Private Equity's Biggest Law Firm Bet Yet: Inside the $700M Charlesbank-WSHB Deal

Private equity has found its next target: insurance defense firms. And judging by the opening bids, investors aren't dabbling—they're writing real checks, even by the standards of an industry that's already seen billion-dollar deals this year.

Last month, in a transaction reportedly valued at $700 million, Boston-based Charlesbank Capital Partners reportedly signed a letter of intent for a stake in Wood Smith Henning & Berman. Wood Smith, headquartered in Los Angeles, focuses on litigation, particularly claims against insurance companies.

If finalized, the deal, first reported by Pitchbook, could become one of the biggest legal business investments yet by a PE group. For perspective, $700 million is roughly the total annual revenue of Am Law 100 firms like Nixon Peabody, Ballard Spahr, and Williams & Connolly. And at 570 lawyers, Wood Smith would most certainly be one of the largest U.S. firms by headcount to partner with private equity investors.

Insurance Defense: PE's Newest Target

The transaction follows news in late July that another insurance defense-focused firm—250-lawyer Tyson & Mendes, based in San Diego—has also been in discussions about accepting private equity investment. Both deals would use a managed service organization (MSO) structure to avoid legal ethics issues, according to news accounts. And both suggest that private equity investors are expanding beyond investments in plaintiffs-side personal injury firms to find defense-side law firms with reliable income streams and significant potential for expansion.

Indeed, insurance defense practices share some of the attributes that have attracted PE firms to the personal injury bar. In general, the work is highly predictable and repeatable and, crucially, is performed for an institutional client base that pays its bills. Wood Smith is known, as Above the Law recently put it, as a “high-volume insurance-defense shop, which is to say exactly the kind of commodity, repeat-business practice private equity has been circling, because the work is predictable and, crucially, sticky.”

For PE investors, insurance defense may provide “an opportunity to consolidate a fragmented collection of regional practices, underpinned by repeat business from institutional relationships,” Pitchbook wrote. Because clients are institutional, they are far less likely to be linked to the firm through relationships to key partners. If a partner leaves, the insurance defense work generally stays with the firm. This gives investors “more predictable revenue and lower key-person risk,” Pitchbook wrote.

And unlike plaintiffs firms, which depend on contingency fee revenue, rates and returns at an insurance defense firm are more regularized. More often than not, a firm will have negotiated an hourly or project-based fee agreement with the client. And thus, the firm’s expected income cannot be scuttled by an adverse ruling from a judge or jury.

A Big Multiple: What Wood Smith Is Actually Worth

Wood Smith grossed $244 million last year, with an estimated $46 million in profit before taxes, interest, and certain non-cash expenses, The Financial Times noted. At $700 million, the firm would be raising a multiple of 15 times its earnings. Other news accounts have placed revenue at $289 million and EBITDA at roughly $38 million, suggesting an 18x multiple.

Whatever the case, either of those multiples is closer to the typical valuations that healthcare industry MSOs command. Many of the transactions that private equity firms have completed with smaller plaintiffs shops have had lower valuations. Scale matters, however. For instance, the nation’s largest plaintiffs firm, Morgan & Morgan, which has engaged J.P. Morgan to explore bringing in investors, is reportedly looking to raise more than $1 billion. The firm’s annual revenues are north of $2 billion, according to news accounts.

In an article on the firm’s website, Evan Atkinson, a corporate partner at Dykema Gossett, recently wrote that there is, as yet, “no universal ‘legal MSO multiple.’ ” That’s because the “market is too young, the regulatory environment is evolving, and the economics of law firms vary too significantly across practice areas,” he said. Atkinson suggested that PE firms are looking for a formula of “strong adjusted EBITDA + predictable revenue + diversified clients + scalable operations + growth + low founder dependence” when calculating their valuations.

The MSO Structure: How PE Gets Around Ethics Rules

According to media reports, both Wood Smith and Tyson & Mendes would create managed service organizations (MSOs) as vehicles for the investments. In an MSO arrangement, a law firm’s legal work and its back-office functions are housed in separate business entities. Services that require a lawyer and that are paid through legal fees remain in a traditional law firm. Non-legal and administrative services, like accounting, technology, and marketing, are housed in the MSO. The firm then pays the MSO for the services it provides.

In most U.S. jurisdictions, lawyers are barred from sharing or splitting legal fees with non-lawyers. The American Bar Association’s Model Rule 5.4 holds that “a lawyer or law firm shall not share legal fees with a nonlawyer” and “shall not form a partnership with a nonlawyer if any of the activities of the partnership consist of the practice of law.” As Hunton Andrews Kurth recently wrote, an MSO creates a fee structure that is “defensible under ethics rules” while also allowing an investor “exposure to the economics of operating a legal services provider.”

Hunton noted that an MSO typically charges law firms in a few ways. In one scenario, a single fee may be assessed for all of the lawyers in a firm. In another, fees may differ depending on the practice area, the seniority of the lawyers using services, or the types of services being used. The MSO and law firm may also use a combination of these fees. All of this is set out in a management services agreement, which is signed at the same time the firm and investor form the MSO.

How Law Firms and PE Both Benefit

For law firms, the MSO arrangement allows an infusion of capital that can be used to expand, hire and retain key talent, and pay for critical technology upgrades—a top-of-mind consideration for firm leaders who are attempting to incorporate artificial intelligence tools into their practices. They also retain full ownership and control of their legal practices.

Private equity groups are able to generate predictable cash flow through the ongoing fees MSOs charge, expand profit margins by lowering operating costs, increase revenue by rolling up several firms into a single MSO, and eventually sell an expanded MSO at a higher valuation than their initial investments.

While relatively new to the legal industry, the MSO is a “tried-and-true model that has been used for years in many other types of professional practices (e.g., medical, dental, veterinary),” DLA Piper recently wrote.

Expansion Plans: Why Wood Smith Wants the Money

Insurance companies are well known for keeping a tight rein on legal fees. Billing rates for insurance defense firms tend to be lower than in other corporate defense practice areas and profit margins can be smaller as well. As Pitchbook noted, technology improvements, offshoring services, and centralizing operations in an MSO could be “important potential levers” for improving profitability.

Expanding a firm’s headcount and geographic footprint through new hires and acquisitions is critical to revenue and profit growth as well. Wood Smith appears keen on expansion. According to the Financial Times, the firm told potential investors that it needed private equity capital to take on a flood of new insurance defense work.

Ironically, that work is being caused, in part, by private equity, the firm told investors. As private equity groups and litigation finance companies have invested in personal injury firms, they have “turbocharged personal injury and other liability claims,” the Financial Times said.

Wood Smith is being advised by Riverbrook Capital, a Los Angeles investment bank, in the deal, according to the Financial Times. And Pitchbook reported that the firm has run an auction to attract outside investors in its MSO.

A Signal to Others?

As we have previously written, MSOs are the subject of increasing regulatory scrutiny. In August, Colorado enacted a ban on lawyers sharing legal fees or revenue with nonlawyers or alternative business structures. The state also prohibited lawyers from contracting with an alternative business structure on anything related to legal services, barred lawyers from forming an entity with nonlawyers that provides legal services and made it illegal for a lawyer to practice in a company that a nonlawyer owns or controls.

Illinois also recently barred non-lawyers and non-lawyer-owned entities from interfering with lawyers’ professional judgment, controlling hiring, or accessing client files. The law also imposes limits on fee structures and contractual provisions and requires disclosure of MSO arrangements to clients. Other states are also looking at changes aimed at law firm investment. Those are in addition to Rule 5.4 and other ethics hurdles.

Still, should a deal like Wood Smith’s close, it may provide a meaningful signal that the MSO is a viable workaround for outside investment. To date, PE investors have stuck to smaller and midsize firms. But Big Law is watching closely. Large firms are “taking meetings to learn what their peer firms are doing,” The American Lawyer recently reported. While they have not made deals, if a large firm jumps into the fray, many others will follow. As one expert told the magazine, no firm will want to be first, “but no one wants to be late.”

Whether more firms follow may come down to a single question of balance: Can they take outside money without losing what made them worth investing in—their culture, their client relationships, their lawyers' independence? As the deals get bigger and more firms take the meeting, that question is only getting harder to dodge.

FAQ

What is the Charlesbank–Wood Smith Henning & Berman deal?
Charlesbank Capital Partners reportedly signed a letter of intent for a roughly $700 million stake in Wood Smith Henning & Berman, a 570-lawyer insurance-defense firm — potentially the largest known private equity investment in a U.S. law firm to date.

How does a law firm take private equity investment if non-lawyers can't own law firms?
Through a managed service organization, or MSO. The law firm's legal work stays in a traditional firm owned by lawyers, while back-office functions — accounting, technology, marketing — are housed in a separate entity the investor can own.

Why is private equity interested in insurance defense firms specifically?
Insurance defense work is repeat, institutional-client business paid on hourly or project fees rather than contingency — making revenue more predictable and less dependent on any single partner than plaintiffs' firm work.

Is the MSO structure legal?
It's designed to comply with rules like ABA Model Rule 5.4, which bars lawyers from sharing legal fees with non-lawyers — but it faces growing regulatory scrutiny, including new restrictions in Colorado and Illinois.

Are other law firms considering private equity investment?
Yes. San Diego-based Tyson & Mendes has also been in discussions about PE investment, and larger firms are reportedly "taking meetings" to understand how these deals work, according to The American Lawyer.

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David L. Brown is a legal affairs writer and consultant, who has served as head of editorial at ALM Media, editor-in-chief of The National Law Journal and Legal Times, and executive editor of The American Lawyer. He consults on thought leadership strategy and creates in-depth content for legal industry clients and works closely with Best Law Firms as senior content consultant.