Walker Clark Worldview

The final demise of the British firm Halliwells, reported last week in the on-line edition of The Lawyer, is a good case study in the financial failure of a law firm.  The Lawyer summarized the factors that led to Halliwells’ failure earlier this month.

The failure and breakup of Halliwells is instructive for law firms anywhere that substitute wishful thinking for attentive management of operating costs and deepening debt.  From what I have read about the final days of Halliwells, they seem to me to have been about as orderly as the evacuation of the Titanic, with reports that more than 30 support staff were handed no-notice dismissals, apparently without any redundancy compensation or accrued vacation pay, at the end of the work day at a meeting that not one partner had the courage to attend.  (To be fair and tell the whole story, more than 460 staff found employment in one of the firms that acquired the surviving pieces of the Halliwells practice.)

A new post this morning in The Lawyer provides a glimpse of the “afterlife” for the parts of Halliwells that were acquired by other firms, who have created “firewalls” in the form of separate LLPs to protect the acquiring firms from the liabilities of the former Halliwells partners, as well as to enable a more reasoned pace of integrating the new partners into their firms.

Norman Clark

This is how a partner from a mid-sized law firm described the departure of several of his firm’s highest-billing partners to competitors over the previous six week, who collectively took almost one-quarter of the firm’s potential billings with them.

“We knew that they weren’t happy with last year’s distributions, but none of us were. They seemed to like practicing with us. We never expected this. It was like a time bomb that was so quiet that we didn’t even hear it ticking.”

Over the past 14 years, I have spoken with many newly-arrived lateral partners. Whether in good financial times or difficult ones, when I ask why they left the their former firms, three words almost always come into the conversation: recognition, opportunity, and fairness.

• Recognition – “My former partners did not adequately value my contributions to the firm.”
• Opportunity – “I didn’t have the incentive or the opportunity to earn what I can earn and deserve to earn from my practice.”
• Fairness – “The compensation plan at my former firm produced results that weren’t just unfair. They were bizarre.”

Each of these points involve more than money. Partners seldom jump ship because they are unhappy about a single year’s pay or profit distribution. Money is only a measuring stick that suggests fundamental flaws in the way that the firm rewards and incentivizes its partners.

Is your law firm’s compensation system a time bomb that could someday blow apart your partnership?  Here are some questions to help you listen for the faint ticking:

1. How long has it been since you conducted a thorough review of your partner compensation system? If you haven’t examined your partner compensation system within the past five to ten years, this could be a good time to do so. My colleagues and I have worked with some partnerships in which not a single active partner had any role at all in the creation of the partner compensation system years ago. Also, business priorities sometimes change. If you have a compensation system that is largely performance based, does it still reward the activities and behaviors that your firm needs today?
2. Have you increased the size of your partnership by more than 20% in the past five years? Some of your newer partners might not share the same priorities that are implicit in your compensation system. A new partner  – particularly one who is being promoted from associate status — sometimes agree with almost anything in order to be admitted; but acquiescence can quickly deteriorate into resentment.
3. Does your system produce wide disparities in compensation? What is the ratio of the total cash compensation received by your most highly-paid partner and the lowest-paid partner.  If the ratio is approaching 3-to-1 within the same class of partners, your system might need adjustment.
4. What do your partners really think about compensation? Some law firms avoid any serious discussion of partner compensation for fear of hurting their collegiality or teamwork. One of the best ways to manage this sensitivity is a confidential partner compensation survey, conducted and reported by a third party such as Walker Clark, LLC. It can confirm the level of consensus and support for your current system and define the few critical issues that might need attention.  A sensitive issue can be defused, in that, as presented by the survey results, it is no longer “George’s issue” or “Maria’s complaint,” but an issue for the entire partnership.

A comprehensive review of partner compensation at your law firm need not be expensive, complicated, or divisive. Instead, it is a prudent investment to manage a quiet but potentially explosive risk.

Do you hear a faint ticking in your partnership?

Norman Clark

With so many smart people who make their livings by intellect and analysis, why do so many law firms have so much difficulty with profitability?

I think it is because they don’t know where to look, or how deeply to probe, for the causes of poor financial performance.  This is why even in good times, some law firms — particularly small and midsize ones — struggle to remain profitable.

Law firm profitability is different.  Some traditional accountants — even ones who are experienced in other professional services businesses  — tend to overlook or minimize the special factors and forces that must be understood and addressed in order to improve the profitability of a law firm or of a particular practice in the firm.

You can’t take a generic profitability analysis, cross out the words “accounting firm” or “architecture firm” and write in “law firm.”

To be fair, there are a lot of excellent accountants and other financial specialists who understand this. I have had the great professional pleasure to work with a number of them. Not surprisingly many of them have in-house law firm experience.

Our firm’s experience advising hundreds of law firms and specialized practice groups throughout the world has confirmed the classic “six drivers of  profitability,” which have the greatest impact on the profitability of a professional services firm:

• Price
• Productivity
• Realization
• Cost management
• Fee earner compensation
• Leverage

This is nothing new. These apply to most professional services firms.  However, in most law firms these six factors interact in ways that can be subtly, but profoundly, different from other professional services. Someone who does not understand the practice of law might not notice these subtleties. Here are five of the more frequent examples:

• The price sensitivities and quality expectations in different types of legal services
• The nature of the various constituencies and business sectors in the firm’s client base
• The seniority, market reputation, and equity interests of the owners of the firm, who usually also are expected to produce a disproportionate amount of the fees
• The availability of partner capital to respond to short-term cash-flow issues or to take advantage of investment opportunities
• The degree to which a practice area or service line is heavily dependent on the management of sophisticated intellectual capital

From a profitability perspective, most law firms actually compete in a number of economically distinct legal markets, not just one. This is why a “one size fits all” profitability strategy — particularly dramatic ones such as across-the-board cost cutting or massive redundancies — might produce desired results in one practice area, but sometimes also can be impotent or even counterproductive in others.

Even the smallest law firms are very complex, sophisticated business entities.  The causes of problems in financial performance frequently can be found and understood only by drilling deeply into the operations, client base, and professional culture of the firm.  There is seldom an easy, quick fix to chronic profitability problems.

Norman Clark

Every law firm managing partner should feel good about starting the new year with a business plan that has already been approved by the owners of the firm.

Unfortunately, most law firms do not meet the “first day of the year” deadline with their business plans. In fact, a surprising number of law firms operate without a business plan at all. I personally think that this is as risky as setting sail on rough seas without a chart or compass; but, whether I approve or not, this is a reality for many law firms.

The most common reason for not having a business plan is the time required to produce a well-informed, carefully-considered one. “I need to spend my time performing, not planning to perform,” one managing partner recently told me.

There is an alternative to making it up as you go along. For some law firms, it might produce better results to wait until the end of the first month — or even the end of the second month–  before you finalize your business plan for the year. Aside from guaranteeing that you will get at least one or two months right, you might have a better understanding of:

• The factors that shaped your performance in the previous year. Sometimes these are not fully apparent until after you close the books. In some law firms that I have advised as much as 50% of the firm’s fees were not collected until the final three months.
• The factors that are beginning to affect your performance in the new year. Most law firms experience revenue decreases and cash flow issues in the first one or two months of the new year. January, in particular, can be the least productive month of the year. If it takes four to six weeks for your firm to get back into “high gear,” it might be wise to wait and see how the firm is actually functioning in the new year before finalizing your business plan.

Above all, deferring the final approval of the business plan until the second month of the new year can relieve the normal year-end pressures that consume so much time at the end of the old fiscal year.

“Wait and see” business planning might not work for every firm. For firms that already are usually on schedule with their business planning, deferring the final approval of the plan by one or two months might not add very much value. However, for firms that have chronic difficulty with formal business planning, this alternative might be a less stressful alternative that can produce equally good — and perhaps even better — results.

Norman Clark