Why private equity firms are increasingly scrutinising their legal costs

Private equity investors are taking a closer look at legal expenses. Slowing deal volume is a primary reason, but it’s not the only one, according to a survey of 100 PE firms in the US and UK with more than $10bn under management, which was commissioned by Apperio.

Four in five respondents to the survey said slowing deal flow was contributing to the pressure on external legal spend. Respondents also cited growth in other costs (87%) and the introductionof procurement skills (65%) as catalysts for examining legal expenses.

There’s a saying that recessions don’t cause trends – they accelerate those already in motion. To that end, this pressure on legal costs isn’t new.

US PE firms reported a 24% increase in the level of scrutiny applied to outside counsel costs since 2018. Similarly, in the UK, the level of scrutiny has climbed 41% over the past five years.

Law firms provide an essential service to PE investors. Some 95% of respondents said they trust their law firm to offer quality advice. That’s an important point because it’s not the quality of legal service that is in question but the lack of transparency around billing and unpredictable costs. Just 54% of PE firms that responded trust their law firm to bill them promptly. Even fewer – 38% – trust them to invoice accurately. About 65% are routinely “surprised” by the invoices they receive from law firms.

The unpredictability is a problem because legal expenses in private equity are significant. Consider the following statistics compiled from the survey.

As the economy has slowed, PE firms have focused inward on benchmarks like these and realised there’s a significant amount of money to be saved in legal expenses.

The problem all this points to is a systemic flaw in the administration of legal services. The question remains what can PE firms do to manage legal spend?

Here are a few considerations:

1. Make legal spend management a priority

About four in 10 senior legal stakeholders in PE firms indicated their organisation makes little effort to manage their legal spend. That’s unthinkable given the expense. The first step is simply to make getting a handle on legal costs a priority.

2. Show a preference for predictable pricing

No investor would agree to a deal without agreeing to a fairly certain acquisition price. The price of legal services should also be predictable. This is a key point because the scrutiny isn’t necessarily aimed at lowering legal costs but bringing a level of predictability to them. An effective technique is to demonstrate a preference for outside counsel that can name a price and stick to it.

3. Visibility into work-in-progress

PE firms need visibility into their law firm’s work-in-progress (WIP). It’s here that costs can soar when billable hours are logged over work that doesn’t need to be done, could be done differently or would be better off sent to a different lawyer with a different specialty. A window into WIP provides insight into the work that’s yet to be invoiced and the venue to refocus outside counsel on their needs.

4. Consolidate your law firm panel

Some PE investment teams have several law firms on their panel but spend the majority of their legal budget with a select few. For example, about half (47%) of PE shops in the US work with between six and 10 firms, however, 75% of total legal spend goes to just four to six firms. This is a proven way to manage legal costs – consolidate legal work with those firms that provide predictable pricing and visibility into WIP.

5. Use modern technology

The surprising finding in the survey was that 91% of PE firms still use old-fashioned spreadsheets to aggregate, collate and analyse law firm billing data.

These are investment organisations that pour billions of dollars into modern business technology but when it comes to managing their own costs they are using an application first brought to market in 1985.

The cost pressure on outside legal expenses is a trend that’s liable to continue. When respondents were asked about the level of scrutiny applied to external legal spend over time – they uniformly indicated it will continue to intensify over the next two years.