Law Firm Economic Cycles -- Part III

This is my third post in a four-part series that offers findings from analyses I performed last fall as my law firm clients were considering how best to respond to the economic downturn. Seven months later, some of my findings from last fall look like a big duh, although others still offer useful insights. (For more details and caveats about this series, read the past two days’ posts.)

5. In this recession, many law firms will be dissolved or acquired by stronger firms.

I maintain a list of “weakest link” law firms—those that are nearing or have passed a tipping point in terms of falling lawyer headcount and net operating income (these two metrics seem to be as good or better indicators of potential law firm dissolution or fire-sale acquisition compared to more arcane metrics). Right now, my weakest links list contains the names of nearly a dozen US law firms among the Am Law 200, the dissolution or acquisition of which would improve the health of competing firms, in some cases dramatically.

As with earlier recessions, this one will drive some law firms to failure and weaken other firms that will fail after the recession ends. US regional markets that are particularly stressed include Atlanta, Boston, Ohio, and the San Francisco Bay Area. During and following this recession, we can also expect to see failures or acquisitions of three or four New York Am Law 100 and 200 firms.

Firms that grew rapidly in recent years, spending or borrowing heavily to fund their growth, will suffer extra pressures during this recession. Those pressures will be hardest to withstand at firms where large blocs of partners have been together only a short while.

These forecasts should not shock anyone. Of the Am Law 100 firms listed in reports describing 1989’s financial performances, twenty no longer exist. Eight were acquired, and twelve have dissolved (see Table 2 below).

Twenty 1989 Am Law 100 Firms That No Longer Exist

A. Eight Firms Were Acquired
1. Brown & Wood
2. Hale and Dorr
3. Hopkins & Sutter
4. McCutchen, Doyle, Brown & Enersen
5. Rogers & Wells
6. Rosenman & Colin
7. Shaw Pittman
8. Winthrop, Stimson, Putnam & Roberts

B. Twelve Firms Have Dissolved
9. Arter & Hadden
10. Brobeck, Phleger & Harrison
11. Coudert Brothers
12. Gaston & Snow
13. Graham & James
14. Heller Ehrman White & McAuliffe
15. Johnson & Swanson
16. Keck, Mahin & Cate
17. Mudge Rose Guthrie Alexander & Ferdon
18. Pettit & Martin
19. Shea & Gould
20. Thelen, Marrin, Johnson & Bridges

6. Stronger firms absorb failing firms’ best assets, producing even stronger firms.

As in the past, many lawyers in firms that will fail or falter in the next few years will remain in private practice. An acquired firm’s strongest assets (lawyers) with the best strategic fit will be retained and assimilated, or they will find even stronger new homes.

Newly acquired and unhappy groups and practices at unsteady firms will be fair game for poaching firms with the resources to invest in new talent.

Odds are also strong that a Magic Circle firm and a top-tier New York City firm will soon find more reasons to merge than to stay single. If I had more courage, I would name here those two firms I fantasize will tie the knot.

Coming soon:

Tomorrow’s post concludes this series and addresses coming changes in:

7. Law firm partnership tiers

8. Marketing and business development functions

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It's hard to accept intelligence that breaks your heart.

It must be very difficult to accept intelligence that foretells your demise or says your dearest strategies and models have failed. That’s the situation in which the major investment banks found themselves in the last few weeks and where many commercial banks also find themselves. It’s also the situation some US-based law firms are in now.

As most readers from law firms know, two Bay Area-based firms, Heller and Thelen, are visibly struggling with “you’re probably not going to make it” warnings, as they seek to find merger partners.

Eleven months ago I prepared a report for a client that was considering expanding in the Bay Area, which included this statement:

At least half a dozen large Bay Area law firms are showing signs of stress. If one or more of these firms were acquired or dissolved, the health of the remaining major firms practicing in the Bay Area—in San Francisco and the Valley and even beyond—would improve. Such change(s) would make a dramatically positive difference for a few firms.

Heller and Thelen were among the six stressed firms I reviewed, although they were in trouble for different reasons.

Over the years, Heller did many things right and built an admirable brand with a strong culture. Following the tech bubble, the firm was quick to jump on the life sciences bandwagon in 2002-2003. But in 2004 and 2005 the firm’s revenue and profit trends faded. The firm responded with partner de-equitizations, staff cuts, and other cuts and lowered expectations. If the firm made any strategic changes, those weren’t visible from the outside, although considerable business development flogging was evident. Still, “work harder, build revenue, cut costs, and de-equitize partners” is not a strategy.

Nearly three years later, after seeking and not finding a merger partner, Heller is considering dissolution, among other options. Their candor on this point is refreshing and, although deeply depressing to loyal Hellerites, will probably ensure that Heller’s best remaining legal DNA mates with the best possible other legal DNA at other firms.

Thelen, another Bay Area firm whose brand is less burnished than Heller, is regularly losing partners and groups while they seek a merger partner—their third. The firm has already squandered opportunities to grow and diversify through mergers it initiated with two New York-based firms, Reid & Priest and Brown & Raysman, but both mergers resulted in little permanent gain. Thelen’s growth strategy, to expand beyond its old-economy practices like construction law into financial, IP, and other practices, was upended by internal West Coast vs. East Coast rivalries. The West Coast winners were merciless, and the East Coast losers fled, as did some West Coast partners who found more peaceful places to practice law.
Memo to file: Collaborate, don’t compete, to achieve post-merger assimilation.

The Bay Area is not the only US geographic market that would be healthier with fewer corporate law firms; Atlanta, Boston, and Philadelphia have long been too crowded. And now it seems New York will experience law firm mergers and failures too. Obvious NYC candidates for hastened demise are firms that have lost big clients and will see double-digit percentage losses in firm-wide revenue and that have a very high transactional to litigation capability ratio.

Bruce MacEwen, the estimable law firm economist who blogs at www.adamsmithesq.com, reminded readers on Sunday that the most basic strategy key intelligence topics now apply: What are your firm’s strengths, and how much does the marketplace need what you have to offer?

Fortunes, careers, and reputations are made in exciting times like these. And hearts are broken, too.

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