Firm finances are getting a lot more scrutiny this year -- including from potential lateral partners.
In good times, candidates tended to focus more on practice fit and compensation. Now they are asking more specific questions about the financial history, equity levels, borrowing habits and financing plans of the firms they are considering. And they are posing them earlier in the process, hiring partners and recruiters say.
Equity partners, in particular, have a lot at stake. That goes double in troubled times.
Former Heller Ehrman partner Michael Charlson, now at Hogan & Hartson, said he expects he and a number of Heller partners will lose between $400,000 and $500,000 in capital because the firm imploded this fall. On top of that, they won't see any profit distributions that may have come at year's end. The professional, personal and financial dislocation "was huge," Charlson said, and he would not want to repeat it.
So finance questions were at the top of the agenda for Charlson, who said he interviewed with a handful of firms. "I'd be crazy not to ask," he said. "You're making a major investment -- for most people it's the largest except maybe their home -- and the notion that you would do a little due diligence on the firm I don't think is particularly surprising."
Concern among lateral candidates has grown over the course of this year along with the increasingly shrill headlines from Wall Street and around the globe. Jones Day partner Joe Sims, who's been hiring laterals on the West Coast since the summer of 2006, said that he saw a significant shift in attitudes in the early spring of this year, in tandem with the first signs of concern cropping up about Heller and other firms. Through the summer and fall, when the general economy took a sharper turn for the worse, people really started to home in on finances, he said.
"I'm seeing it from everybody," he said. "I don't have a conversation with a potential lateral partner where that subject doesn't come up."
Southern California legal recruiter Valerie Fontaine said it's even more important to bring up now, because firms that didn't appear vulnerable in good times have gone under. "We learned this lesson with Brobeck," she said, referring to the 500-plus-lawyer firm whose fortunes rose and fell with the tech boom and bust before it dissolved in 2003. Fontaine said that her firm, Seltzer Fontaine Beckwith, has always asked clients to provide finance details and counseled candidates to ask whether and how retirement is funded, what the leases are and what the credit line is used for. Most law firm clients have been happy to oblige, she said.
Reed Smith partner Jack Nelson said that a couple of years ago, interviewees asked for a description of the capital requirements and a summary of the firm's borrowing positions, including term debt. Now, candidates want to know more about leases, personal liability and the firm's plans for capital and debt, "something that you rarely heard a couple of years ago," he said. And they want to know that information earlier, long before an offer has been made, Nelson said. Today's laterals seem to be using the information to weed firms out of consideration, rather than to make a final decision on a particular firm.
Pillsbury Winthrop Shaw Pittman Chairman James Rishwain Jr. agreed that in previous years, a firm's overall health wasn't front and center: Candidates tended to focus more on potential earnings, equity buy-ins and bonus structures, Rishwain said in an e-mail.
"But now all candidates, including those who may be coming from troubled firms, are being particularly cautious and delving deeper than ever before to ensure they are joining a firm on solid financial ground," he said.
RED FLAGS
If a law firm is borrowing money to pay draws or to pay partners, "that's serious trouble," said one partner from a recently collapsed firm. If in today's environment, a firm admitted that its profits would be down 5 to 10 percent compared to last year, it wouldn't be an instant kill, that partner said. But if profits were down 20 percent or more, that would be a warning signal, because that's when you'd expect big rainmakers to begin leaving. "Once you're in that psychological bind, more people get scared and more people leave," said the partner who, like some of those interviewed for this story, asked not to be named because of the sensitivity of the subject. "It just spirals."
But even asking all the right questions doesn't guarantee a firm won't end up in trouble years down the line.
One former Heller corporate partner said that when he joined the firm, it had no debt. He was impressed by then-Chairman Barry Levin, viewing him as a forward-thinking leader. The firm had been building a bigger transactional practice to balance against its litigation heft, the partner said.
But the experience highlighted the importance of effective management, which he considered when interviewing with other firms this fall. His new workplace, a global Am Law 100 firm, is run more like a business, he said, in contrast to what he called Heller's "old-fashioned" consensus approach. One weakness he saw was the way Heller worked up to a layoff: The partners had decided that a certain reduction had to be made, but by the time the different "factions" had had their say, the cuts were superficial. Now he asks: "When a firm has to be nimble, can it be nimble?"
Others who have emerged from the rubble of a failed firm say they perhaps err more on the side of caution than the average candidate. One partner formerly with Brobeck said that he learned from that experience that a firm is never too big to fail.
"Brobeck went into a death spiral, where you couldn't cut expenses fast enough as attorneys were leaving and taking business with them," he said. "You just couldn't catch up. And because Brobeck had a lot of debt, the banks took control of the money and Brobeck had no choice but to fail."
He thinks that people are getting smarter on the topic, but believes that he and other partners who survived Brobeck's troubles -- many of whom are still involved in a lawsuit related to the firm's collapse -- are much more cognizant of, and careful about, finances than the average lateral partner. "Unless you've been through it, you really don't understand all the ramifications and the consequences," he said. "It didn't matter if you'd win the bankruptcy lawsuit. The cost of the lawsuit is just extraordinary."
One partner from a recently collapsed firm said that joining a firm as a non-equity partner would have been a "deal breaker" for her 10 years ago. But after losing a lot of money through this recent experience, she considered it "for a minute."
The global Am Law 100 firm she joined this fall inspired confidence because it had already gone through a lot of growth successfully.
She didn't just ask to see balance sheets; the partner also wanted to know where the firm was to date against its budget, including what its inventory was and what part of it was collectible. "Huge inventory that's all going to be written off is not going to do much good," she said. Constrained by time, she and her group only got that far in discussions with "no more than a couple" firms. Had the firms not shared their financials, she said, "after this experience, that would be the end of the discussion."
CUSHIONED FOR A FALL
Compared to the tech-bust era, many firms entered this economic downturn with a stronger balance sheet.
"We saw line borrowings increase year-over-year in the first quarter of 2008," said Cindy Tambourine, a managing director in the Citi Private Bank Law Firm Group. "When, however, you look at the broader trends for the industry, based on our database, you generally have seen industry debt levels decrease and capital levels increase."
As a percent of net income, firm liabilities fell from 19.8 percent in 2000 to 10.6 percent in 2007, based on data Citi collected from 139 law firms. In that same period, capital per equity partner increased, from $137,000 to $252,000, Tambourine said.
Hiring partners willing to comment for this story said they use their financial situation as a selling point with laterals.
Pillsbury's Rishwain, for example, described his firm as having "a low and declining debt level, a strong balance sheet, with robust partner capital in hand."
"We barely touched our revolving credit all year," he said. "Laterals have been voting with their feet by jumping aboard." Pillsbury, with about 800 lawyers, has recruited 20 lateral partners in the last 12 months, including some who came on board in September and October from the now-dissolved Thelen and Heller firms, Rishwain said.
Sims said Jones Day has added about 35 laterals in 2008. The firm has zero debt, he said, and no credit line. "Our partners take home less money than they would if we were more leveraged, but we also have the comfort of not having to answer to any outside lenders," he said. "It's a very attractive point to candidates."
If somebody's goal is to become the richest lawyer in the world, Sims added, they wouldn't come to Jones Day. "We obviously look relatively more attractive in bad times than in good times."
