That prediction comes from the latest report issued by Hildebrandt International, which examines the reasons that law firms fail. “Recognizing that the legal market is continuing to segment, we expect that we will continue to see a steady number of both mergers and dissolutions, even after the recovery from the current economic downturn,” the report reads.
The report isn’t all doom and gloom, though. It concludes that firms tend to fail for several specific reasons, and dissolution can be avoided if leaders are able to recognize those problems early on.
“The seeds of most law firm failures are sown long before the actual dissolutions,” the report reads. “In our experience, early diagnosis and action can usually prevent the fundamental flaws . . . from deteriorating into full-blown law firm failures.”
‘Poor financial hygiene’
Hildebrandt examined the circumstances surrounding the failure of 80 firms between 1998 and 2004, as well as the recent firm dissolutions that have grabbed headlines. Those failed firms typically faced problems in one or more of the following areas: below-average financial performance, internal dynamics and external dynamics.
In many cases, those existing problems were worsened by a certain event — such as a large group of partners leaving, overexpansion or a failed merger — leading to dissolution.
The report concludes that the struggling economy didn’t cause the failures of Thelen and Heller Ehrman, but did exacerbate existing problems at those firms. Some weaker firms have been propped up by a strong economy, but that support has been stripped away in the past year as the economy has grown increasingly sluggish.
“As a consequence, poorly performing firms whose problems were previously masked by thriving economic conditions will now find themselves in a stark new reality,” according to the report.
Firms should be especially wary of high levels of debt, productivity problems and “poor financial hygiene.” Past failed firms have borrowed heavily to fuel growth or to pay partners in lean times, which is risky in a tough economy. Low productivity among partners is also a danger sign, the report concludes, because many firms will opt to reduce that partner’s compensation instead of asking him or her to leave. That can prompt strong partners to leave out of frustration. Additionally, failed firms may be too sloppy with their business practices, which include allowing partners to accept questionable clients and to discount fees.