What’s the deal with… IPOs?

If there is one type of corporate work that does not make money straightaway it is initial public offerings (IPOs). Unlike M&A or major litigation, IPOs – listing companies on stock exchanges – rarely make firms much cash.

Instead, a firm will carry out an IPO for a company over the course of several months – or years, if the deal is shelved and reignited – and at the end of the process will have a listed client with the potential to instruct the firm on future, more lucrative deals.

Doing some work and winning a client, after all, is better than doing none, especially in a downturn.

Corporate lawyers largely agree that issuer-side IPO mandates are loss-leaders and questionable earners to start with, even if they complete.

“You make bugger-all money on an IPO,” says one City corporate partner. “IPOs are one of the most strategically important but low-recovery [matters] of the things we do. It’s miserable, but it works for many firms.”

It all comes down to the competitiveness of the legal market, and IPO work is particularly harsh in this regard. Firms are usually asked to tender for IPOs, so partners have a tendency to give ridiculously low quotes to secure these mandates, especially at a time when work is hard to come by.

A large London IPO could cost a magic circle firm between £2m and £4m in hours – the due diligence report can be a sight to behold – but this varies depending on the case. A simple, UK-based company that firms will already understand (a fund manager, for example) will put less of a time burden on lawyers than, say, a Kazakh miner or a gambling company such as Betfair, whose 2010 IPO will have been towards the upper end of the fee spectrum.

The fees that the issuer’s counsel recovers are significantly below this. The competitive nature of the tender process and the potential to win a new client means fixed fees are common on IPOs. Firms will put a cap on fees of between £750,000 and £1.5m, effectively limiting themselves to a work recovery rate of less than 50 per cent and putting them in the red before the deal has even flown. And even after this, firms will often recover only 70 to 80 per cent of the fees they quoted.

Yet firms can give lower quotes still when bidding to win the work. One partner tells of an IPO whereby Clifford Chance is believed to have pitched at £500,000, while Allen & Overy, Herbert Smith and Norton Rose were said to have all asked for less than half of that. The three firms did not comment.

“Corporate partners are under such pressure,” explains one City corporate partner. “Our equity capital markets guys were flat out early last year. Now they’re not entirely overburdened.”

It seems lawyers will do anything to win a client.