Tuesday, September 25, 2012

Legal Industrial Complex Still Struggling with Rising Costs

Parsley Sage Rosemary & Ginsburg llp
“always a reasonable result for a reasonable fee, always”
MEMORANDUM

To:
Management Committee
From:
Mike Marget
Date:
September 25, 2012
Re:
Legal Industrial Complex Still Struggling with Rising Costs

Two big financial institutions, who bank many of the largest US law firms, recently released surveys concerning the financial condition of the Legal Industrial Complex.[i]  While these surveys attract less attention than pronouncements from the Federal Reserve, The American Lawyer magazine makes a big deal out of them, as do most big firm managing partners.

The elite law firm lending units at Wells Fargo and Citi Private Bank surveyed 115 and 176 law firms, respectively.[ii]   Since some firms participate in both surveys, it is not surprising that both banks reached the same conclusion about big firm financial results for the fist six months of 2012:
·         Revenues up
·         Expenses up more than revenues
·         Profits down.

The magazine’s takeaway:  After 4+ years of lawyer headcount reduction, staff layoffs and overhead cost reductions, managers at the Legal Industrial Complex firms are running out of ideas for aligning slow revenue increases with faster escalating expenses.

What’s a law firm manager to do?  Plenty actually, but it will require some out-of-the-box thinking and nimble execution.  I’m indebted to Hal M. Stewart (who I’ve never met), the COO at the mega-firm Chadbourne & Parke LLC, for suggesting a list of technology-centric initiatives in an articlepublished last December.  I’ve tweaked Stewart’s list a bit to emphasize operating efficiency and lawyer productivity improvement opportunities.  Most of these initiatives will improve the bottom line for small and midsize firms, too.

 
applicable to
smaller firms, too?
1.
Back office functions:  outsource or relocate them to lower-cost locations.  (Selective big firms are doing this and the trend is sure to continue.)
√ Absolutely, especially outsourcing
2.
Digitize all incoming mail/Document Management Systems:  improvements in scanning technology and integration with document management systems bring efficiencies to mail distribution and storage-and-retrieval of correspondence; enhanced use of client-matter databases to keep track of all relevant documents, emails, voicemails, PDFs and filings.
 
√ Absolutely,  document management is a big deal
3.
Reduce office rent – “hoteling” and other efforts to reduce office space
Probably Not
 
4.
Workflow automation to streamline client billing process: faster processing of client charges; electronic distribution of pre-bills; email invoice delivery (no mailing of paper invoices); faster processing equals faster collection cycle
√ Absolutely, available through outsourcing
5.
Actionable financial data:  faster, more informative financial reports; client budgeting, especially for fixed fee and contingency matters to gauge profitability
 
√ Absolutely
 
6.
Unified messaging for email/voicemail and lower telecommunications costs:  VOIP (voice-over-Internet protocol) telephone systems; ability to forward voicemail messages and save them (long-term) for retrieval via case-matter database
 
√ Can be accomplished
inexpensively
7.
Social media to recruit associates:  Facebook as a recruiting communications tool.
Probably makes sense
8.
Precedent retrieval/Document assembly: utilize document management systems to store prior work product for prompt retrieval to avoid duplicating prior research or drafting; and utilize form documents integrated with specific case management databases to draft recurring forms (e.g., pleadings; interrogatories; motions).
√ Absolutely, available through  managed
 IT services

Let’s be real.  There is still a lot of work to be done to realize the potential of law firm workplace technology – both in big firms and small/midsize firms. 

Value billing, alternative fee arrangements, contingency fee windfalls and busts aside – at the end of the day there are only 24 hours for lawyers to do what they do – represent current clients, prospect for future clients, and all the other things.  Lawyers (and administrators) need more time for all three. 

Full Disclosure Note:  4L Law Firm Services manages – for small and midsize law firms – all those things given the √ Absolutely references.



[i] “Legal Industrial Complex” is a term applied to the 200 largest US firms identified each year by name in The American Lawyer magazine as having the highest gross revenue.  The published numbers there are mostly about bragging rights – to impress corporate clients and potential lateral candidates (i.e., the richest clients use the richest lawyers).  Although the magazine claims to do extensive due diligence on the numbers, the “real numbers” sometimes get massaged multiple times by managing partners, management committees and image consultants before being given up for publication.  The Wells Fargo and Citi Private Bank surveys, as well as a private one conducted by PricewaterhouseCoopers, provide comprehensive, reliable financial data, useful for peer group comparison purposes because the data for each participating firm is kept confidential. 
[ii] What, you might ask, do these 2 banks get for all the time, expense and trouble of compiling these surveys 4-times a year?  They get a “sit down” with the managing partner of each participating law firm; an excellent time to solidify relationships with their law firm customers and to market themselves to firms who bank elsewhere.

Friday, September 21, 2012

No 4th Quarter Lateral Hiring! (Subject to Exceptions)

Parsley Sage Rosemary & Ginsburg llp
“Always a reasonable result for a reasonable fee, always”
MEMORANDUM

To:
Management Committee
From:
Mike Marget
Date:
September 21, 2012
Re:
No 4th Quarter Lateral Hiring! (Subject to Exceptions)

There is never a bad time to add a lateral partner; especially someone with a big book of business, whose practice fits the firm’s culture, and who will be accretive to the financial bottom line.  However, certain times are better than others – early (in the fiscal year) is much, much better than later.

At a prior firm, we had a rule – no lateral hiring in the 4th quarter.  Being a law firm, there were many exceptions to this rule.  One permitted filling vacancies when short-handed or when special expertise was needed for an active matter.  Another was crafted for the proverbial “lateral too good to” turndown; somebody certain to be snatched up by another firm if we don’t act immediately; the “let’s thank our lucky stars and ignore the calendar” candidate (“L2G2” for too good to…).

The rationale for the 4th quarter lateral hiring freeze is simple arithmetic.  Assume the following:

a)     L2G2 joins New Law Firm (“NLF”) effective October 1, 2012, agreeing to the same 2012 compensation package as at Old Law Firm (“OLF”) – $300,000 annually: monthly draws of $15,000, plus deferred comp of $120,000 payable as a year-end distribution.

b)     L2G2’s October production at NLF is subpar due to transition issues – delays in transferring files, obtaining conflict waivers and the like.[i]

c)      The headhunter’s invoice (15%-to-20% of one year’s compensation) is paid before year-end.

d)     Invoices for October time are issued by mid-November, and then scheduled for payment on a 45-to-60-day cycle by L2G2’s clients.  November time is billed in December.  Little or no revenue is received in 2012 from L2G2’s clients or L2G2’s work on other firm clients. 


 The negative financial impact to NLF’s legacy partners is fairly easy to calculate.  NLF will generate virtually no incremental cash-basis revenue to cover L2G2’s 2012 compensation and the recruitment fee.  As a result, NLF will have roughly $210,000 less net income available to distribute to legacy partners when it comes time to make the year-end distributions.[iii]  The $210,000 “loss” represents the investment NLF is making in L2G2.

cost to NLF
paid by OLF
L2G2 total 2012 comp
 NLF revenue from L2G2 
 $      --0--          

 3 monthly draws
 $       45,000
 $     45,000
 9 months draws
 $    135,000
      135,000
 year-end distribution
         120,000
      120,000
 recruitment fee (15%)
           45,000
 L2G2 2013 Compensation
 
 
 $  300,000
 total expenses
 $    210,000
 $  135,000
 NLF Net Income (Loss)
$ (210,000)

Note:  The financial loss is greater if L2G2 joins NLF with a supporting cast (staff and/or other timekeepers) or if NLF incurs other incremental costs (e.g., higher insurance premiums).[iv]

With any lateral partner candidate – but especially those who must join the firm in the 4th quarter – there are two questions to be answered after due diligence is completed and financial terms and projections made:

1.      Are the partners willing to relinquish current year compensation in exchange for projections of higher earnings in future periods?

2.      If the answer to the first question is “yes”, then how much current year compensation for what magnitude of return?

These two questions will be explored in future Management Committee Memos focused on:
  • Creative accounting[v] for lateral partner investments, and 
  • Financial due diligence/financial projections for potential lateral partners.

[i] Lateral partners invariably assure me they will “hit the ground running;” their initial month’s billable hours will be exceptionally high; all client files will be transferred on Day 1.  It never happens that way. 
[ii] L2G2 worked 9 months of 2012 (January through September) at OLF, but forfeited the accumulated deferred comp by joining NLF.  In order to make up the difference to L2G2, NLF is on the hook for the entire $120,000.  The subject of Making a Lateral Partner “Whole” is discussed at length in a previous Management Committee Memo.
[iii] In an effort to reduce the 2012 “loss,” some law firms might structure L2G2’s compensation so the $120,000 make-whole payment is paid in 2013 against the 2013 budget, rather than as a 2012 payment.  L2G2 might be amenable to this structure – deferring taxable income on $120,000 for a year has some merit assuming tax rates are unlikely to increase.  However, I don’t think this is the best approach.  How to “cover” compensation “hit” to legacy partners will be covered in the promised future “creative accounting for investment in lateral partners” memo.
[iv] Despite the fact I really love footnotes, this is point is too important to bury in one.
[v] Creative lawyering is a good thing.  Creative accounting is a bad thing.  I sometimes find this troubling. 

Thursday, September 20, 2012

Making a Lateral Partner "Whole" for Deferred Comp

Parsley Sage Rosemary & Ginsburg llp
“Always a reasonable result for a reasonable fee, always”
MEMORANDUM

To:
Management Committee
From:
Mike Marget
Date:
September 20, 2012
Re:
Making a Lateral Partner “Whole” – Year-end Distributions

Partners leave “money on the table” when they move from one firm to another. The money in question is deferred compensation – their share of profits for the year over-and-above monthly draws received – which is forfeited when they change firms before the year-end distributions are paid to partners by their Old Law Firm (“OLF”).  No worries though.  When this happens, lateral partners invariably look to New Law Firm (“NLF”) to “make them whole” with respect to the compensation left behind.

The term “year-end distributions” references payments to partners in Year 2 relating to their respective share of the firm’s net income earned in Year 1.  These payments are typically made several weeks or even months after year-end.[i] 

If your law firm intends to hire lateral partners, the earlier in the year you can accomplish this, the better.  “Earlier” means less expense in terms of NLF “make-whole” payments to lateral partners.

If your firm is going to lose partners to lateral hiring, “later” is better.  The longer OLF can hold onto them means (a) more billable hours generating more profits in the current year and (b) departing partners will forfeit more deferred comp which can be used to additionally compensate those who remain at OLF.  Although this incremental money is inconsequential in the long run, short-term it is better than a poke-in-the-eye.  Plus, if the departures can be delayed from say February 28 to April 30, OLF enjoys the knowledge that the poaching firm (NLF) is on the hook for larger make-whole payments, as explained below.

Fact Pattern
1)     “Partner” expects to earn $300,000 from the profits of OLF.
2)     The $300,000 will be paid in the form of 12 monthly draws of $15,000 each ($180,000) and $120,000 in the form of a year-end distribution.
3)     Accordingly, each month Partner is working and “earning” $25,000, of which $15,000 is paid currently and $10,000 is deferred.
4)     The deferred comp earned at OLF does not vest until actually paid, meaning Partner will be reluctant to make a lateral move unless indemnified for all the deferred comp.
5)     OLF (like most firms) pays the year-end distributions days/weeks/months after December 31 and has a partnership agreement provision requiring 30-days notice of withdrawal.

Most law firm’s take their time before paying year-end distributions.  Some time is needed to “close the books” and calculate net income for the year.  Additional time may be required at those firms where the amount of each partner’s year-end distribution must be decided by a compensation review process.  Year-end compensation decisions are time intensive.

Such delays are inevitable, but there also are practical benefits to those law firms who engineer a significant gap between December 31 (year-end) and the later payment date of the year-end distributions.  One such benefit is reduced interest expense.  During the gap period, the firm can utilize the accumulated cash for working capital purposes, postponing the inevitable borrowing from bank lines-of-credit once the year-end distributions are funded. 

Another collateral benefit accrues to those law firms who defer paying the year-end distributions the longest.  Each month of delay means:
A.     For OLF – more money left on the table which will be used to increase compensation for everyone else; and
B.     For NLF – more money must be allocated from its budget to make-whole the lateral partner with respect to the deferred comp left behind at OLF.

A Tale of Two Laterals
There are two law firms.  Let’s call them G&J and JLY.[ii]
·        G&J pays its year-end distributions by January 31. 
·        JLY delays the year-end distributions until the end of March.

As a result, at G&J partners who plan to leave make their intentions known during the first week of February – as soon as the year-end distribution checks clear the bank.  That “whooshing” noise you hear at midnight on February 28th – after the standard 30-day notice period expires – is the revolving door as partners move out of firms like G&J who pay their year-end distributions in January.

The timing is different at JLY.  New partners tend to join JLY laterally earlier in the year, but because JLY delays these distributions until the end of March, JLY partner defections typically commence on April 30.

Assume NLF makes offers to two lateral partners – one from G&J; the other from JLY.  Both earned $300,000 for 2012 (pursuant to the terms set forth in the Fact Pattern box) and agree to accept the same terms from NLF for 2013.  Keeping these lateral partners pari passu with their 2012 compensation package obligates NLF to pay each of them the entire deferred comp amount for the year.  Without this deferred comp indemnity, partners would require some significant other motivation to change firms.

The former G&J partner is able to join NLF on February 28, 2013, after collecting $30,000 from 2 monthly draws from G&J and forfeiting 2 month’s deferred comp ($20,000).  In order to “annualize” the former G&J’s 2013 compensation at $300,000, NLF will pay $270,000 for 10-months’ work – 10 monthly draws of $15,000; plus $120,000 in deferred comp for the year.  ($100,000 of the deferred comp amount accrued while the former G&J partner worked at NLF; $20,000 represents a “make whole” payment for the deferred comp earned but forfeited at G&J.)  In essence, the former G&J partner is costing NLF $27,000 a month for the 10-months’ work in 2013.

lateral from G&J
 monthly
2013
 paid by G&J
 paid by NLF
 # months worked
1
12
2
10
monthly draws
 $      15,000
 $   180,000
 $      30,000
 $   150,000
deferred comp
         10,000
       120,000
                  -  
       100,000
"make whole" pymt
                  -  
                  -  
                  -  
         20,000
Total
 $      25,000
 $   300,000
 $      30,000
 $   270,000
 compensation per month
 $      25,000
 $      15,000
 $      27,000

Meanwhile, the former JLY partner is not available to join NLF until May 1, 2013.  The former JLY partner collected 4 monthly draws totaling $60,000 at JLY and forfeited 4 months’ deferred compensation upon joining NLF.  As a result, to annualize the former JLY partner at $300,000 for 2013, NLF will pay this lateral partner $240,000 for 8-months’ work – 8 monthly draws of $15,000 and the entire $120,000 deferred comp for the year. 

lateral from JLY
 monthly
2013
paid by JLY
paid by NLF
 # months worked
1
12
4
8
monthly draws
 $      15,000
 $   180,000
 $      60,000
 $   120,000
deferred comp
         10,000
       120,000
                  -  
         80,000
"make whole" pymt
                  -  
                  -  
                  -  
         40,000
total
 $      25,000
 $   300,000
 $      60,000
 $   240,000
 compensation per month
 $      25,000
 $      15,000
 $      30,000

Because G&J pays its year-end distributions at the end of January, the make-whole payment by NLF to the former G&J lateral partner is $20,000 and the average monthly compensation for this lateral is $27,000 per month over 10 months. [iii] 
 
The former JLY requires a make-whole payment of $40,000 simply due to how JLY manipulates its year-end distribution funding which delays lateral movement 2 months longer than firms like G&J.  As a result, NLF pays the former JLY lateral partner $30,000 a month over the 8 months of the transition year.

[i] Granted there are firms who pay year-end distribution on or about December 31 each year.  Law firms taxed as corporations pay their bonuses before year-end to avoid double taxation on profits.  There are a few partnerships who similarly like to make these payments between Christmas and New Year’s.  Nevertheless, even in these situations partners rarely announce their intentions to depart until after these payments are made.  So, considering partnership “notice” provisions, delays due to notifying clients and simple good manners, there is usually a 30-day transition period (if not more) between year-end and a lateral move.  That 30-day period represents one month of deferred compensation for the current year which will be “left on the table” when the partner leaves.
[ii] These are real firms and the year-end distribution dates are factual.
[iii] This is $2,000 more monthly than what it cost G&J (see, in the Fact Pattern narrative).  Assuming the former G&L partner receives no increase the following year, the monthly cost to NLF in 2014 reverts back to $25,000 a month.  (Aren’t numbers fun?)