Selling BigLaw Short
[by Bill Henderson, cross-posted to the ELS Blog]
It is mid-December and the vast majority of large law firms arefrantically pressing their clients for their fees in order to pay downthe firm’s credit lines and generate a profit pool that can hold thepartnership together. See, e.g., Susan Beck, Collecting, But Hardly Calm and Cool,Am Law Daily (Dec. 10, 2008). Every investor knows that leverage canbe a wonderful thing in boom times but a killer in a down market. Inthe last few years, law firms have expanded the use of two types ofleverage: (1) bank financing, often for working capital, and (2)salaried lawyers, in the form of contract attorneys, staff attorneys,associates, of counsel, and income partners, who each generate profitsfor the equity partners.
Yet, with the potential forhistorically low collection rates, a large proportion of Biglaw firmsare in one hell of a vise. Salaried lawyers represent fixed costs. And even if you lay them off, managers are under intense pressure topay a reasonable severance (e.g., 6 months pay) to preserve the firm’sreputation for an eventual recovery. Further, firms with the mosthuman capital leverage will nonetheless be stuck with vast expanses ofClass A office space under lease terms negotiated during the saladdays. If Biglaw revenues go down 20% for the fiscal year, which iscertainly in the realm of possibility for many firms with large capitalmarket practices, profits could dive by 50% or more.
Similarto what happened at Heller Ehrman, the grim financials could put thefirms in violation of their bank lending agreements, see Drew Combs, Why Heller Died,The American Lawyer (Nov. 2009), thus requiring partners to pony upmore cash. Sensing trouble, lawyers with the most options startheading for the doors, initiating a sudden and rapid death spiral. Inshort, there is good chance that several hallowed Biglaw firms,particularly those with weak balance sheets, will cease to existsometime in early to mid 2009.
Through the Law Firms Working Group,I have access to detailed financial reports for law firms in the Am Law200 and the NLJ 250. Here is what the revenues per lawyer (RPL)figures for Thelen and Heller Ehrman looked like for fiscal years 2003to 2007:
Mostfirms in the Am Law 200 posted steady rises in RPL during the 2003 to2007 time period. But it is pretty amazing that in the cases of Thelenand Heller Ehrman, both old-line firms with established brands,seemingly modest diminutions in revenues were precurors to totalcollapse. As noted by Marc Galanter and I in The Elastic Tournament,large law firms have become immensely fragile institutions. As largefirm lawyers, many of them young and connected to clients, flood thestreets over the next several months, look for a new model of corporatelaw practice to emerge that is modest, thrifty, and more sustainable.
Closerto home for us academics, the collapse of Biglaw could have asignficant impact on law schools, particularly those at the top of thefood chain who could pass along ever higher debt loads onto studentsbecause of a virtual lock on lucrative Biglaw jobs. Cf. Mike Cahill, Legal Education Bubble?,PrawfsBlawg (Dec. 15, 2008). Even if law school follows the usualcountercyclical pattern of higher admission volumes, the lack of cheapcapital in combination with the lack of high paying jobs may stifleenrollment. It is time to pay attention and carefully evaluateassumptions we have formerly taken for granted.