May 25, 2004
Private equity investment in Canada is expected to become increasingly competitive as large pension funds look to different asset classes to beat equity returns, and more U.S. funds take advantage of what they see as lower Canadian multiples and the income trust as a built-in exit strategy.
This is in one sense great news for Canada’s corporate law firms. Private equity deals involve multiple tiers of transactions, pulling in lawyers from various high-margin practice areas.
But the work is a double-edged sword. An acquisition can end up being an annuity for the law firm involved because of all the secondary deals, including the exit strategy—generally an IPO seven to 10 years out.
But it can just as easily turn out to be a loss. Bay Street sources say the most powerful private equity players in Canada and the United States expect their law firms to work at sharply reduced rates unless they emerge the winning bidder. Most private equity firms assign the cost of mounting a successful bid to the acquired company, leaving an unsuccessful bid an "orphaned expense" on their books.
Canadian law firms are going to be asked to take more risks as the market matures and becomes more competitive.
Stephen Donovan says private equity investors are not completely price-insensitive any more. But he says that private equity work is prized because "it doesn't end with the deal getting done. The investor eventually has to leave the investments. In the meantime, these deals have a little bit of everything. They have equity, they have debt, they may have more than one equity player and more than one lender, and several layers of debt involved in the transactions. So you use M&A, corporate finance, employment—tax is very important for structuring—intellectual property, pension—it could touch on environmental or any number of specialty groups. These are very just very good deals for law firms."
The pickup in Canada in recent months, says Stephen, is due in great part to the fact the U.S. market has become so competitive that smaller U.S. funds have been forced to look further afield for deals. He says Torys, which has the largest New York office of the major Canadian firms, has been seeing a fair bit of that action. "What's been very interesting from my perspective over the last year or so is you might have had KKR coming up here and doing a Shoppers transaction, or a Yellow Pages transaction, with Teachers—and we acted on both of those—but you didn't see many U.S. private equity funds coming north of the border below those very large deals. Now we're starting to see them. They're digging up deals that, frankly, we don't even know how they found them. There's a lot more money being dedicated to private equity than five years ago. I expect to see more funds focused on mid-sized coming north of the border. I think we'll see a lot more of those than the blockbusters."