Leaders of the country’s highest-grossing law firms are ready to put the recession behind them and embrace a cheerful narrative—if only the world economy will play along. In The American Lawyer ‘s 10th annual Law Firm Leaders survey, 75 percent of the 113 participating Am Law 200 managing partners and chairs described themselves as either somewhat or very optimistic with respect to their firms, a slight increase over 73 percent a year ago.
But financial instability in Europe, political and regulatory uncertainty in the United States, and the collapse of debt-laden Dewey & LeBoeuf remind them that the world can be a dangerous place. Seventy-one percent of respondents said they expect the economic recovery in the U.S. to either continue at its current plodding pace or slow down. (Only 29 percent predicted that the recovery would pick up next year.)
“My sense is that a boom wants to happen, which makes me optimistic,” says Proskauer Rose chair Joseph Leccese. “But there are all these macro-level economic issues that are making clients hesitant, and that makes me pessimistic.” Leccese was one of 11 managing partners who were interviewed about the results of the survey, which was conducted from mid-August to mid-October on a confidential basis.
The survey contained 59 questions covering a wide range of topics, including the U.S. and world economies generally, lateral activity, projected hiring by practice area and office, client relations, projected billing rates and profitability levels, discounting, and use of alternate fee structures. Full results are available at americanlawyer.com.
The results of this year’s survey depict an industry that has moved on from the recession—one that has abandoned the large-scale cost cuts and personnel reductions that became commonplace in 2009 and 2010. But in the absence of a clear upswing in the overall economy (and subsequent increase in demand for high-end legal services), leaders of Am Law 200 firms have sought to maintain profitability increases by relying on small-scale tactics, such as capital calls, deequitizations, and increased use of alternative staffing models. “Demand continues to be challenged as business’s appetite for new investments, expansions, and acquisitions remains constrained,” says Jeffrey Stone, cochair of McDermott Will & Emery. “We, like other firms, are trying to find that sweet spot of practice mixes, pricing, staffing levels, and fiscal stability.” Stone highlighted his firm’s increased use of alternative staffing arrangements that include nonpartnership-track attorneys.
In the U.S., the prospect of two more years of divided government has done little, at least initially, to ease uncertainty surrounding deficit reduction, tax rates, and the so-called fiscal cliff. Overseas, meanwhile, there’s likely to be no quick fix to the European debt crisis and China’s economic slowdown. In this slow-growth environment, firm leaders’ small measures are emerging as not only a necessary development to keep balance sheets in line, but also a possibly lasting one.
With market conditions unsettled, many firm leaders say they aren’t counting on a resurgence in transactional and corporate work. Forty-one percent of respondents said they expect their firm’s corporate practice to be their most challenged, a 12 percent increase from a year ago. (Real estate was the second most common answer, at 22 percent.)
“There has been a downward trend in mergers and acquisitions activity, particularly in the second and third quarter of this year,” Stone says. Perkins Coie chair Robert Giles concurs. “One month you have clients talking about an initial public offering, and then the next month they’ll be pulling back,” he says.
Another place where firm leaders see little potential for short-term growth is Europe. Forty-three percent of respondents said they expect the continent’s financial condition to decline further, and 47 percent said they expect it to stay the same. Still, few see pulling out of Europe as a viable option: Only one respondent (who could not be identified because the survey is confidential) said his or her firm plans to close an office there. “The European economy is foundering, and so it’s a less productive setting,” says Ralph Baxter, chair of Orrick, Herrington & Sutcliffe, which has offices in nine European cities. “But it’s mission-critical to be able to service clients in Europe and do cross-border transactions.”
On the bright side, intellectual property work, both litigation and patent prosecutions, continues to be a saving grace for many firms. Respondents pointed to litigation, generally, and IP litigation, in particular, as an anticipated source of increased revenues. Eighty percent said they intend to make lateral additions to their litigation practices in 2013, and 57 percent said they plan to add IP laterals. “Intellectual property litigation is booming,” says John Murphy, chair of Shook, Hardy & Bacon. “There’s uncertainty out there, but our clients, particularly those in software, are as committed as ever to protecting their intellectual property.” Firm leaders interviewed for this article pointed to the recent patent case between Apple Inc. and Samsung Electronics Co. Ltd. over mobile technology as the type of dispute that is playing out across the country, albeit on a smaller scale.
To cope with slack demand outside the litigation and IP spheres, respondents plan to use an array of staffing measures to maximize profitability. Sixty-seven percent of respondents said they had utilized contract attorneys in 2012, and secondments were even more popular, with 77 percent of respondents saying they’d used them in the past year. But firms show little inclination to increase their ranks of full-time associates. Sixty-eight percent of respondents described the size of their first-year class as the same as last year, an increase from 58 percent who gave that answer a year ago. The percentage of respondents who described this year’s first-year class as larger than last year’s declined 8 percentage points, to 21 percent.
Associates have come under increased scrutiny too: Fifty-three percent of respondents said that their firm had implemented a competency model for these lawyers, a 10 percent increase over a year ago. Says Shook Hardy’s Murphy: “We’re having smaller associate classes, and we’re quite comfortable with the quality of candidates we get for contract attorney and staff attorney positions.”
Equity partner rosters are also being constrained. Forty-five percent of respondents said they deequitized partners in 2012 (a 6 percent increase from a year ago), and 46 percent said they plan to do so in 2013 (an 8 percent increase from a year ago). The percentage of managing partners who indicated that they would ask between one and five partners to leave in the coming year remained steady at 55 percent, but there was movement among the smaller number of respondents who said that they would ask between 11 and 20 partners to leave—it rose to 5 percent from 1.2 percent a year ago. “There is less tolerance in the system to carry partners for longer periods of time after their performance has tailed off,” says one firm leader, who asked not to be identified.
For partners who remain, capital calls are part of the new reality. Twenty percent of respondents indicated that their firms made a capital call this year, and 23 percent indicated that their firms would likely make one in 2013. (This was the first year we asked about capital calls, so year-previous comparisons are not available.) One managing partner at a firm that is likely to make a capital call next year says that despite the global economic uncertainty, his firm remains committed to growth through lateral partner additions, and a capital call is the most prudent way to pay for it. This managing partner was no outlier: Despite the uncertainty about demand and growing leeriness about increasing the number of partnership-track associates, 80 percent of respondents predicted that their firm’s total head count would grow in 2013, with 60 percent of respondents forecasting growth of 1–5 percent. (This figure is down from the 2011 survey, in which 89 percent of respondents expected their firm to grow in the upcoming year.)
A majority of respondents (58 percent) said that their firms carry bank debt and other third-party debt, but generally their use of it was conservative. Sixty-six percent of respondents whose firms carried third-party debt said that it totaled $10 million or less, and 78 percent indicated that the debt represented no more than 5 percent of total assets. Thirty-six percent of respondents whose firms carried debt said that they borrowed less in 2012 than in 2011.
Generally, firms appeared to be prudent about their debt. Only three respondents put their firm’s debt at more than 15 percent of total assets. “Even though interest rates are low, there is a general uneasiness in having a significant debt load,” says Bruce McLean, chair of Akin Gump Strauss Hauer & Feld. Several managing partners said that as a result of Dewey & LeBoeuf’s collapse, their partnerships and, especially, potential laterals began to attach greater importance to healthy balance sheets.
But despite the challenges, most respondents said they expect their firms to post increases to their bottom line in 2013. Nearly 32 percent expect partner profits to grow at their firm by more than 5 percent, up from 26 percent who said growth would top 5 percent a year ago. Forty-five percent expect profits to increase by 5 percent or less in 2013. “There’s reason to be cautious, but we are growing,” says Proskauer’s Leccese. “We have some really busy practices, and we expect to be profitable.”