The caliber of law firms that have failed in recent years is staggering and includes the likes of Brobeck Phleger & Harrison; Heller Ehrman; Thacher Proffitt & Wood; Wolf Block; Howrey; and now, Dewey & LeBoeuf. As I worked with many of these firms earlier in my career, either as a GC or while in private practice, their ultimate fate is not something I foresaw at those times. All of these firms were justifiably renowned for their outstanding lawyers and seemed to be well-positioned for the long term.
So, what triggered their downfalls? In some respects, outsiders will never know all the particular reasons for a specific firm’s demise, as some answers will go to the grave with former partners. However, the decline and fall of those firms, and others, has made it increasingly apparent that there are some common factors that “legal coroners” have cited as key contributing causes to the deaths of these firms.
In this column, I will analyze the most prevalent factors. In trying to assess where your firm may stand as to its future, it is important to note that there is no perfect firm. Thus, even if a factor or two exists in your firm today, it may not mean that your firm faces imminent demise. It often depends on how deeply rooted the problems may be and how toxic the combination is.
On the other hand, when the issues have become glaring, lawyers in firms should not delude themselves by wistfully remembering the good days and thus hoping that a miraculous cure will surface. Absent aggressive remedial measures, such reversals rarely occur. To paraphrase a movie title from the ’90s, there are some “dead firms walking,” and it is just a matter of time until they join the ranks of the departed.
Not surprisingly, lack of financial health is almost always cited as a cause of death. The actual financial strength of a firm is not often truly known to outsiders, even among those firms that are included in the annual Am Law surveys. The reason for that is that there are quite a few critical factors that are only known within a firm (or perhaps to its lenders), that are far more important than how high the firm’s PPP may be. These include:
• Assessing whether the firm has been able to maintain, or hopefully, increase its profit margin. The recession has required firms to focus hard on the expense side, but, at some point, there is a limit to what can be done in that regard. If margins start to slip, it is often difficult to reverse the trend and can become quite troubling.
• Gauging how much cash a firm has on hand at various times during the year. As we have seen with the fall of some of these law firms, things can spiral out of control very quickly. Having adequate cash reserves can stanch the bleeding — without them, a wound may prove to be fatal.
• Weighing whether a firm is adequately capitalized. Not all firms have capital accounts, and this is especially the case for many that are organized as corporations. This may present some distinct advantages for those firms, but, for many, being well capitalized provides important security and can lessen the need to go too deeply into a line of credit. The key is whether the capital structure fits the culture of the firm. In some this may entail increasing the amount requested from equity partners, while in others, it may require reshaping a program that is too (or not enough) egalitarian.
• Examining a firm’s noteworthy obligations. While a de minimis judgment is of no concern, hefty verdicts or pending matters that are underinsured may pose major risks to a firm’s future. Similarly, major obligations to retired partners, especially if they are unfunded, may be a cause for alarm. Lease obligations have risen to the fore today, as violations of covenants are not as easily overlooked as in the past. It thus has become increasingly important to assess just how good a firm’s lease may be in a key market.
• Critically evaluating the lawyers’ productivity. It is in this area that the proverbial rubber meets the road and one rarely, if ever, sees firms ranked in this realm, as the data are not disclosed. Key items in this respect that reflect on how well a firm is doing include whether: 1) billable hours have started to increase now that the economy is beginning its tepid recovery; 2) time is promptly being entered, with bills consistently being sent in a timely fashion; and 3) bills are being paid promptly, with a resultant diminution in accounts receivables turns.
• Analyzing how prudently a firm is utilizing its line(s) of credit. It is typical to go into a line early in the fiscal year, especially if a lot of one-time charges are due, but is your firm going in much deeper than in the past? More importantly, is your firm using its line to pay salaries or bonuses? An affirmative answer to the latter question should trigger alarms.
Human capital is the lifeblood of professional services organizations and law firms are no exception. The quality and character of the lawyers in a firm weigh heavily in analyzing its prospects. As we have seen in recent years, a significant spate of partner defections has often led to the downfall of a firm. When firms start losing more partners than they take in, particularly when the magnitude of the losses outweighs the value of what is brought in, trouble is frequently looming.
An important caveat is offered here, as merely tabulating the net total of lateral partner moves does not tell the true story. Personal experience has shown, many times over, that there are some prodigious rainmakers, who have escaped notice outside of their firms, as to the size of their books, and have moved with little or no fanfare. Conversely, there are frequently more ballyhooed partners, who have received considerable coverage of their exits, even though the size of their practices pales in comparison to their reputations in the legal community.
It thus can be difficult for outsiders to truly know how telling a departure may be. Lawyers in a former partner’s firm often will know how critical the loss is if they are truly being honest. Some firms suffer from rationalizing how every departure is not a loss and such a mindset can be crippling. I do offer one insight and that is to pay attention to large group moves. When lawyers move in groups, it normally signals that the team is cohesive and typically increases the odds that most or virtually all of their hoped-for work will actually follow them. Acquirers of large groups conduct heavy duty due diligence today, so, when large groups are brought in, it almost always is done with considerable care. As such, absent extenuating circumstances (such as conflicts or an important strategic change in a firm), a series of large group departures is often a crucial warning sign of danger ahead for a firm.
A somewhat related issue is for lawyers in a firm to critically assess whether their organization is successfully luring a high percentage of the attractive partners (and groups) that it is trying to land. Current laterals have become much more incisive in examining firms, and their assessments provide crucial, real-world evaluations as to how a firm stands in the market. While there will always be deals that become too expensive, or others that shouldn’t be made because of a range of factors, there are many others that a firm badly wants (and needs).
If your firm keeps missing on those deals and is left at the altar, this is cause for concern. In a perfect world, laterals would not be needed if more work and new clients keep flowing in and new generations of rainmakers keep coming up through internal ranks.That perfect world just doesn’t exist, which has made laterals an important piece of the puzzle for firms. If your firm is not getting the stars it has been in the hunt to acquire, and has been relegated to competing for B and C players, this is a major problem.
Finally, the positioning of a firm and how strategic it is help to separate long-term survivors from those that become imperiled. For example, although bigger is not necessarily better, it is vital that a firm continues to grow, whether that takes the form of adding lawyers, offices or new practice areas. Neither life nor business is static, and firms that ultimately fail have often been victimized by adhering too strongly to the mantra of “this is how we have always done it,” and by not adapting to changing conditions.
Leadership is vital in this realm and is becoming increasingly important today. A lateral’s view offers just one glimpse into how a firm’s leader is perceived, but, for the reasons noted, it is a critical one. While there are a lot of factors that determine which firm a lateral picks, the assessment of a firm’s leader is weighed much heavier than most. Firms that don’t appreciate this, and just turn leadership over to the next best person who wants it — or worse — to the person who is the least objectionable, pay dearly for that if the leader does not do well in recruiting or when he or she is in the public eye.
Excellent leaders are not intimidated by stars in their firms. In fact, outstanding leaders seek to hire, develop and reward lawyers who may be better than them or shine in other respects. Firms in which leaders desperately fight to hang on to power, quell rising stars and fail to put well-reasoned succession plans in place are much more likely to be on the endangered list. This last point is especially vital, as, without an established and supported succession plan in place, it can often prevent many partners from truly wanting to dig in for the future with that firm.
Strong leaders also help to move firms forward by not simply maintaining the status quo. Diversification, for example, is often quite important, and it may take the form of ensuring that a firm is not too narrow with respect to its practice areas, markets in which it operates, or breadth of rainmakers, especially from a demographic perspective. There are some exceptions here, such as labor and employment and intellectual property boutiques that have limited practice areas, but even those firms need a diverse group of rainmakers. Rank and file partners, and even many on management teams, often do not have the time or inclination to ensure that this diversification is accomplished. Strong leaders keep these goals in mind and the great ones push their firms to actually accomplish them.
This is, by no means, an exhaustive list, but the factors discussed here are the most prevalent ones I have seen in play. Experience has shown that when firms start to slip in one or more of these areas, especially if that slide is a steep one, the road back is often far too precipitous to navigate. •
Frank Michael D’Amore is the founder of Attorney CareerCatalysts , a Pennsylvania basedl egal recruiting and consulting firm that focuses on law firm mergers and partner placements. He is a former partner in an Am Law 200 firm, general counsel in privately held and publicly traded companies, and vice president of business development. He can be reached at email@example.com.