How to Save Your Law Firm If It is in Trouble

It’s time to head home. But, as you’re packing your briefcase, you receive a call from the firm’s most significant partner, who tells you he’s taking his clients and starting a new firm. He’s tired of subsidizing under productive people. He’s taking the best ten lawyers in his practice, along with $5.0 million in business. Suddenly, the firm is in crisis, and your partners don’t even know it. But, by Saturday morning, they will . . .

The Loss of Significance

How did the firm, long a mainstay in the local legal community, reach the point where the departure of one partner—any partner—could be the cause of panic? The roots of a firm’s decline are usually long. A firm doesn’t fall from excellence to mediocrity overnight. Likewise, turning the situation around cannot be accomplished quickly. To get the firm back on a solid footing, you must begin by examining how you got where you are. Most law firms don’t have problems because their economics are poor. Rather, their economics deteriorate because they have other problems. Economic problems result from neglect of management fundamentals. Most firms in crisis suffer from one or more of the following conditions:

• Lack of Leadership. Successful firms have a vision of their future, their markets and goals. They have lawyers who at all levels—firm, department and practice—can and are willing to articulate a vision and lead others toward achieving that vision. Too often, firms in trouble have few if any lawyers who are both able and willing to lead the firm. Or, no one is willing to follow.
• Lack of Management. This is often associated with an excess of democracy. While the partners are the owners of the firm and should have a voice, effective management is crucial if the firm is to steer clear of problems and make timely, proactive decisions concerning opportunities. But if partners can tell you who voted for what in a meeting four years ago, you know you have a problem!
  
  In many firms, partners spend a great deal of time discussing internal issues, focusing on the compensation system, and generally chirping about how things should be done. Of course, a favorite subject is how costs can be controlled (it’s far easier than focusing on revenue!). But, while the partners are all having their say, no one is making significant decisions, and far too many people are spending far too much time on management.
  
  In successful firms, most management responsibility is delegated to a relatively small group of well-respected and capable partners. Yes, there are some decisions that should be put to a partner vote, but these are rare. And it is highly unlikely that a firm in trouble is going to extract itself through a series of partner votes!
• Lack of Practice Management. Even many firms that have good firm-level management still suffer from a lack of sound management at the practice level. Few firms with weak management have any practice management capability. But, it is practice level management that ultimately distinguishes the strongest firms from the rest of the pack. Absent quality practice management, the likelihood of poor economic performance, including eroding leverage, stagnating revenues and large write-offs grows significantly.
• Lack of Accountability. Lawyers, and all firm employees, must be accountable for their contributions. This means, in essence, that the interests of the clients come first, those of the firm come second, and those of the individual come after these.
  
  In most troubled firms, exactly the opposite is generally the reality, if not the stated culture. In many of these firms, no one holds anyone accountable. Most partners see this as a “valuable part of our culture.” Of course, no one ever says this. But invariably, when you ask a partner why he or she likes the firm, they will tell you they are given a great deal of autonomy to manage their practice as they see fit. Management does not “interfere” with the practice of law.
  
  Such firms often maintain a compensation system where some partners are paid far more than they are worth, while the most valuable lawyers are under compensated.
• Greed. If you`ve got it, you`ll know it. But the problem is that greed sets the interests of the partners against each other. At any given time, there is only so much money to go around—compensation is a zero-sum game in the short run. It’s not that successful firms are full of partners that do not care about money. This is certainly not the case! However, when the partners start to push their own interests at the expense of others, it becomes impossible to achieve cooperation and teamwork. Ultimately, client service and revenues suffer, and the firm’s performance lags.
• An Internal Focus. Firms in trouble spend far more time focusing on what’s wrong internally than on market opportunities. The compensation system becomes a major topic of conversation. Finger-pointing increases. People start talking incessantly about cost cutting.

This problem is directly related to a lack of leadership. No one is leading the firm, and partners focus on the easiest things to blame for the “problems.” But, the real problem is that the partners don’t understand what it takes to be successful—finding clients and providing the best possible service to those clients the firm has. While managing the core business is also important, this should be delegated to a limited group of skilled people. Most partners in strong firms practice law. (What is surprising is that this is not always well understood!)

These problems and others will, over a few years, erode the firm’s justification for existence. Gradually, some of the most productive people will move on to other opportunities, leaving behind a disproportionate number of under performing lawyers. At first, these departures may be explained away, or accorded little significance. (“He didn’t really pull his weight anyway” or “We were paying her more than she was worth, so we’ll be better off.”) But, clients will go with the departing lawyers, and others will fail to come because the firm’s skill mix is eroding. For a while, the firm maintains its former reputation, but eventually the market image catches up.

If the situation is significant, the firm may shrink a bit. Billable hours for the remaining lawyers start to drop off. At first, this is hardly noticed, because collections of accounts receivable and work-in-process keep revenue on track for some time after the departures. But realization rates start to decline as well, and eventually revenue starts to fall off, often dramatically.

At some point, the firm’s management notices that expenses are not dropping as quickly as revenues. It may take some measures to adjust costs, such as firing a few secretaries, or even associates. Invariably, investment plans for such items as technology and training are put on the back-burner. However, this generally does not solve the basic problems.

Eventually, the firm reaches a crisis point, perhaps triggered by a serious cash shortage (missed draws) or a significant drop in partner income. At this point, the law firm is fighting for its survival.

Day Two

The Management Committee is convened for an emergency meeting at 10:00 A.M. Saturday morning to decide how to respond to the crisis. Two of the twelve members show up around 10:30, grumbling about canceling their golf games. Another doesn’t show at all, and no one knows where he is.

The immediate agenda item is to decide how to respond to the partner’s departure. Can any of the clients be kept? How about the lawyers? Is there any chance that the decision could be reversed? What would it take? More importantly, what will it take to prevent any further, similar departures?

The meeting ends with indefinite conclusions, except that you will call the firm’s administrator to ask her to prepare an analysis of the economics of the firm, factoring in the departure. The marketing partner is charged with preparing a press release. And, anyone with any relationship with the departing partner’s clients will be asked to make a call . . .

Fixing the Problems, Beginning at the End

Ironically, to resolve the crisis and give the firm a chance to get back on track, it is generally necessary to begin with the last problems to arise. In the end, the crisis is an economic one.

The firm’s survival will depend on the answers to three related questions:

• What must be done to get the firm’s economics back on track?
• What kind of structure is necessary to assure that the underlying issues that ultimately resulted in crisis are addressed?
• Is whatever is left of the firm when the immediate crisis is over viable? Does it still have market logic? Are the partners prepared to support the firm and its practice during the inevitable period of convalescence?

Only if all three of these questions or groups of questions can be answered affirmatively is there much chance of the firm surviving long term.

Dealing with the Economics

The economic crisis is always the most immediate concern, because in many situations, unless there is an economic structure that works, the rest of the questions are academic. So, the first question that must be resolved must always be: What form of restructured firm has a chance of being economically viable. To answer this, the firm must begin with an assessment of its remaining client base, and then design a new law firm around that client base. How much accrual-based revenue could the new firm expect (leaving aside the collection of current accounts receivable and work-in-process), and who controls the revenue? The firm must be structured around the core base of clients and the partners responsible for that work, while accepting the loss of some business to necessary downsizing. Once the firm knows how much revenue it can count on, and how much is likely to be lost with any further reductions in the partner (or lawyer) ranks, it can begin to build a firm as if it were starting over.

Essentially, the firm needs to put together an assessment of how much revenue per lawyer it needs to assure a competitive income position for the partners, then build the rest of the firm around it. Inevitably, this involves decisions concerning:

• Which partners will remain with the firm? In most cases, the firm has become top-heavy because it is always easier to cut back on the associate ranks than to ask partners to leave.
• Which and how many associates and paralegals are needed to service the business that is likely to be retained? The firm must focus both on capacity and on skills, recognizing that it may not be able to preserve all skills if the firm’s clients have only a limited need for certain kinds of work.
• What level of support staff is necessary to properly service the remaining business? This often requires that the firm accept a different cultural mode with regard to secretarial support, and that it address problems that make workloads inefficient in other areas, such as accounting. It may also require a reconsideration of the level of senior administrative management. A shrinking firm can often not afford the team it has in place.

In most cases, when trying to restructure the firm, it is important that decisions err on the conservative side. Invariably, things do not work out exactly the way they are planned. The firm will need some margin for error to assure that these can be taken in stride.

Once the personnel decisions have been made, a variety of other economic issues will have to be addressed, including:

• Where else can costs be reduced, and how can the firm identify these areas? Does the lease need to be restructured? How will this get done?
• What does cash flow look like?
• How will the firm repay the capital accounts of all those partners who have been asked to leave?
• Can the banking relationship be restructured? Should the term structure of debt be renegotiated?
• How much can be collected from the firm’s inventory? Is there some way to realize something from all the “garbage” on the books?
• Can the firm afford its draw payments or do these need to be adjusted? Can this be accomplished without the firm collapsing through additional departures?
• What does the firm owe to departed and retired partners, and should this be renegotiated?

Many other economic issues will, no doubt, arise. All of them must be addressed, often through the precarious balancing of competing interests. For many firms, there is a very fine line between survival and dissolution. Often, as part of this process, and analysis of the likely results of dissolving the firm must be prepared to provide the partners with a clear set of choices.

Two Weeks Later . . .

After a great deal of effort, you have come to some fundamental conclusions about what it will take to save the law firm. However, the steps that appear necessary look almost impossible to carry out. Among other things, the firm needs to terminate several partners, two of whom are members of the Management Committee. In addition, it is critical that those partners who have significant business remain, but some of them are clearly underpaid, even within the context of the firm. You’ll never get the approval of the management committee, and terminating a partner requires a very large, super-majority vote. How will these decisions ever get implemented?

Qualitative Restructuring

Many firms are not structured to deal with crisis. They are saddled with cumbersome administrative and management structures, an outdated compensation system and often no practice management structure at all. The firm might pride itself on its democracy, but ultimately this means that no one has the authority to make major decisions. To make matters worse, in many firms, those in management positions have relatively little management capability.

Surviving the crisis usually requires a significant restructuring of management. Among the more important considerations are:

• Creating a relatively small and very efficient management team, vested with the authority to act. For some time, this might include the power to make any decision in the firm, including termination of partners.
• Identifying someone or some group to serve in these capacities. To be successful, this usually requires both a significant amount of credibility and trust and a significant amount of management skill. Those in management cannot be everyone’s best friends, and the job will be both thankless and painful.
• Revisiting the compensation system to assure that the partners remaining with the firm are, within the ability of the firm to produce income, compensated as fairly as possible.
• Making assignments to accomplish major points on the economic agenda. For example, who will deal with the landlord? The bank? The press?

It will also inevitably require significant cultural change. For one thing, those partners who are not part of management must get back to work as quickly as possible. Inevitably, a few months of significantly reduced billings are one aspect of a law firm crisis. However, if this isn’t turned around quickly, it could be the final straw. Beyond going back to work, the partners will also need to focus on collecting the inventory of accounts receivable and billing the work-in-process. If this doesn’t happen, the firm is likely to face an extreme cash flow crisis within a few months.

Partners will need to understand that business as usual has changed.

Two Months Later . . .

Looking back, you cannot decide whether it was worth it. Somehow, most of what needed to be done got done, but it probably would not have happened if you had not threatened to resign as Managing Partner. That’s when the partners decided to disband the Management Committee and appoint three people to fix the problems.

The downsizing got accomplished, and it looks like the firm might be close to a new deal with its landlord. Cash flow has been tight, but it seems as though the worst may be past. Still, there are a number of unresolved economic issues, such as how are you going to repay departed partners’ capital and, sooner or later, the firm has got to replace the Pentium Pro computers and install a document management system. But, you’re still here.

The only problem is you are no longer sure just what “here” means anymore. You felt the firm had lost its direction prior to the crisis. Now, whatever was left of the old firm has been shattered. If the firm is going to be viable in the long run, the partners will have to come to a consensus on just what the firm’s role in the marketplace will be. But, the partners are tired...

Focusing on the Future

The firm got in trouble because it lost its direction in the first place. With very few synergies among practices, there was little “firm.” Many of the partners functioned as solos sharing space with one another. No one cross-sold anyone. Why should they? They could hardly trust the lawyers in the other practices, because no one ever even considered training the associates.

For the firm to survive longer term, all of this will have to change. Otherwise, the pain and agony of fixing the structural and economic problems will have been of little value. Yes, they may buy the firm some time, but will not assure its long-term health. To succeed, the firm must address a number of issues that, collectively, will define its place in the market. These include:

• Who are the core clients, and what do they need? Who does the firm want them to be? How can the firm provide the best possible service to its core clients?
• Who are the competitors? What does the firm offer to the market that is unique?
• What is the firm known for? What is its brand?
• What practices will the firm build, and which will it downplay? Will the firm invest in some areas? Completely abandon others? Ultimately, successful firms do not try to be all things to all clients. They define their market niche.
• Should the firm remain independent, or would it be better off merging with another firm, perhaps becoming a branch office for an out-of-state firm?
• Does the firm have the right lawyers to accomplish its goals? What types of lawyers should it begin to hire?
• Where does the firm need to invest its resources? Laterals? Technology? Training?
• What practice management structure is most suited to helping the firm accomplish its goals?
• Who are the firm’s future leaders, and how can the firm encourage their development?

Ultimately, the firm must define a market niche for itself that will satisfy the desires of the partners while offering a valuable set of services to the clients. The market, ultimately, will determine whether the firm succeeds.

Two Years (and Many Gray Hairs) Later . . .

Things seem to be going very well. After a nearly fatal crisis, the firm’s economic performance has improved substantially. More importantly, next year looks like it will be a banner year. Somehow, the firm survived.

Things seem to be on track. The firm’s strategic plan was approved at the annual retreat last fall, and partners seem to be excited about the future. You’re hearing a lot more talk these days about new clients and marketing opportunities; no one seems to be talking about how unfair compensation is anymore. And, you’ve just heard from a headhunter wondering if your firm would like to acquire a very successful bankruptcy group . . .
 

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