Law Firms Find Novel Ways To Reduce Risk Of Lateral Hires
Law360, New York (March 17, 2017, 5:40 PM EDT) — Some BigLaw lateral partners are being forced to wait to share in the profits at their new firms when they first join, one of several strategies that experts say firms are increasingly using to mitigate the risks of lateral hires.
Rather than refraining altogether from bringing on laterals when faced with the risks involved with the legal industry’s low retention rates, law firms are simply being more cautious in their approach so that they don’t get burned, performing more due diligence, using creative methods of funding and even bringing some equity partners on as salaried attorneys.
“We know what is happening at a large number of firms is laterals who are destined for full equity partner status are, in fact, joining as income partners. They are treated as an income partner, and then, after a year or two years, they are up for elevation to full equity partner,” said Michael McKenney, managing director of Citi Private Bank’s law firm group.
This can even be true of lawyers who were considered full equity partners at their previous law firm, McKenney noted.
“It allows the destination law firm to be more careful about who they admit to full equity status. They can try the partner out for a year or two and make sure they deliver on promises they made during the interview process before elevating them,” he said.
Several reports over the past year have revealed sluggish client demand for law firms’ services, a challenge for growth some law firms have addressed through lateral hiring. A 2016 survey by consulting firm Altman Weil found that 85 percent of law firms reported adding lawyers during the past year who brought new business to the firm while 47 percent lost lawyers who left and took business with them during the same time period.
According to McKenney, firms are now faced with managing the risks involved with bringing on new laterals, including often woeful retention rates, occasional embellishment by partners of the size of their book of business and major upfront costs.
McKenney said his company’s research shows that there is an average partner turnover rate in U.S. law firms of 17 percent each year — about half of those incoming and half outgoing partners. It’s a risky proposition when law firms typically don’t break even on a lateral partner hire for at least the first several months, due to the price of paying staff and covering other overhead costs all while client billings have not yet been collected.
“It’s a significant challenge for law firms. … And firms are right to be skeptical [of new lateral hires] because there has been a problem with people overpromising and underdelivering,” McKenney said.
Additionally, the expense of lateral hires is nothing to sneeze at. While the vast majority of hires are compensated well below the $1 million mark, some new partners’ compensation rises up and above $4 million, according to Sabina Lippman, co-founder of Lippman Jungers LLC.
Of the partners her firm has placed over the past four years domestically and internationally, there have typically been one or two who pulled in more than $4 million annually, approximately three compensated at between the $3 million and $4 million level and about five who earn between $2 million and $3 million, out of around 35 total placements.
“Those amounts are going up every year,” Lippman said.
That means the risks are high as law firms make sometimes massive investments in new hires.
Another step law firms are taking is performing extensive due diligence on laterals before they join the law firm, according to Chris Batz, president of legal recruiting firm The Lion Group LLC.
“Pre-recession, BigLaw was throwing money at partners if they even mentioned they had a book of business, and due diligence was very light. Now, it is taken much more seriously,” Batz said.
Many firms will approach a big partner lateral hire almost as they would an acquisition, according to Batz, evaluating them as if they’re evaluating buying a small business. One way they’re doing their homework on candidates is through lateral partner questionnaires that dig into the attorney’s practice, financials and client relationships.
According to McKenney, the legal industry has a “mixed track record” in terms of performing due diligence on laterals.
“Some firms have developed very sophisticated, very effective processes for vetting laterals and making sure they get laterals that deliver on promises, as opposed to many other firms that bring on laterals and don’t get what they thought they were getting,” he said.
McKenney pointed to a survey the bank conducted that included responses from 41 of the 50 largest law firms in the U.S. by revenue. Between 2010 and 2015, just a dozen of those law firms reported high success rates with laterals. Nearly three-fourths of the firms surveyed reported 20 percent of their laterals were “unsuccessful,” while 47 percent were successful, and the rest were somewhere in between.
One of the major reasons laterals fail, according to McKenney, is that law firms bring on partners simply because they want to boost revenue but have no specific plan to integrate the practice they’re taking on and don’t have a way to properly accommodate that practice.
“In an essentially flat-demand environment, there are firms bringing on laterals in an effort to gain market share, and there are firms trying to bring on laterals to fill out their bench and complement their strengths,” he said. “The latter cases seem to be having better experiences. Firms that are trying to bring on laterals simply to grow their numbers are more susceptible to making a mistake in their quest for revenue.”
Some law firms take on debt to finance their growth ambitions, according to Batz, who says he usually asks law firms how they plan to fund a lateral hire. Firms typically fund laterals either through existing cash flow, through partner capital contributions or by using a line of credit from the bank. In today’s environment of caution, many are moving away from bank funding, he said.
“I think more firms are cautious about taking on debt. I’m finding that more firms are doing capital calls,” Batz said.
By Aebra Coe
–Editing by Christine Chun and Emily Kokoll.