Comfortably High?; Realization Down; Layoff Update
Comfortably High?
Profits per equity partner will decline for the first time since 2009, according to a new report by Thomson Reuters and the Center on Ethics & the Legal Profession at Georgetown University Law Center (2023 Report on the State of the Legal Market “Report”, Jim Jones - Lead Author, 1/9/23) (analyzing data through Nov. 2022 from 170 US-based law firms, including 46 Am Law 100 firms, 47 Am Law Second Hundred firms, and 77 Midsize firms). The decline will be modest, however, and PEP “should still be comfortably high when compared to pre-pandemic levels” (Report; see also 2023 Client Advisory “Client Advisory”, Citi Global Wealth at Work Law Firm Group & Hildebrandt Consulting, showing 9.9% compound annual growth rate from Sept. 2019 through Sept. 2022 (based on data collected from 175 firms from the Citi Flash Survey, including 41 Am Law 1-50 firms, 37 Am Law 51-100 firms, 48 Am Law Second Hundred firms and 49 additional firms)).
The main drivers for profit decline were falling demand and increased headcount, coupled with an increase in associate compensation. Hours worked per lawyer dropped to 119 hours per month through November (averaging all lawyers - partners, counsels, and associates), the lowest point in the past two decades (Report). Most of the drop-off occurred in the 2nd half of the year (Report). All law firm segments (Am Law 100, Second Hundred, and Midsize) registered a decline in transactional work in the 2nd half relative to 2021 (Report), consistent with Refinitiv data showing an 18% decline in deal volume over 2021 and a 35% decline in deal value from the 1st half to the 2nd half of 2022, the largest six-month percentage drop recorded (DealWatch_M&A Deal Value Down 38% Last Year, as Hopes Fade for Quick Rebound, Patrick Smith, 1/3/23, American Lawyer). Interestingly, Midsize firms showed demand growth in non-transactional practices (litigation, labor employment and intellectual property) in the 2nd half, which the Report credited to in-house counsel shifting work to firms with relatively lower rates, as the economy worsened.
Analyzing the data further, Report authors found that “Specialized” firms outperformed all firms in demand, worked rates, and revenue and saw a smaller decline in productivity through Nov. 2022 (Report, analyzing 24 firms (4 Am Law 100, 6 Second Hundred, and 14 Midsize), which concentrated 70% or more of their total billable hours in one practice area). Because Specialized firms grew demand while simultaneously growing worked rates, the Report concluded that Specialized firms were rewarded for producing high quality work efficiently, by clients who sought “the most bang for their buck, not just the lowest sticker price.”
Realization Down
Gretta Rusanow, Head of Advisory Services for Citi’s Global Wealth at Work Law Firm Group, reports that collections cycles continued to lengthen through the first nine months of 2022 (What's Really Driving Slowdown in Paying Law Firm Bills?, Hugo Guzman, 12/1/22, Corporate Counsel) (“if it used to take 30 days for a payment, it’s now taking 60; if it used to take 60 days, it’s taking 90”). Firms surveyed by Citi reported 10.4% growth in accounts receivable, through Sept. 2022 (Client Advisory). Firms also reported high levels of unbilled time (up 5.8%), due to deals being put on hold (Client Advisory). Some firms are reportedly seeking to address this by selling receivables and/or asking clients for progress payments (in lieu of payment at the conclusion of a deal) (Client Advisory). Rusanow/Hildebrandt predicted a decline in realization, if this unbilled time results in write-offs (Client Advisory). Thomson Reuters data through Nov. 2022 reflect this, noting a drop in realization in both Q3 and Q4, counter to the norm of realization rates increasing from Q1 to Q4 (Report). the decrease in demand in Q3, AmLaw 100 and Second Hundred firms were able to increase worked rates 6.7% and 4.7%, respectively, over Q3 2021; and Midsize firms grew worked rates 4% (Across-the-Board Declines Mean an 'Inflection Point' for Law Firms, Andrew Maloney, 11/7/22, American Lawyer, citing Bill Josten, strategic content manager for Thomson Reuters). And law firm leaders appear to have further rate increases planned for 2023. In response to a survey of law firm leaders by Thomson Reuters, 98% respondents reported that their firms “definitely will” (56%) or “probably will” (42%) raise rates in 2023 as a mechanism to improve firm performance (2022 Law Firm Business Leaders Report, Thomson Reuters Institute).
Layoff Update
Robust hiring in transactional practices in recent years and the decline in transactional demand have resulted in significant under-utilization, with some associates billing as little as 40 hours a month for several months. Still to-date, there have only been a handful of reported layoffs. Two of the largest layoffs occurred at Cooley and Goodwin, which laid off 150 and 113 attorneys and staff, respectively, approximately 5% of firm employees (Cooley Lays Off Attorneys and Staff, Taking 'Painful' Steps to Address Overcapacity, Justin Henry, 11/30/22, American Lawyer; Goodwin's Layoffs Spotlight Balancing Act Between Associate and Partner Preferences “Balancing Act”, Jessie Yount, 1/9/23, American Lawyer). Both firms had grown associate headcount significantly in recent years, particularly in transactional practices; from 2019 to 2021 Goodwin increased its associate head count by 22%, and Cooley by 37% (Balancing Act).
