Equity firms have done with fields like hospitality and retail, it is beginning to infiltrate the legal field and strongarm firms under their control. While protections like the ABA’s Model Rule 5.4 of Professional Conduct are in place to protect client interests and the integrity of the field, PE firms have found a way to skirt those protections using the new LSO model. PE firms have only recently begun to invest in the legal field, so they’re still in the honeymoon period. As private equity worms deeper into the industry, however, some of the country's top law firms may go the way of Red Lobster, Sears, Joann Fabrics, and all the other companies that were bought by PE firms and ushered into bankruptcy.
