December 15, 2008
Selling BigLaw Short
[by Bill Henderson, cross-posted to the ELS Blog]
It is mid-December and the vast majority of large law firms are frantically pressing their clients for their fees in order to pay down the firm's credit lines and generate a profit pool that can hold the partnership together. See, e.g., Susan Beck, Collecting, But Hardly Calm and Cool, Am Law Daily (Dec. 10, 2008). Every investor knows that leverage can be a wonderful thing in boom times but a killer in a down market. In the last few years, law firms have expanded the use of two types of leverage: (1) bank financing, often for working capital, and (2) salaried lawyers, in the form of contract attorneys, staff attorneys, associates, of counsel, and income partners, who each generate profits for the equity partners.
Yet, with the potential for historically low collection rates, a large proportion of Biglaw firms are in one hell of a vise. Salaried lawyers represent fixed costs. And even if you lay them off, managers are under intense pressure to pay a reasonable severance (e.g., 6 months pay) to preserve the firm's reputation for an eventual recovery. Further, firms with the most human capital leverage will nonetheless be stuck with vast expanses of Class A office space under lease terms negotiated during the salad days. If Biglaw revenues go down 20% for the fiscal year, which is certainly in the realm of possibility for many firms with large capital market practices, profits could dive by 50% or more.
Similar to what happened at Heller Ehrman, the grim financials could put the firms in violation of their bank lending agreements, see Drew Combs, Why Heller Died, The American Lawyer (Nov. 2009), thus requiring partners to pony up more cash. Sensing trouble, lawyers with the most options start heading for the doors, initiating a sudden and rapid death spiral. In short, there is good chance that several hallowed Biglaw firms, particularly those with weak balance sheets, will cease to exist sometime in early to mid 2009.
Through the Law Firms Working Group,
I have access to detailed financial reports for law firms in the Am Law
200 and the NLJ 250. Here is what the revenues per lawyer (RPL)
figures for Thelen and Heller Ehrman looked like for fiscal years 2003
Most firms in the Am Law 200 posted steady rises in RPL during the 2003 to 2007 time period. But it is pretty amazing that in the cases of Thelen and Heller Ehrman, both old-line firms with established brands, seemingly modest diminutions in revenues were precurors to total collapse. As noted by Marc Galanter and I in The Elastic Tournament, large law firms have become immensely fragile institutions. As large firm lawyers, many of them young and connected to clients, flood the streets over the next several months, look for a new model of corporate law practice to emerge that is modest, thrifty, and more sustainable.
Closer to home for us academics, the collapse of Biglaw could have a signficant impact on law schools, particularly those at the top of the food chain who could pass along ever higher debt loads onto students because of a virtual lock on lucrative Biglaw jobs. Cf. Mike Cahill, Legal Education Bubble?, PrawfsBlawg (Dec. 15, 2008). Even if law school follows the usual countercyclical pattern of higher admission volumes, the lack of cheap capital in combination with the lack of high paying jobs may stifle enrollment. It is time to pay attention and carefully evaluate assumptions we have formerly taken for granted.
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People will still make money in the law, even without biglaw. I had $70k in debt back in 1988 (equivalent of at least $100k today), and worked for government for 2 years, and a firm for 3 before I went solo. But I paid my debt off on time with only a 3 month deferral.
By the way, law firms SHOULD leverage - but they should do it the way solos do it -
Posted by: Carolyn Elefant | Dec 23, 2008 6:35:48 AM
Professor Henderson you hit the nail right on the head! I have been working in and consulting for the legal profession for twenty years. I have written many articles and maintain my own blog aobut AR and financial management. In the past 20 years, after visiting over 200 firms domestically and internationally, I can honestly say, less than 5 are run like real businesses. I have no idea to make change.
Posted by: Don Downey | Dec 28, 2008 12:34:22 PM