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About a year ago, gloom-and-doomers were predicting that astronomical associate salary increases would drive some law firms to an early grave. Well, firms aren’t dead yet, despite a slipping economy. Instead, most of Atlanta’s Daily Report Dozen had yet another bang-up year in 2000. Revenue growth averaged 15 percent, and net income was up 10 percent. Though profit margins dropped — indicating the firms are spending more on expenses such as associate pay — equity partners’ compensation rose more than $37,000 on average. The secret to an economic phenomenon that could be described as a shopper’s dream — spend more money and keep more money at the same time — is leverage. Leverage is the ratio of a firm’s total lawyers to its equity partners. Go ahead. Suppress that yawn. Leverage might sound stodgy, but when it comes to law firm finances, leverage is the leggy brunette in the short red dress. There’s no question about it. Leverage is sexy. Why? Because it’s the key to equity partners’ profits. After years of relatively low leverage — especially compared to their New York counterparts — some Atlanta firms finally are getting wise to the power of that ratio. They’re increasing the number of nonequity worker-bee lawyers while letting fewer and fewer into the ranks of equity partnership. In short, this means those lucky enough to share in law firm ownership make more money. Troutman Sanders provides a $100,000-plus example of what leverage can do. First, keep in mind that, like many Atlanta firms, Troutman was blindsided by the market increases in associate salaries. All its associates got a $15,000 raise in 2000. Multiply that by 143 associates and you’ve got a $2.145 million tab. But the extra digits on associate paychecks didn’t reduce partners’ profits. Now for a little historical perspective on leverage. Back in 1996, Troutman had 196 lawyers and 90 equity partners. In 2000, it had nearly 100 more lawyers and one fewer equity partner. (Hang in there, the sex appeal is coming.) In 1996, equity partners’ profits averaged about $317,000. In 2000, they were nearly $388,000. If leverage had stayed the same, the firm would have had about 40 more equity partners. Because more equities would have split profits — even with higher net income — they’d all have earned less money — $267,442. So here’s the sexy part. Troutman’s higher leverage helped its partners get, theoretically, about a $120,000 raise that wouldn’t have been theirs if the firm had maintained its leverage of five years ago. Law firms finally have become smart, says Charles J. Santangelo, a director at legal consulting firm Hildebrandt International in Naples, Fla. “To try to make the kinds of increases that some law firms earn, or to raise profit per partner, really is not practical in most practice areas,” he says. The only way to earn more than your billing rate, multiplied by the number of hours you bill, multiplied by your realization rate, according to Santangelo, is leverage. For example, he says, it’s virtually impossible for the average equity partner to earn $600,000 without leverage. The person might bill 2,000 hours at $400 an hour for a total of $800,000. But before the partner gets paid, expenses for support staff, liability insurance, rent, utilities and benefits will eat away more than $200,000 of that, he says. So, leverage to the rescue. Enter the leggy brunette. Low-paid associates (granted, that’s a relative term in this environment of $100,000 to $120,000 first-years) bill lots of hours. After expenses and their salaries are paid, equity partners get the rest, ideally about one-third of associates’ gross earnings for the firm, Santangelo says. The more nonequity lawyers a firm can keep busy, the higher its equity partners’ profits can rise. Since 1995, leverage at six of the top 12 law firms in Atlanta — King & Spalding; Alston & Bird; Kilpatrick Stockton; Sutherland Asbill & Brennan; Troutman Sanders; and Long Aldridge & Norman — has increased by about one lawyer per equity partner. On average, leverage for these six firms rose from 2.41 to 3.38. At Morris, Manning & Martin, leverage rose by slightly more than one — from 2.44 to 3.45 — just between 1999 and 2000. “A move of one in your leverage is a very big move,” says Peter D. Zeughauser, an attorney and founder of ClientFocus, a law firm consulting company in Newport Beach, Calif. “It’s a great way to drive profits if you’ve got the work.” A STRONG PULSE Also, he says, it’s a sign that law firms are very healthy. In 2000, Morris Manning’s equity partner profit was the poster child for law firm health. Equity profits rose nearly $146,000 — the highest increase ever in the Daily Report Dozen — to an impressive $625,000. The firm’s managing partner, Robert E. Saudek, credits leverage with propelling that increase. If leverage had stayed the same, instead of rising by a factor of one in the course of just a year, equity profits wouldn’t have skyrocketed in 2000. Instead, they’d have fallen by more than $35,000 from 1999 levels. Of course, if you’re an associate, rising leverage has a decidedly unsexy mien. “The criteria for admission to equity partnership in this country have gotten stiffer and stiffer and stiffer and are being more rigidly applied,” says Hildebrandt’s Santangelo. Neither he nor any of the other consultants could supply statistics on how much harder it is to make equity partner. Those numbers vary from firm to firm, and firms don’t like to talk about them, they say. If firms say, and some do, that it’s not harder to make equity partner, “They’re not being honest with you,” says Ezra Tom Clark Jr., president of law firm consulting company E.T. Clark Inc. in Mesa, Ariz. “It’s a lot harder to become a partner today.” Firms have begun offering the thin bone of nonequity partnership to those who aren’t thrown an ownership share. But, says Clark, “That’s not really a partner. They don’t share in the profits, they don’t buy in … . They don’t have a vote. They’re glorified associates.” Though rising leverage that propels partner profits may be a smart business decision, it has some potential drawbacks. Associate loyalty, perhaps not at its peak even now, may dwindle further as partnership possibilities recede. And an economic downturn may mean firms have extra associates knocking around with little to do. To be sure, leverage doesn’t always rise. Last year, Long Aldridge & Norman, which for years has had the highest ratio of lawyers to equity partners in the Daily Report Dozen, dropped its leverage from 5.16 to 3.45. To keep it at the 5.16 level, the firm would have been forced to cut three partners from already sparse ranks because its headcount dropped from 160 to 145. Instead, Long Aldridge added 11 equity partners for a total of 42. The firm’s president and chief operating officer, Jeffrey K. Haidet, says the increase wasn’t to stem attrition among associates and nonequity partners who’d lost hope of gaining an ownership share. “As I recall, we just had an inordinate number of people who came up. We don’t have a certain formula [for partnership],” he says. If the firm had maintained its 5.16 leverage, however, its equities could have taken home more than $678,500 on average. The new, expanded equity ranks still did well, however. They earned $452,381, about $33,000 more than a year prior. The trend at most big firms is to raise leverage, and according to Santangelo, higher leverage signals that there’s work available to keep associates busy. “Now we’re seeing some of that soften. Bonuses are being withdrawn,” he says. The marquee example is Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, the California firm that in late 1999 started a national trend by raising associate pay 30 percent and offering a guaranteed $20,000 bonus. Earlier this month, however, Gunderson cancelled that bonus, effectively cutting salaries. LETTING GO Other firms around the country are quietly or not so quietly laying off lawyers. The Atlanta office of Lord Bissell & Brook shed four of its 15 associates in April. In January and February Arter & Hadden asked 16 partners and associates to leave its Los Angeles office, and New York-based Dewey Ballantine gave pink slips to 17 associates, according to Corporate Counsel magazine. “You wouldn’t know it, but there’s almost no firm that hasn’t done some layoffs,” says Thomas S. Clay, managing director of legal consulting firm Altman Weil Inc. in Newtown Square, Pa. How it all plays out for Atlanta’s ever more highly leveraged firms is anybody’s guess. Santangelo says that for firms in general, it’ll come down to culture: “Some firms will gird themselves and experience diminished profits per partner and other firms will go through the place with a meat axe.” Santangelo says Hildebrandt warns clients considering layoffs not to cut too deeply. Replacing lawyers costs $200,000 to $250,000, he says, and when business picks up again they may have to break the bank just to rehire. “In my opinion,” says Altman Weil’s Clay, “there’s less risk in having too many associates. They’re easier to fire than partners.” Santangelo, too, is unapologetic about the economic bonuses of leverage. “We can’t continue to admit everyone to the sanctum sanctorum because it dilutes profits,” he says. And at some firms, those who’ve already entered the sanctum sanctorum may find themselves once again outside the pearly gates. Wyck A. Knox Jr., chairman of Kilpatrick Stockton, confirmed that in 1999, the executive committee took on the authority to change partners’ status from equity to nonequity. In 1999, the firm had 157 equity partners. In 2000, though its overall headcount grew, its number of equity partners fell to 138. The firm’s managing partner, William H. Brewster, did not return calls about this issue, but a current partner who asked not to be named says that though he doesn’t see Kilpatrick’s rising leverage as part of a purposeful design to raise partners’ pay, it can’t be ignored. To illustrate: Leverage rose from 2.59 to 3.35 last year at Kilpatrick, the equivalent of about half a lawyer for each equity partner. If leverage had stayed the same, partners’ pay would have dropped by about $63,000 from 1999 levels. Instead, their profits grew by about $25,500 to $394,928. Behold, the power of leverage — sexier than you thought. Staff reporter Julia D. Gray contributed to this story.

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