Managed Services Organizations vs. Alternative Business Structures: Two models for outside investment in law firms

In recent years, investors have shown substantial interest in investing in private professional practices.

These practices – such as medical, dental, veterinary, accounting, and legal – typically have consistent and predictable income, expenses, profitability, and demand.[1]

They are also scalable, albeit on a linear basis. They provide steady and reliable income streams that can be less sensitive to market forces than other types of investments.

For professional practices looking to scale, adopt new technologies, or make other investments in their business, private capital can be an alternative to traditional debt financing. Not surprisingly, the majority of these fields – medical, dental, veterinary, and accounting – have seen a large influx of private capital in recent years.

Law firms in the United States, however, have not experienced the same influx of outside investment. This is, in significant part, attributable to a longstanding patchwork of state laws and rules that prohibit nonlawyer fee-sharing and ownership of law firms, as embodied in ABA Model Rule 5.4.

Although a few jurisdictions have relaxed or are considering relaxing these restrictions, the trend is far from universal, and prohibitions on nonlawyer fee-sharing and ownership of law firms remain the norm in most of the US.

That, however, has not stopped private capital from infiltrating the legal profession. The key is to chart a path for this private capital to invest in, and earn profits from, legal services without violating lawyers’ legal and ethical obligations. In recent years, two approaches have emerged: (1) the Alternative Business Structure (ABS) Law Firm model and (2) the Managed Services Organization (MSO) model.

In this article, we break down these two models and explain why, for many law firms and investors, the MSO model may be the more attractive option.

The ABS Law Firm model

The ABS Law Firm model, at least in its platonic ideal form, is true nonlawyer investment in, and ownership of, law firms. It permits private investors to share directly in fees earned by the firm and gives them a voice in the management of and direction of the firm’s business on a macro level, without impinging on lawyers’ professional judgment or ethical obligations in individual cases.

At present, relatively few US jurisdictions have adopted laws or rules permitting the establishment of ABS Law Firms. Arizona, Utah, and Washington, DC are typically identified as three examples. Puerto Rico recently became a fourth. However, in practice, only Arizona and Puerto Rico come close to the “platonic ideal” described above.

In Washington, DC, nonlawyer ownership is limited to an “individual nonlawyer who performs professional services which assist the organization in providing legal services to clients.” D.C. Rule 5.4(b). This restriction “does not permit an individual or entity to acquire all or any part of the ownership of a law partnership or other form of law practice organization for investment or other purposes.” D.C. Rule 5.4(b), cmt. 8.

In Utah, to obtain regulatory approval to become an ABS Law Firm, the firm must demonstrate that outside investment “will allow it to reach Utah consumers currently underserved by the legal market” and that “the impact on Utah consumers [will] be substantial relative to the entity’s overall reach.” Utah Supreme Court, Letter to Utah Legal Services Innovation Committee, Sep. 5, 2024. This restriction excludes most law firms from ABS eligibility.

In Arizona and Puerto Rico, an ABS Law Firm is, in essence, a fully authorized nonlawyer‑owned law firm, licensed through a detailed application process.

Arizona’s ABS Law Firm structure permits:

1. Direct equity investment by nonlawyers into the law firm entity itself, with investors sharing in firm profits as owners

2. Integrated control and alignment between business leadership and legal operations within a single entity, subject to robust regulatory oversight

Puerto Rico’s ABS Model is similar, but slightly more limited: It prohibits nonlawyer owners from acquiring more than 49 percent of a law firm, and it prohibits nonlawyer investors from providing any services other than investment dollars to the law firm. Puerto Rico Rule 5.4(b).

By all accounts, ABS Law Firms in Arizona are finding success, with new ABS Law Firms emerging on a regular basis. It’s too early to say whether the same will be true in Puerto Rico.

The MSO Model

The MSO (two-company) model, in contrast to the ABS Law Firm model, is not true nonlawyer ownership of law firms. Rather, it carves out the nonlegal parts of a law firm and channels outside investment into those parts only. This allows some nonlawyer investment in and ownership of law firm operations without running afoul of state laws and rules regarding fee sharing and law firm ownership. It is a tried-and-true model that has been used for years in many other types of professional practices (e.g., medical, dental, veterinary).

To adopt the MSO model, a law firm restructures into two entities. One entity, the “core” law firm, continues to be owned entirely by lawyers and exclusively practices law and receives legal fees. Another entity, the MSO, is owned by investors, entrepreneurs, or others (lawyers or nonlawyers), and absorbs essentially all of the nonlegal business infrastructure previously handled by the law firm.

The core law firm:

• Is a traditional law firm under the relevant jurisdiction’s rules
• Is owned exclusively by lawyers
• Is solely responsible for the practice of law and all professional-judgment decisions
• Receives and retains all fees earned from the lawyers’ practice

The MSO:

• Aggregates and provides all “back‑office” and operational functions, including technology development, information technology (IT) services, marketing and lead generation, office space, equipment and tech leasing, human resources, staffing, finance, and accounting
  
  
• Owns and licenses to the law firm critical intellectual property, including software and the trade name under which the firm practices
  
  
• Is compensated by the core law firm via arm’s‑length, market‑based service fees, which are structured not to constitute prohibited fee‑sharing or nonlawyer ownership of the firm

The key to ethical compliance is the services agreement between the law firm and the MSO. Properly structured and operated, that agreement:

• Avoids fee‑sharing by ensuring the MSO’s compensation is not tied to the law firm’s fees, revenues, or profits, but is instead a “reasonable” market price for the services delivered – akin to any other third‑party vendor arrangement
  
  
• Preserves lawyer independence by giving the MSO no contractual right to control legal judgment, client selection, case strategy, or settlement decisions
  
  
• Maintains real corporate and operational separation between the law firm and the MSO, with distinct governance, financials, and personnel structures

In practice, MSOs in the legal market increasingly act as platforms that “collect” law firms, acquiring or building the back‑office infrastructure of multiple firms without merging their legal entities.

This is directly analogous to long‑established models in medicine, dentistry, and veterinary practices, where management companies or MSOs sit alongside professional entities to navigate corporate‑practice‑of‑medicine and fee‑sharing restrictions.

ABS or MSO?

An assessment of the pros and cons between the ABS Law Firm and the MSO models suggests the MSO model may be preferable for most investors and most investments.

The principal benefit of an ABS Law Firm over an MSO is that it allows investors to share directly in the law firm’s profits and to have a voice in management decisions. This is a key pro over the MSO model, which segregates legal fees and law firm management decisions from outside investors. Investors in an ABS Law Firm can participate in the firm’s upside if it has a profitable year, and they may have more say in the firm’s strategic direction than MSO investors.

However, this pro of the ABS Law Firm model also comes with a drawback. ABA Formal Opinion 91‑360 provides that a nonlawyer‑owned firm lawfully organized in one jurisdiction cannot maintain a “branch office” or otherwise operate as a firm in jurisdictions that prohibit nonlawyer ownership. Thus, an ABS Law Firm formed in Arizona or Puerto Rico cannot have offices or lawyers based in jurisdictions that follow the ABA Model Rules (which are the majority).

Some lawyers have attempted to work around this prohibition. For example, one common suggestion is to use referral relationships and referral fees to allow for fee sharing while keeping an arms’ length distance between the ABS Law Firm and firms operating in other states. But these strategies face significant practical challenges, and some jurisdictions are actively taking steps to foreclose them.

For example, California’s legislature recently passed AB 931, which provides that “[n]o attorney licensed or otherwise authorized to practice in [California] shall share legal fees directly or indirectly with an out-of-state alternative business structure[,] unless” the attorney is also licensed in the state where the ABS Law Firm is approved and the fees are compensation for the provision of legal services in that state. (Emphases added.)

In other words, AB 931 effectively forecloses ABS Law Firms from having any sort of financial relationship with lawyers or law firms in California – one of the US’s largest legal markets.

Meanwhile, the MSO model, as opposed to the ABS Law Firm model, can work anywhere. Because the core law firm in the MSO model remains a traditional, lawyer‑owned professional entity that does not share its fees with the MSO, it is widely understood not to run afoul of Rule 5.4(d), and therefore more easily accommodates law firms operating outside of – or looking to operate outside of – the handful of jurisdictions that allow ABS Law Firms.

The MSO model does not limit law firms’ growth potential, and it opens up a larger field of potential investment opportunities. Until the ABS Law Firm model is more widely adopted, the MSO model’s flexibility on location is a significant benefit.

Additionally, because the MSO operates as a vendor, it can be scaled independently from the law firm(s) from whence it came. It can grow to serve multiple law firms across multiple states – just as outsourced IT providers, e‑discovery vendors, and staffing companies already do today.

This sort of resource-pooling can confer benefits on law firms in the form of economies of scale, improved technology and tools, and greater staff specialization and professionalization than certain law firms might be able to facilitate on their own. An MSO may also be able to grow in size – by entering into service relationships with additional law firms – faster than a traditional law firm (or an ABS Law Firm) can grow its size by increasing lawyer head count and/or attracting new clients.

The main challenge of the MSO model is enabling investors to benefit from the core law firm’s profitability without violating fee-sharing rules. Indeed, it’s the restriction on fee-sharing that makes the MSO model necessary in the first place. This limitation may in some situations make the ABS Law Firm model more suitable. However, while there is currently no clear “one-size-fits-all” solution to this problem, bespoke fee arrangements for MSOs can be (and have been) implemented). Until the ABS Law Firm model is allowed in more jurisdictions, the MSO model could be a more practical option with greater growth potential.

Conclusion

Currently, neither the ABS Law Firm model nor the MSO model is a perfect solution to the challenge of facilitating nonlawyer ownership of law firms. The ABS Law Firm model has desirable attributes, but its present geographic limitations make it unsuitable for many US law firms. Unless and until the ABS Law Firm model is adopted in more jurisdictions, the MSO model may be the structure of choice for nonlawyers to invest in law firm businesses.

For more information, please contact the authors.

^{[1] Law firms operating on a contingency-fee model are, in some cases, an exception.}