Sunday, February 15, 2009

Night of the Long Knives

for major law firms.

I suppose it is fair enough. The Wall Street and Beltway lawyers were the shock troops of financial deregulation, and to this day in the pay and under the thumb of their clients who prospered in the recent economic episode now ending in tears and terror for all involved.

But, if you're enough of a street fightin' man, when the times change, your ability to belt out the leider inevitably ends in the gurgle of a slit throat.

Law firms are interesting animals. Full of sophisticated people, they are themselves quite primitive. They tend to have one big long term liability--their real estate leases--and one big short term asset--their accounts receivable. They don't have any capital to speak of--in a partnership the capital accounts are kept minimal and in an LLC the shareholders equity is de minimus for a combination of tax and practical business reasons.

On top of that, the quarter to half of the attorneys who are the proprietors--the partners--tend to view their incomes, not as the firm's profits, but rather as their salaries/draws for their own law practices. So, in effect, the firms have Godawful operating leverage, even if they don't have much financial leverage (and even less of an equity cushion).

In a truly bad year, not an off year, a bad year, the firm's profits disappear. That means the partners have no incomes. In a horrible year, with losses, not only do the partners have no incomes, the firm has no equity cushion to absorb the losses.

Major law firms are a post WWII phenomena. The major firms of earlier eras were fundamentally different creatures. Most of the partners of those versions of today's power houses could go a year or so without income from the firm. I'm not sure that is still the case.

My guess is that you'll be seeing some chaos in the legal profession.

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