Financials; Rates; & Mergers
"Multiple surveys suggest most law firms believe they’ll at least meet or beat expectations in 2023," largely due to conservative budgeting (Many Law Firms on Pace to Meet Budget but Uncertainty Lingers in ' Strange Year', Andrew Maloney, 10/20/23). However, Thomson Reuter's Law Firm Financial Index Q3 Report ("Q3 Report") predicts disparate year-end results by law firm segment:
The AmLaw 100 are expected to lead in profit growth "on the back of high-rate growth and conservative hiring decisions;"
Midsize law firms are expected to "break even;" and
The Second Hundred are expected to lag relative to 2022 profits (Law Firm Financial Index Q3 Press Release, Thomson Reuters, 11/6/23).
Thomson Reuters concludes that each segment faces a unique challenge going-forward:
The Am Law 100 need to increase demand;
The Second Hundred need a clear strategy; and
Midsize firms need to manage expenses, after increasing headcount 8.2% from Jan through September (compared to 1.3% in the AmLaw 100 and 3.7% in the Second Hundred).
Across all law firm segments, demand was up .1% in Q3 2023 over Q3 2022, but still well below Q3 2021 (Q3 Report, 11/6/23). Transactional practices continued to lag.
Worked rates were up 6.3% in Q3 2023 over Q3 2022 (Q3 Report). According to Thomson Reuters, this growth is not the result of mid-year rate increases, but instead of firms billing closer to their standard rates, across titles and practice areas.
Rates
Thomson Reuters also released an in-depth report analyzing rates and addressing the decline in realization across all law firm segments since mid-2022 (Law Firms Rates in 2023 ("Rate Report"), Bill Josten, Thomson Reuters, 10/4/23). In sum, the gap between rates billed and collected has remained relatively small and constant over the last seven quarters, indicating that clients are largely paying for the time that is presented in the bill; and worked rates (defined as "rates that clients agree to pay a law firm for a new matter") have grown over the same period. Thus, the decline in realization since mid-2022 is largely self-inflicted, through pre-bill write-offs of time billed at agreed-upon rates. To address this, the Rate Report suggests:
coaching partners and rising partners on rate structures and the value proposition behind them;
tracking why time was written down; and
analyzing the data for tasks or work types that are more susceptible to write-downs.
Mergers
Legal industry consultant Hugh Simons analyzed 30 mergers between 2000 and 2020. He divided the mergers into healthy mergers and unhealthy mergers, in which one of the merging firms was facing steep decline in profits per equity partner ("PEP") (How Big Law Firm Mergers Succeed: The Quiet Part Out Loud, Hugh Simons, 10/30/23, American Lawyer). In unhealthy mergers, the combined entity suffered a drop in PEP rank immediately upon merger (relative to the rank of the larger predecessor firm) and did not regain that pre-merger rank until 5 years later. By contrast, in healthy mergers, the combined entity saw no drop in PEP rank upon merging and rose nine places within 3 years.
Taking a deeper-dive into the healthy mergers, Simons concluded those mergers succeeded not due to scale or enhanced client offerings as much as to "paring back the equity partner ranks to those with higher-revenue practices." As support, he noted that these merged firms saw a decline in equity partner headcount throughout the 5 years following the merger; yet, revenue per equity partner increased over the same period, indicating that equity partners responsible for relatively more revenue stayed, while equity partners responsible for relatively less revenue departed or were de-equitized.
Simons argues that a similar culling of equity partner ranks could occur without the substantial direct and indirect costs associated with a merger. But such changes are hard to effect absent a merger. In a merged entity, leaders from the predecessor firms "can call each other out on their sacred cows and protected fiefdoms" and can pin difficult changes on "the new leadership team."
