Law Firm Turnarounds By William F. Brennan Dewey & LeBoeuf, the 20th largest law firm in the country Overly rich benefits provided to former partners via an according to the 2012 NLJ 250, has declared bankruptcy unfunded partner withdrawal entitlement; and is in the process of dissolving. According to the firm’s Compensation systems not perceived as equitable or management, in 2011 it had more than $900 million in pay levels significantly below market; revenues with average profits per equity partner of about $1.8 million. The Am Law Daily reported that those Loss of confidence in firm Leadership/Management; statistics were substantially overstated and had to be Inattention to client/practice concentrations; restated to $782 million in revenue and $1.04 million in average profits per equity partner, still impressive statistics Failure to react to market shifts; for a law firm. (Dewey says that the former numbers were Reliance on billing rate increases at twice the rate of and are accurate and are due to methodological inflation as primary means to increased profits. differences.) How could such a prominent law firm end up in such a mess? The occurrence of one of these problems, if corrected If Dewey’s situation is consistent with other law firm quickly, is unlikely to cause a law firm to fail, but the financial crises, it fell victim to a series of different issues simultaneous convergence of two or three, or an inability to that individually might have been manageable, but together adjust quickly, can spell doom for a law firm – a business proved to be insurmountable. Typically law firms in crisis structure that relies primarily on the shared trust of its co- face more than one of the following critical challenges: owners and thin capitalization. Loss of key clients; A strong economy can mask serious underlying financial problems. Firm leaders are convinced that generating more Loss of key partners; revenue (often by charging more and working harder) is the Regulatory or legislative change affecting key path of least resistance to address a cash flow shortfall. In practices; a recessionary economy all firms feel greater financial stress and firms that have not been prudently managed will Excessive reliance upon debt; be severely challenged. The protracted economic malaise Overhead expenses out of control; of the legal profession during the past several years has caused many law firms, including some of the largest in the country, to literally fight to survive. By William F. Brennan www.altmanweil.com Law firm failures are not that uncommon as indicated by A third party advisor can provide needed objectivity, this list of Am Law 200 law firms that failed during the past facilitate the process and ‘take the heat’ for what can be two decades: very painful and difficult decisions. Altheimer & Grey; In Altman Weil’s crisis management work, we help firm’s leaders prioritize which payments must be made to Arter & Hadden; continue operations, and which non-critical obligations can Bogle & Gates; be deferred. Every law firm CFO is capable of making those distinctions without any difficulty. The challenge is Brobeck Phleger & Harrison; implementing this process and dealing with the public Coudert Brothers; relations issues for those payees who have been relegated Heller Ehrman; to the “non-critical” list. Often times these issues affect long-time vendor relationships and friendships that may Howrey LLP; include vendors who are also clients and those who have Jenkins & Gilchrist; personal relationships with one or more partners. McKee Nelson; RESTORE TRUST IN LEADERSHIP Morgan & Finnegan; We have found that all too frequently the firm’s leadership Pennie & Edmonds; has understated the extent and magnitude of the fiscal crisis, and has projected optimistic results that did not Shea & Gould; and materialize. Rather than “confront the brutal facts,” they Testa Hurwitz & Thibeault. have not fully understood the magnitude of the issues Thacher Proffitt & Woods; confronting the firm, misinterpreted the financial data and/or have attempted to boost morale by portraying a rosier Thelen Reid & Priest; picture of future operating results wherever possible. Wolf Block Schorr and Solis-Cohen. For example, as partners leave for greener pastures Can a firm be saved when it is facing multiple critical elsewhere the lawyer headcount decreases so that even if threats to its existence? The answer is yes – if the firm revenues decline the “revenue per lawyer” statistic might acts quickly and decisively. increase due to the lag time in collecting receivables and the lower headcount. Clearly, the decline in revenues is not The primary steps in an effective rescue plan are: good and portraying it as if it were because “revenues per Stop the bleeding; lawyer” increased would be misleading. Restore trust in leadership; Once leadership loses the confidence of the firm’s lawyers Retain key partners; there is no choice but to change the leadership team. There is no time for the existing team to regain the trust of the Shrink to a profitable core operating size; lawyers. This is another area where the need for swift, Restructure operations and renegotiate commitments. decisive action may be best served by an independent expert who can guide the partners to consensus on new STOP THE BLEEDING leadership at a time of high tension and crisis. The underlying cause of the fiscal crisis must be addressed directly. Cash flow and liquidity are the primary concerns for Frequently the most qualified and respected individual is the law firm to continue operations and survive. Usually a unwilling to make the sacrifices required to accept a financially distressed firm will begin this process on its own, “battlefield promotion.” Other viable candidates must be but it often balks at taking all of the steps that are required. identified and consensus built around their elevation. In addition to assuming substantial potential risk as a leader of LAW FIRM TURNAROUNDS PAGE 2 OF 4 By William F. Brennan www.altmanweil.com a law firm that might implode, the partner’s clients and law partners until cash flow recovers. Then they can replenish practice will certainly suffer from less attention as the that capital by delivering results. partner focuses on the firm’s survival. Here is a telling paradox: those very clients are the lifeline for the partner if the firm does not make it, as the market seeks lawyers who SHRINK TO A PROFITABLE have sizable, profitable, portable and strategically important CORE OPERATING SIZE clients. Difficult decisions often have to be made to save the troubled law firm. The first step is to identify a core set of A willingness to make large personal sacrifices and clients, practices, offices and lead partners that will form the dedication to the law firm are essential qualities of aspiring surviving law firm. This is the inner ring. Surrounding this leaders. Some call this statesmanship or stewardship. group are the essential lawyers, paralegals and other Whatever one wants to call it, finding a leader who will timekeepers that service this business. This is the second place the firm’s interests and preservation above all else is ring. Finally the appropriate administrative support group an absolute requirement for a successful turnaround. Once and infrastructure is wrapped around creating the third ring. the selection process is complete, an announcement All else is redundant. Usually this will result in a smaller should be made that includes the new leadership’s honest law firm. assessment of the situation and an outline of the process going forward. Clear and forthright communications from Unfortunately, the execution of this outcome is far more this point forward is paramount. complicated than the more straightforward number crunching. Some personnel may be marginally profitable – RETAIN KEY PARTNERS that is they cover direct costs and contribute something to indirect costs that can not be relieved in the short-term The importance of listening to the concerns of partners and (such as long-term leases). And here exists another eliciting their input cannot be over-emphasized. The paradox where locked-in costs stymie efforts to achieve a partners have to believe their concerns are being heard, reduced core size. Yet another challenge may come from considered in a thoughtful and careful manner and that clients who may require a portfolio of services from their appropriate action will be taken. law firm. Some of those services may not be core, but are essential to retain important clients. Often those services Partners with vitally important clients, and their associated are less profitable and will require some creative re- revenue, have the most options in terms of moving to engineering to improve. another firm. In order for the law firm to have any chance for success, those partners and their clients must be The business of law is currently dominated by people and retained. The firm’s leaders must maintain an open, candid compensation expenses. Restructuring will affect the lives and constructive channel of communication. These and livelihoods of many individuals. It is one thing to partners want actions that will help them demonstrate to release an individual in a market where realistic alternate their clients that the firm can survive and their legal needs job prospects exist. This past economy was and in many will be properly serviced. The firm must demonstrate a ways continues to be an enormous challenge in this deep and thorough understanding of the situation and a respect. We have counseled many leadership teams on pragmatic, decisive approach to recovery. these issues as they struggled with business and moral implications of their decisions. The right course varies by Fair and competitive compensation is not the most firm and the immediate circumstances of their situation. important short-term consideration. However, a realistic Decision paralysis is not a viable position if the firm wants path to this end is absolutely necessary.