Professional service firms (PSF) operate in a market which is subject to profound change, and macro-economic pressures, geopolitical shifts and technological advances combined with ever-increasing cost and regulation place a heavy burden on even the most robust PSF. Competition for talent, clients and revenue among PSFs is intensifying, and the pressure on partners of PSFs is unrelenting.

Notwithstanding those headwinds some PSFs have achieved significant revenue growth in recent years, although relatively few now enjoy sustainably high profit margins. The cost of doing business rises year on year, and consistent investment in technology, people and new markets is often beyond the pocket of a PSF. However, for those firms with economic firepower the opportunities are greater than ever and many PSFs are exploring the pros and cons of external capital as a means of unlocking value and accelerating plans for profitable growth.

Traditional bank lending and overdrafts remain the backbone of working‑capital support for PSFs, but a deepening ecosystem of specialist and alternative funders is reshaping the market. These providers are drawn by the lure of stable returns from an often counter cyclical professional services market which has experienced steady expansion in recent years and shows no sign of slowing. Some PSFs have turned to private equity (PE) investors, on both a majority (the PE investor acquires a majority stake in the PSF) and minority (the PE investor acquires a minority stake in the PSF) basis. However, a PSF partnering with PE on either a majority or minority basis is likely to have to give up full operational and economic control of its business in exchange for investment and, whilst that might be an acceptable trade-off for some, it will not be tolerable to others. For more on these impacts see our articles Private Capital in professional services: understanding the landscape and Private capital in professional services: strategic opportunities and transaction execution.

Accordingly, well advised PSFs seeking investment will consider a range of capital options and increasingly are favouring “alternative capital solutions” (ACS) which are capable of financing growth plans without the material impact on control and culture which can be a feature of PE deals.

What is a PSF?

A PSF is, at its most basic, a business formed by one or more professionals to provide services to clients. They come in all manner of shapes and sizes and operate across a multitude of markets. From small, high street, single practice firms providing commoditised services such as conveyancing and probate, to legal and advisory megaliths that operate in multiple jurisdictions and provide complex, highly specialised and high value advice, the PSF market is both broad and highly fragmented. 

Law firms in particular are often structured as partnerships where partners invest capital into a firm in return for a share of ownership, profits (and losses), and management responsibilities. However, in contrast to many accountancy firms which benefit from known and repeatable audit income streams, most law firms have no repeat business and start each financial year at “zero” having paid 100% of profits from the previous financial year as partnership distributions. This model has an obvious impact on the ability of a law firm to set aside capital to invest for its future growth.

How are PSFs typically funded?

So how do PSFs, and in particular law firms, invest in their future strategy and growth? 

• Partner contributions: A PSF might look to its partners to raise capital by retaining profits or by seeking cash contributions sourced from a partner’s personal funds. However, each partner will have a uniquely personal perspective since (e.g.) a partner coming towards the end of his or her tenure will have little or no appetite to promote the long-term growth of their firm beyond the period for which they will share in partnership profits. This can lead to a short-term focus which ties investment to individual partners and their personal priorities rather than longer term business goals. 

• Third-party equity: The UK PSF sector is highly regulated, but public policy has evolved in recent years to allow third party equity investment in firms which were previously the exclusive preserve of regulated professionals. In particular, the introduction of Alternative Business Structures under the Legal Services Act 2007 opened the legal market to external ownership of law firms, and it is against that backdrop that the market has seen growing interest from PE and other sophisticated investors who are attracted by a fragmented but (in some instances) highly profitable market for legal services.   

  Investors are drawn to law firms by the genuine value proposition that they offer: generally uncorrelated to the rest of the economy, law firms with cross practice expertise are often able to thrive in even the most turbulent of economic conditions. This has enabled UK law firms to attract over £1.18bn of PE investment since 2019, with a record £534m injected in 2024 alone^[1].

• Third-party debt funding: Debt is ordinarily available where a borrower demonstrates clear evidence of growth, a solid pipeline of ongoing work and an established team, alongside tangible, realisable assets that might be liquidated if a lender is obliged to enforce its rights to get its capital back. Accordingly, whilst a modest working capital facility is a common component of a PSF capital structure, term debt is often not the right solution for a PSF. 

What is ACS, and how might it be structured?

The ACS market is vibrant and comprises a mix of “legal asset” funders and other specialists who understand the PSF business model and have deep experience of providing capital to PSFs for a wide range of purposes. Every deal will be bespoke dependent on circumstances and need, but options might include:

• case funding: a funder agrees to meet the ongoing costs of a specified matter as they arise in return for a portion of proceeds when the case is won. The funding is used to meet the PSF’s on-going costs, allowing it to meet its capital needs even when it has agreed to work on a fully contingent success-based basis;
• portfolio funding: a funder agrees to provide capital to a PSF in return for a share of proceeds derived by the PSF from several separate matters on which it acts on a contingent success-based basis. If one case loses, the funder can rely on the remaining elements of the portfolio for its return;
• LTV funding: a funder agrees to provide capital in an amount proportional to the value of a designated portfolio of on-going cases. A quarterly valuation methodology is agreed, and the amount of available funding fluctuates accordingly;
• WIP funding: a funder agrees to provide capital in an amount proportional to the value of a PSF’s WIP (work in progress) book. The valuation methodology will be bespoke and will be dependent on (e.g.) the PSF’s historic ability to translate WIP into cash receipts; and
• debtor funding: a funder agrees to provide capital against the value of debts which are owed to a PSF. The valuation methodology will be bespoke and will be dependent on (e.g.) the identity of those counterparties which owe money to the PSF.

Is ACS an alternative to PE, or can they be used together?

An ACS package can be used instead of PE but can also be used as a means of introducing quasi-debt leverage to a PE-owned PSF and it is this that is likely to become more prevalent as the incidence of PE investment in PSF firms (and in particular law firms) increases.

ACS packages are bespoke and must be structured with a close eye on tax and regulatory considerations. However, ACS funders are keen to gain capital exposure to good quality PSFs and are flexible when considering deal terms and structures not least since many are now able to mitigate their risks in the insurance markets. ACS packages provided to PSFs range from £500,000 to £500m+ and funders are open to discussion as to the best way to ensure proper protection of invested capital.

Is traditional “litigation funding” part of the solution?

Notwithstanding growing investor interest in the legal sector, the UK market for single‑case, non-recourse, litigation finance has been subdued in the past 2 years following the UK Supreme Court’s decision in PACCAR (R (PACCAR) v Competition Appeal Tribunal [2023] UKSC 28; [2023] WLR 2594).

Litigation funders had anticipated increased opportunities following the publication of the Civil Justice Council’s (CJC) review into litigation funding^[2], but certain of the CJC’s recommendations have been met with scepticism and the timeline for implementation remains uncertain. For more on litigation funding generally, please see An overview of legal finance in England and Wales.

Funders have capital to deploy and given the uncertainties surrounding single case funding arrangements there has been a marked move towards holistic PSF funding (sometimes structured as “portfolio funding”) which better diversifies risk and removes some of the legal and regulatory uncertainties which are now inherent in case-specific funding structures. 

How does portfolio funding work? 

Funding is provided to a PSF to enable that firm to meet its working capital needs, and the funder will receive an agreed return from cash derived from a designated pool of cases. It is thus usually “limited recourse” in nature (sometimes called “non-recourse”) in that a funder typically will not have access to the PSF more broadly but is taking a considered bet that the designated portfolio of cases will be concluded successfully and will thus generate cashflows sufficient to return both capital and agreed upside to the investor. 

The matters within the portfolio need not be, and preferably are not, related. The proceeds of the funding can be used to meet PSF costs associated with the underlying portfolio cases (typically, advanced against an agreed budget case by case and thus closely aligned to traditional single case litigation funding), but increasingly firms are obtaining funding lines capable of being used for general business needs unrelated to the portfolio. The funder’s return is “cross-collateralised” and comes from proceeds generated across the portfolio so that wins can offset losses. 

What are the key challenges presented by ACS?

Providing funding to a PSF is not always straightforward since the tax and regulatory issues which arise will be bespoke to each firm, and careful analysis will be needed before settling on a structure suitable to the facts. 

For various tax and related reasons funding is often not structured as “debt”, and thus a funder will not benefit from “security” in the traditional sense. However, with careful thought a funder can be suitably shielded against downside risk, and an ACS package is therefore able to give a PSF the firepower that it needs whilst ensuring that the funder is protected.

Conclusion

As the UK PSF market matures an increasing number of firms will seek third party capital to drive growth in a hyper-competitive market. Equity investment will be the right path for some, ACS will be better for others, and a combination of the two may be compelling for those PSFs seeking a fundamental change to capital and firepower.

All PSFs have unique characteristics, and regulatory, tax and cross-border issues need to be carefully analysed before a capital solution is agreed. Success then depends on careful structuring and disciplined execution. However, the market is willing to address these issues, and we anticipate more and more ACS funding solutions in coming months to enable forward-looking PSFs to invest for the future. 

Macfarlanes has the leading practice in PSF and legal assets funding and has been closely involved in the development of the UK and European market over recent years. 

The team advises law firms, accountancy firms and advisory firms in relation to their capital needs and has acted for a wide range of funders (traditional litigation funders, sophisticated special opportunities funds, and hedge funds with PSF-backed strategies) in relation to all types of funding arrangements.