Private Equity Is Buying Law Firms: What Every Partner Needs to Know Before Signing

Private equity money is moving into law firms, and legal MSOs sit at the center of the shift. Frederick Shelton advises law firm owners through these deals and explains what separates a strong offer from one that costs a partner their leverage, their income, or their license. Billie Tarascio walks through valuations, EBITDA multiples, Rule 5.4 exposure, and the questions every firm owner should ask before the first meeting.

Frederick Shelton serves as CEO and Firm Side Advisor at Shelton & Steele, where he works almost exclusively on law firm M&A and legal MSO transactions. He built a legal recruiting practice thirty years ago, moved into law firm mergers and acquisitions two decades later, and now represents firms across the table from private equity buyers. His predictive analysis on virtual law firms and artificial intelligence ran in Attorney at Law Magazine and American Lawyer ahead of both curves, with commentary picked up by Forbes and Bloomberg. He currently advises firms ranging from three million to over three hundred million in annual revenue.

Key takeaways:

- Understand how a legal MSO lifts administrative work off partners

- Compare standard MSOs with private equity backed MSOs

- Learn why Rule 5.4 shapes every deal structure

- Spot the terms that signal a weak offer

- Value a firm using EBITDA multiples ranging from four to ten times

- Recognize why the highest upfront number rarely means the best deal

- Negotiate ownership of an internal AI platform and other intellectual property

- Plan for the income dip that follows the upfront payment

- Structure MSO distributions so partner income recovers and climbs higher

- Merge with like minded firms to reach a stronger valuation

- Understand why micro investors now court firms at one million EBITDA

- Hire a deal attorney and an ethics attorney before the first conversation

- Vet the buyer as closely as the buyer vets the firm

Chapters:

01:19 Thirty years in legal recruiting and law firm M&A

03:00 Predicting virtual law firms and AI ahead of the curve

04:15 What a legal MSO does for partners

06:49 Broker, banker, or something new

08:56 Why upfront valuation misleads sellers

10:45 Bad deals being signed right now

13:19 What a strong MSO deal looks like

14:56 Partner income after closing 

15:48 Merging with other firms before a sale

16:59 Why smaller firms hold real upside

18:00 Rule 5.4 and the coming backlash

21:24 Vetting private equity partners

24:08 Seller friendly MSOs entering quietly

25:06 Results from firms already closed

Connect with Frederick Shelton:

LinkedIn: https://www.linkedin.com/in/frederick-shelton/

Transcript

SPEAKER_02 0:00

Welcome to Law Labs, where a law firm life gets a glow. I'm Billy Carassi, a founder of Modern Law, and every week we crack open what it really takes to run, grow, and scale a law firm inside the age of AI and innovation. This is where firm owners, legal rebels, and business minds come to swap ideas, share wins, and methods, and rethink what's possible in the project. If you're ready to lead smarter, scale faster, and build a firm that actually works for you and your clients. You're in the right place. Let's get to it. Hello and welcome to the Modern Arizona podcast. I'm your host, Billy Tarassio. Today, joined on a law labs edition by Frederick Shelton, who is the CEO of Shelton and Steel, who does self-side legal MSO advisor. So this is firmly within what we've been talking about regarding MSOs and money coming into law. And Frederick probably has a front row seat more than anyone. Frederick, welcome to the show.

SPEAKER_00 1:07

Thank you very much. I appreciate it.

SPEAKER_02 1:08

Yes. So tell everyone a little bit about who you are, your background, what got you into what you're doing, and then we can talk about what you're seeing in the market.

SPEAKER_00 1:19

Sure, of course. Uh so I started a legal recruiting firm 30 years ago. And when we would place uh attorneys into these great big law firms, the firm would pay a fee, but we would represent the attorney because a lot of times it was their very first move. They didn't know what to ask, they didn't know how to negotiate salary, that kind of thing. Uh about 20 years ago, we started doing law firm mergers and acquisitions. And in MA work, we kept to the same model. I was very fond of telling the founders of firms that had anywhere from five to fifty attorneys, look, the great big AMLAs don't need my protection. You do. You've never done this before. They've acquired firms over and over again. So the great big firm would pay our fee, but we represented the smaller firm. Um, and we also started doing a bit of predictive analysis. Uh I wrote an article once in 20 late 18 or 2019. Uh, I had come across this anomaly called a virtual law firm. And I realized that it solved a lot of problems that partners had in when it came to lifestyle, uh control of their hourly rates and things of that nature. So I wrote an article in Attorney at Law Magazine predicting that virtual law firms and lawyering was going to be the next big thing. And of course, all of my attorney friends laughed at me and said, Oh, you're crazy. A client would never tolerate me working with the kids and the German Shepherd in the background and this kind of thing. And, you know, they kind of mocked me for a bit, and then COVID hit. And next thing I know, you know, I was in Forbes and Bloomberg and this kind of thing. And and uh so sometime later I wrote an article and predicted that this new tech phenomenon was going to be the big game changer for Ball. And uh it was called artificial intelligence, and it's been around forever, but I'd seen where it was really starting to improve. And a while later, this thing called Chat GPT came out, and so I wrote another article and I said, Look, guess what? This is it. Yeah, uh, this may not be the exact iteration, but this is what's going to change everything. Uh so a couple years ago, I found out about a legal MSO. And uh I was quoted in American Lawyers saying, Look, this is going to be the big structural change because where virtual law firms solved a lot of problems like control of her lifestyle, these MSOs solved a lot of management level problems like handling HR issues on the weekend, or you know, how does someone who does not have a computer degree get put in charge of the tech stack? Stuff like that. And uh so there were several uh, and there still are, there's uh a few standard MSOs out there, uh, but we only work with one, we only recommend one. As a matter of fact, you had TJ on your show not too long ago. Uh and Federate is the only standard MSO that we'll work with. And for any of your audience who doesn't know what that means, they don't take any equity in a firm. So there's no rule 5.4, there's no control issues, they just relieve the partners of all the administrative burdens, and it's a great idea. Uh, and then last year I was approached by a private equity firm that said, look, we're doing what the standard MSO is doing, but we're offering something that attorneys never had before. And that is they can actually sell their practice. Um and when they retire, they could walk away with tens of millions of dollars as opposed to just de-equitizing and getting their capcoms back or whatever. Uh, and that's something that never occurred before. Additionally, if a firm, a small to mid-sized firm, wanted to grow. Uh for example, I have a friend in Chicago, and he's got buddies at in AMLOC who've wanted to join him for years. But he is the only equity partner, and it would cost him $300,000 a month to pull them out of there. Well, talk about getting a little bit nervous, you know. Uh, well, these MSOs solved that problem. Uh, same with like KE just spent a half a billion dollars on artificial intelligence, and small to mid-sized firms don't have that kind of capital, but private equity does. You know, so this is really going to level the playing field. And I wrote in Attorney at Law and American Lawyer last year that by the end of this year, these were going to be a billion-dollar industry. They're just inevitable. Um, some people got angry with me. Wasn't it back when I wrote the article about AI, people were upset sometimes. And my intent is not to rock anybody's boat or whatever. I just make observations and do predictive analysis. And so at this point, we are working with dozens of firms ranging from, say, three or four million dollars in annual revenues to over $300 million in annual revenues. Uh, and we've taken that same model from MA. Uh, I used to tell my law firm clients, you know, look, even though they pay me, you know, big law doesn't need my protection, you do. Well, now I tell my MSO law firms, look, the MSO pay me, pays me, but anyone who can write a nine-figure check does not need my protection, you do. And that's what our job is now.

SPEAKER_02 6:49

Okay, so if I understand correctly, you are uh essentially a broker between private equity money in the in the form of MSOs and law firms who want to sell to these MSOs. Is that is that correct?

SPEAKER_00 7:06

It's close. Um so brokers will make an introduction or a bunch of introductions. Um, you know, if a company needs capital, they'll make the introductions and kind of say, well, good luck. Let me know I'm getting paid. Okay. Um when our law firms go to a meeting with an MSO, we go with them because you and I both know attorneys want to be the smartest person in the room. And so if someone says something they don't understand, they'll just nod. You know, oh, oh yeah, that, you know, like when we did uh AI consulting, um, you know, an attorney would listen and say, Oh, LLM. Yeah, I've got one of those in text, you know, and I'm like, oh not the same L different one. Different LLM, yes. Um, so we go with the attorneys to the meetings and then take copious notes, of course, and and then we hold a debrief afterward, and we'll say something like, Okay, clawback, what a great name private equity picked for that particular provision. I would have gone with something like, please don't screw us or I'd like to get my money back, but they went with that. Now let's explain to you what it is, how it works, when it's okay, and when it's not. And what happens is one, we prevent attorneys from getting bad deals. And I will tell you, there are a lot of bad deals being written right now. Um, and two, we help them to get the good deals because if something sounds scary or intimidating or they don't know what it is, we're they're a lot more comfortable with us as a recruiter. Sure. Who's done this for 30 years, you know. We put everything in plain language, they'll ask us things, you know, and that they would never ask uh private equity or you know, a broker or whatever. And it's so it just makes it easier for everybody.

SPEAKER_02 8:52

Okay, so is that are you the are you the equivalent of an investment banker, or is that different as well?

SPEAKER_00 8:58

No, we've actually created our own little new profession in the universe. Um, so an investment banker will put together what's called a CIM, a confidential information memoranda, and they'll send it out to everybody in their Rolodex, and they'll get uh bids, you know, they'll get offers or IOIs. And typically they'll take the two or three or whatever largest offers, the biggest upfront capital and valuation, take that to the head of the law firm and say, well, here are the best offers that we've gotten. Um I've learned very quickly that the most, that the highest level of upfront valuation and upfront capital does not mean the best deal. Um I've seen deals where attorneys were offered six times their profit margin or what they call evida, uh, and told them, you know, this is this is horrible. Um you know, these people are not gonna take care of your people. Your next generation of attorneys are gonna be their indentured servants. Um, you can't even get your own money out of this thing unless it's by mutual consent. So you're this is really bad. You're better off taking five times or four times with uh better second bite of the apple or upside later on, you know, these kinds of things. So we are not investment bankers, we're not broker dealers, uh, we're basically consultants to the law firms who are paid by the MSOs.

SPEAKER_02 10:27

Interesting.

SPEAKER_00 10:28

Yeah. Okay. Very different. It never existed before. We're kind of our own little thing.

SPEAKER_02 10:32

Thanks for working through that with me. It's new. So I have questions. All right. So what are you seeing? I one question I have is are there more attorneys looking to sell or or private equity MSOs looking to buy?

SPEAKER_00 10:45

Yeah. So right now, like I said, some of the worst deals that will ever be written are being underwritten because I feel sorry for these poor personal injury and labor and employment attorneys and, you know, whatever who go into these deals without an advisor and sometimes without an attorney. I mean, uh, you know, I've seen deals where the MSO never told the law firm that they should seek counsel. And if there was one piece of advice that I would give your listeners and your viewers, it's get an advisor, get at least one attorney, at least a deal attorney, but also you should get an ethics attorney like Lucian Perra or Trisha Rich, who are inescapable in this space. And I'm very fond of both of them, by the way. Um so but on the other side, we are writing the best deals that will ever be written right now. I mean, I am I'm having a very good time, and and the partners that we have concluded these deals with are very, very happy because the MSOs are hungry. They need the law firms right now. Um there are some, you know, like in personal injury, for example. That's what's getting a lot of attention. There are uh probably 70% of the MSOs out there, somewhere close to that, are after personal injury. And now a lot of them are adding family law, trust and estates, and other consumer-facing practices. Okay. Uh, about 30% of the MSOs out there are going after corporate business firms, that kind of thing. Um, and so all of them are hungry. They all need the firms. It's first market mover advantage, okay? Uh, so they all need the firms more than the firms need them.

SPEAKER_01 12:31

Yeah.

SPEAKER_00 12:32

Uh, and so we're, like I said, we're negotiating wonderful deals. Um and um it's it's great because it really is a a wonderful symbiotic loop. Um these private equity firms or or like corporate backed MSOs, where they don't even have a the pressure to scale real quickly and and they're not looking to get exit multiples. In other words, make 10 times the money or whatever it is. Um we're getting offers from these MSOs that are great, and we're still able to improve on them a bit, even on a really good deal, because if it's their first law firm, um they're under a lot of pressure, you know.

SPEAKER_02 13:16

So, what does a good deal look like in terms of it's all over the board?

SPEAKER_00 13:21

Yeah. So um we did a deal with a little tiny firm um that had some challenges going for it. Um, and so we got them four times their profit margin or EVITA, as the finance bros like to use all day. Um and we got them very good terms where their income did not go down very much. Um, and the upside at the end was unlimited. Okay. Uh on the other hand, I have uh a firm I'm representing right now who's got over 500 attorneys. Um we're not talking to anybody for less than eight times IVITA, uh, and we'll probably end up somewhere more like 10 times. And we'll be able to negotiate certain things. Uh, for example, intellectual property is always a very important commodity in these negotiations. And uh so who gets to own that? Well, that's gonna be going from deal to deal, you know. Uh if you've already got an internal um AI platform, for example, that is functioning and advanced, should that belong to the MSO or should that remain your property? You know, these kinds of things are all negotiable right now. Um, a good deal typically what happens is because the profit is usually paid out to the partners, um, the partner's income are is going to go down once they get that upfront money because it needs to fund and operate the MSO. Okay. Well, a good deal will offset that by paying the partners' distributions out of the MSO so that in two, three, four years, their salaries might actually be more than they what they were making before the deal happened. So their income is gonna come back, get back to where it was. Um, and then it could increase dramatically over where it was, and a few years up the road, they could walk away with you know, eight figures. I mean, there's there's a lot to be had out there.

SPEAKER_02 15:26

So it sounds like uh in and what I've seen or heard is that basically bigger is better. And and if you are a law firm right now who, you know, maybe you're doing five million dollars or whatever, and this sounds good to you in three, four years, people might be looking and might be looking to merge with other like-minded attorneys who also want to sell. Are you seeing that?

SPEAKER_00 15:50

We're coordinating it. Um Yeah, so we've done law firm MA for over 20 years. Uh, and we've actually had people contact us specifically to say, hey, look, uh our firm is only doing two or three million a year in in Ebida. Um can you find us a good partner where either they're gonna be larger or will be larger or whatever it is? Now, the beautiful thing is we've been working with uh some new MSOs, uh, one of whom is specifically looking for family law firms that are led by someone who looks like they could be a TV lawyer or something. Okay, I may or may not be referring to you. Um and they are uh fine with one million in EBITDA. Um so we've now got micro investors who will who are are realizing look, at 10 million in EBITDA and above, the market is already saturated. So, you know, maybe we should take a look. It's certainly easier to grow a firm from doing say one to five million up to ten times that than it is to grow a firm that's doing fifteen million a year to half a billion. Okay. So the ability for all ships to rise with the tide and and for the attorneys and the MSO to reap wonderful rewards is much higher.

SPEAKER_02 17:12

Okay, so uh what what I think I heard you say is like there's deals happening at every level. It's not necessarily that bigger is better, but the multiples are higher the higher the evening.

SPEAKER_00 17:24

Yes, yes, absolutely. I understood what you're saying. Yeah, absolutely. So if you're doing, you know, say um like one of the deals we did, the partners got I think it was four million, five million up front. Um, and in five or six years, they'll be able to walk away with about 20 million in capital, which is something they would never be able to do. Yeah, okay.

SPEAKER_02 17:53

That's crazy. I mean, that means like everything has changed. Lawyers, law firm owners, if you're listening, the whole world has changed.

SPEAKER_00 18:00

Yeah, it really has. And this is inevitable. Now, let me tell you that this is gonna be very much like AI. Um, there are some downsides, and there's we're gonna have our what I call the Avianca Airlines moment. Um when I wrote the article about AI, every Luddite in the legal profession yelled at me because we all know lawyers just love innovation. Oh yeah outright. Um so you know, there were people who would just, you know, eschew any kind of AI altogether and and were absolutely convinced it was just never gonna be a thing. And then along came this brief with five hallucinated cases in it for a firm called Avianca Airlines. And of course, all the Blaudites pointed their fingers and said, See, I told you this has no place in the law, you know. And um, guess what? It's been years since then, and we still have AI, and KE just invested a half a billion dollars in it, and it ain't going anywhere. Well, the same thing is gonna happen with legal MSOs. Right now, if you go on LinkedIn, you'll see 20 people a day typing, oh my god, private equity is gonna steal your soul, and they're gonna hire Satan's accountant to do your valuation and you know, these kinds of things. Because again, I'm not saying that attorneys have egos or can be control oriented. I'm just saying that the idea of anyone making decisions without partner approval is considered heresy in the profession. You know, well, lots of decisions should be made without partner approval. Yeah. Um, and so someone, I'll give you an example. I've had an MSO approach me and this guy said, okay, so after everything's cashed and funded, how do we get around this stupid rule 5.4 bullshit? You know? And I'm like, oh, I'll tell you how. You lose all of your investors' money and you watch the firm burn to the ground because you're gonna go down. You know, if if you're gonna try to control the the front end, you're going to go down. And and they're like, well, we won't let it get out. And I'm like, no, the Domacles sword hanging over your head isn't from some guy complaining on LinkedIn. It's gonna come from inside the law firm because a lawyer would rather burn their own firm to the ground than watch some PE bro like you come in and take over things, you know. Um, so that moment's gonna happen because I've talked to, like I said, we turned down 60 out of 70 MSOs. I mean, there are a lot of people coming into this space who are unethical, they have no idea what they're doing, whatever. Um, and at some point, the Abianca Airlines moment will happen with MSOs. Someone's gonna get caught, lose a lot of investors' money, some firms are gonna get sanctioned or dissolved or whatever it is. Everybody's gonna point their finger, and guess what? They're coming anyway. It's inevitable.

SPEAKER_02 20:50

Right, right. Well, in this case, lawyers seem like they have more to lose than private equity investors. Private equity investors do a ton of deals and some work and some don't. But if we end up selling to the wrong partner and losing our license, we're done. Our livelihood is gone, our biggest asset is gone, we our our our professional career could be over. And so I I think there's a lot of um concern about that. And there should be to even talk to these people, right?

SPEAKER_00 21:24

Yeah, yeah. No, look. Um I mean, private equity has never had the reputation for being benevolent angel investors who are only trying to help people, okay? Some of them really are great people. I mean, we've got some clients. I'm just so fond of some of these private equity clients. They're just such really good people, okay? But a whole lot of them ain't. You know, it's kind of like used car salesman. Uh, I'm sure there are some out there who are just the greatest people in the world, but they didn't get their reputation by not being pushy. And By not trying to sell cars for an overly, you know, overpriced or whatever it is. Same with these PE bros. You know, um, I the way that I mean, like, and and some of them who like tried to seem like they were being okay were like, no, no, we don't want to take over the front end. We just want to help them make better decisions about which cases to take. And I'm like, um, I'm gonna guide you to an ethics council. You know, it can be really tough to tell. Uh, for example, if you just do an auction and get a bunch of bids, you're not vetting the people at all. Okay, if you get an introduction, um and you just go, me, well, a lot of these private equity people are very slick, and they're not gonna go into a deal and ask an attorney, so how do we control you once all this is over? You know, they they won't say that to an attorney. Um, and it's fun because being a recruiter, the attorneys will talk to me more candidly. And working 30 years with partners, this may shock you, but there are some partners who exaggerate the size of their books of business when they want to move because they want to get a higher pay. I know, I know, just falling out of our seats, right? So you develop very good instincts uh about when people are BSing you or whatever it is. And um, I would just say that, you know, look, there are a few advisors out there. I don't know that there's anyone who does it quite like we do. Most of them are gonna charge the firm, but it's pennies compared to millions. Okay. Um uh there are a few really good attorneys out there, we know them all, uh, because it's such a small community. Um, do not walk into a deal without both. I mean, you know, look, if you have them both, you can get the best deal and the best partners. Um, I'll give you a great example. One of our favorite um MSOs, actually, we've got a couple, and that's another thing is some of these MSOs are not announcing their entry into the marketplace. So the Yeah, so the very best MSOs with the best deal structure, investment bankers and stockbroker or dealer broker dealers don't even know they're they're here. Okay. So um we had an MSO come to us through one of uh the attorneys in our network, and 30 years of getting partners their jobs, we got a lot. Okay. And the attorney called me and said, Frederick, I'm gonna introduce you to these people. They came to me and they said, We want you to help us structure an MSO that is seller friendly, as seller friendly as possible. Okay. When private equity goes to an attorney and says, Look, we want to be as favorable to the sellers as we can, that's a home run, you know? And and I've already got deals in front of those, uh, those guys, because they really are. I mean, they are really concerned. They really do uh want to, they're very adamant about not doing fee sharing. They're very adamant about not having any control over the front office. I mean, these are good partners.

SPEAKER_02 25:04

Last question. How long, how, how long before we know whether or not this is working or not?

SPEAKER_00 25:13

Yeah. So I've got firms who have done deals and they're already saying it's working. I mean, they're thrilled. Um, I had a woman write me an email saying, look, you helped us make the best business decision we have made in our 30-year career. I mean, uh, she loves uh marketing. She loves giving speeches. And now she's got more money to give speeches and better positioning at the conventions and you know, all these kind of things. And she doesn't have to deal with any of the other stuff, which she hated.

SPEAKER_02 25:45

It does sound nice, doesn't it?

SPEAKER_00 25:47

Yeah, it does. I mean, just you know, do the stuff like podcasts and working with clients. I have a client who would love to talk to you, by the way. Yeah. So just we'll feed the plant. You know.

SPEAKER_02 25:59

Well, thank you so much for coming on the show. I'm gonna have to have you back. We're gonna have another round table part two, so maybe you can join us for that. And um just thank you for sharing your expertise when so few people have it. So it's very, very valuable and I really appreciate it. Have a wonderful day.

SPEAKER_00 26:14

Yeah, absolutely. Thank you, and I've enjoyed being here.

SPEAKER_02 26:19

Thanks for joining me on Law Labs. If today's episode gave you something to think about or something to act on, I'd love to hear from you. Don't forget to subscribe, leave a review, and share the show with someone building the future of law. Until next time, keep experimenting, keep evolving, and I'll see you back in the lab.