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As this year’s economic drought stretches into midsummer, the technology sector and the IPO market have withered to husks and cash-strapped clients are shuffling law firm bills to the bottom of their in-boxes. “Corporate work has dried up, there’s no doubt about it,” says the managing partner at one of Washington, D.C.’s largest firms. The cash flows couldn’t be thinning at a worse time. Many firms in the past few years, riding the economic boom, expanded aggressively — opening new offices, building out more space, acquiring firms, poaching squads of laterals, all the while handing out larger-than-ever paychecks to associates. And, to finance it all, a number of these firms took on significantly more debt, according to a recent study conducted by Citigroup, the leading lender to U.S. law firms. “We found a substantial increase in the levels of debt” at several of the nation’s largest firms, says Danilo DiPietro, the head of Citigroup’s law firm group. “Capital levels have not risen in proportion to debt,” he adds. The study, which Citigroup has not released to the public, plots debt, income, and capital levels over the last three years at the bank’s 10 largest law firm clients. All are among the country’s 50 highest-grossing firms, and “almost all” are either based in or have substantial offices in the D.C. area, DiPietro says. He declined to be more specific. DiPietro emphasizes that he hasn’t “seen anything that alarms us, in terms of workouts.” But he acknowledges that some firms confront a relatively unforgiving fiscal landscape. “There’s this horrible combination of a downturn in the economy and an upturn in associate salaries,” he says. “There are going to be firms that are able to absorb that better than others.” DEBTORS BEWARE The numbers are significant. Last year, three of the firms surveyed had total “approved debt facilities” of more than $200 million. None of the 10 firms had that much debt exposure three years earlier. The debt facilities include long-term loans for capital improvements, revolving lines of credit that many firms draw upon early in the year to cover operating expenses while collections lag, and letters of credit that firms often have to provide landlords when renting space. In 1997, four firms had more than $100 million in total debt facilities. All 10 firms exceeded that amount by the end of last year. Over the three-year period, debt per equity partner at all 10 firms grew an average of 150 percent, DiPietro says. And growth in paid-in capital now lags behind debt growth. DiPietro says he compared the 10 megafirms to the rest of his group’s portfolio of several hundred firms. “The growth in the largest firms was about three times higher than in midsized and boutique firms,” he says. The large firms that increased their debt loads typically did so to finance high real estate and technology costs, DiPietro explains. Technology is now effectively a recurring, annual expense, he notes. And during the past few years, when many firms sought to rapidly expand their empires, the real estate markets in major metropolitan areas skyrocketed. Beyond rent, “the costs of buildout and the requirements for letters of credit from landlords grew substantially,” DiPietro says. Firms that embraced a strategy of aggressive lateral hiring also found themselves borrowing to cover their new hires’ salaries (and the cost of their headhunters), while waiting for them to actually reel in paying clients. These firms face “expenses for new lawyers for six to nine months before they realize their bills,” DiPietro says. Some firms draw on lines of credit to bridge the gap and, as collections slow, a few firms are digging deeper into their credit lines than in the past. DiPietro says that most of the rising debt at law firms stems from long-term borrowing. That’s the case at Shaw Pittman, according to managing partner Paul Mickey Jr. Shaw Pittman, which has marketed itself as a new-economy firm, added about 100 lawyers and increased its acreage by 52 percent over the past year, Mickey says. It took on space in London, tripled its square-footage in Tysons Corner, Va.; added Washington offices; and contracted for new space in New York and Los Angeles. The firm’s debt level reflects the growth: After holding fairly steady at about $100,000 per partner from 1996 through 2000, Mickey says, the firm’s debt — furnished in large part by Chevy Chase Bank — increased significantly this year. He declines to say how much. Mickey also acknowledges that his firm’s corporate and technology practices are “less frantic than they have been,” although he says that other practice groups are “busier than ever.” Nevertheless, Mickey concedes that some clients “have tended to pay a little more slowly.” And for three of the first six months of this year, partner distributions were, Mickey says, “light.” He stresses that the firm is currently “on budget” for the year. At Holland & Knight, which has been on a campaign of domestic expansion and acquisition, debt has also “inched up” according to L. Kinder Cannon III, the firm’s general counsel. He says debt per lawyer hovered in the low $60,000s in the mid-1990s, and is projected to reach about $80,000 this year. In terms of debt per equity partner, the figure is roughly $200,000. In the face of significant buildout costs in several cities over the past year, the firm, Cannon says, considered making capital calls to partners. Bill McBride, then the firm’s managing partner, ultimately declined to do so, Cannon relates. A larger well of paid-in capital can result in more favorable lending terms, he says. But he adds that Holland & Knight’s capital base is “much more substantial than at many firms.” Hogan & Hartson managing partner Warren Gorrell Jr. is unapologetic about his firm’s debt. “Clearly, our level of borrowings has increased over the last five to 10 years,” he says. “But as a percentage of our gross revenue, it’s fairly consistent … within 1 percentage point of where we were five years ago.” Inasmuch as Hogan’s reputation and financial performance enable the firm “to have expansion financed with very attractively priced long-term debt,” Gorrell says, it makes perfect business sense to do so. THE COST OF DEBT? What impact will higher debt levels have on the region’s — and the country’s — biggest firms? In the near term, many of the firms atop DiPietro’s chart confront a less than ideal situation. They’ve got a sizable debt to service, associates soaking up cash, and — for the moment — corporate wells running dry. Every partner interviewed for this article insisted that his or her firm’s other practice groups have made up for any drop-off in corporate work. (A few firms insisted their corporate lawyers are busier than they were last year.) Cash has therefore kept flowing, they say. And the impact of debt — increased or not — is negligible. Yet the growing number of associates who find themselves job-hunting in the wake of “performance reviews” suggests that some firms, at least, are facing a cash crunch. Whether a significant number of firms will need to dip deep into partner draws remains to be seen. But Shaw Pittman is probably not the only firm that will trim its partners’ checks at some point this year. “Traditionally, that’s one of the risks of being an equity partner,” says Stuart Pape, managing partner at Patton Boggs, noting that his firm’s debt has not “materially” increased. “We’ve gone through such a long period of expansion, a lot of partners have forgotten that that’s part of the bargain.”

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