Selling BigLaw Short

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. 2008), 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 to 2007:

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.

Comments

[raivo pommer -eesti.]

Die Auftragslage im Geschäft mit Lastwagen hat sich weiter verschlechtert. Vorstandsvorsitzender Hakan Samuelsson hat auf der Hauptversammlung der MAN ein düstereres Bild gezeichnet als noch vor sechs Wochen. Der Absatz werde um mehr als die Hälfte gegenüber dem Vorjahr und damit auf weniger als 50.000 Fahrzeuge zurückfallen, sagte er. Damit werden die Kapazitäten noch stärker gekappt: Die in eine SE umgewandelte MAN weitet die Kurzarbeit auf das zweite Halbjahr deutlich aus. Mit den Belegschaftsvertretern im Werk Salzgitter ist nach Informationen der F.A.Z. gerade vereinbart worden, im zweiten Halbjahr die Produktion von zwei Schichten auf eine Schicht zurückzufahren. Außerdem soll es - statt bislang einen Tag - zwei Schließtage geben. Somit wird die Fertigung um mehr als die Hälfte gegenüber 2008 zurückgefahren, als das Werk Salzgitter mit 20.000 Einheiten noch voll ausgelastet war.

[raivo pommer -eesti.]

Der Konsumgüterhersteller Henkel bekommt die Folgen der Rezession immer stärker zu spüren - besonders in der Klebstoffsparte. Henkel meldete am Donnerstag überraschend, dass das Betriebsergebnis (Ebit) im ersten Quartal auf 215 Millionen Euro gesunken ist - dies entspricht einem Rückgang von 33 Prozent gegenüber dem Vorjahr. Der Grund: das schlechte Geschäft in der Klebstoffsparte zum Jahresbeginn 2009.

Analysten sprechen von einem „Desaster“ in der Sparte und bewerten die Zahlen als Gewinnwarnung. Eigentlich hatte Henkel erst für den 6. Mai Unternehmens-Zahlen angekündigt.

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[Matt]

Why are we assuming that the slight decrease in FY2007 did precipitate the collapse?

The events of FY2008 are probably far more significant, right? It may be that the firms were doing fine in 07, but were very fragile.

[Karl Marx]

If profits per partner dive 50% for a year or two, why is that a tragedy? Partners who are making $2 million now make $1 million? It is still a profit, and a significant one. Perhaps the new model should be one where partners just make less than the obscene profits they are used to, but still make a pretty damn good living.

[Thomas MacEntee]

A former Heller Ehrman staffer here and author of the Heller Highwater blog. After working in BigLaw for 20+ years, here's my take on where BigLaw needs to be in the next five years:

- more virtualization
- more telecommuting
- follow the Accenture model and dump the fancy offices
- lower billing rates but keep more of what you bill
- embrace technology including social media, cloud computing

[Amos W Omolo]

Law firms need to develop a new business model and embrace cooperation rather than competive rivalry. In Kenya competitive rivalry is making the industry and no profit zone.

I have been conducting training to bring change but the pace is slow here in Kenya.