Breaking traditions: The end of traditional partnerships?

 

In 2012, we saw Dewey & LeBoeuf face collapse. This is a firm which traces its roots back to 1909 and, as recently as 2010, was ranked among the top 25 global law firms. Many smaller and medium-sized UK law firm partnerships are also struggling to survive in the current market.

Some have said that this, together with some other law firm failures, shows the vulnerability of the traditional partnership structure. While this model has existed and been used successfully for many years, is it the right model for the law firms of the future, and particularly the large global firms?

The image of a traditional partnership has all of the partners sitting around the boardroom table, sharing knowledge, discussing the firm’s business and taking the decisions. The partners remain highly independent and are left alone to develop their practice areas. This type of partnership is often described as strongly collegiate and a partnership culture usually develops, often providing a comfortable environment for partners to provide professional services to clients.

However, many law firms have now changed beyond recognition from the days when all of the partners would sit around a boardroom table to the modern businesses we see today, often with multiple offices across the globe and a management board making the decisions and providing direction and leadership.

Challenges to partnerships

Law firms have had to respond to a number of strategic and financial challenges over the past decade, some of which have been brought into critical focus by the changing economic situation in the western world.

There are four main areas that frequently put strain on the partnership model.

1. Partners no longer consider their entire careers to be lifetime roles in the firm and are likely to move onto another firm when it suits them for either lifestyle or career reasons. Firms also no longer view partners as remaining for a lifetime and are interested in attracting the best lateral hire partners, along with the fees that they hope those partners will bring in. Firms are finding that partners come and go, often taking some or all of their top clients with them.

2. Certain legal services have become commoditised. This trend is going to continue, with general counsel in client companies forcing law firms to reconsider what they charge for some services and GCs, in some cases, finding it easier to obtain alternative lower-cost solutions. In the UK, new entrants will also keep challenging the traditional model and finding innovative ways to deliver legal services.

3. The demise of the hourly rate is leading firms to reconsider their pricing methods, prompted by tougher economic conditions and an oversupply of lawyers (and law firms) in many countries. So, while some firms are still able to do parts of the more complex or time-critical legal work at higher profit margins, overall, profit margins are under pressure.

4. There is also demand from global businesses for law firms to be able to service them consistently across the globe. For partnerships, investing in new offices in new countries puts pressure on cashflow and margins, and requires partners to invest for the longer term. However, in a traditional partnership structure, partners are often focused on short-term profitability. Many partnerships typically divide the profits between the partners at the end of the year and then pay profits out to partners shortly thereafter.

As these four areas illustrate, the significant external forces being applied to law firms cannot be ignored and the pressure to change is more considerable than ever before. Well-run firms are reacting to those external pressures and making changes to become modern global firms. But, have their management structures, partnership governance and infrastructures kept pace with that change?

Changes to firm management

There are eight ways in which law firms have started to change their management style and governance to ensure they are efficiently run, as well as able to face the tensions and pressures of operating in today’s business climate.

1. Practice management

The type of person carrying out the role of managing partner has changed considerably. Historically, the managing partner in a law firm was a senior lawyer with a large client following and, in many cases, was expected or preferred to carry on servicing clients as well as performing the managing partner role.

Many firms now look for somebody who will be more like the CEO of a large business, with a focus on strategy and developing a clear vision for the firm’s future, as well as great people skills and sound judgement.

For major firms, the practice management departments of finance, HR, marketing and IT are now frequently headed by people who have held senior positions in these roles, often with experience from outside the legal sector.

2. Decision making

While in traditional firms their leaders largely lead by consensus, today’s managing partner or chief executive is likely to have the authority to take most operational decisions without reference to the partners and to ensure they are implemented.

This is one of the biggest areas of change. A well-run firm needs to have a clearly-defined board, with sufficient authority to make most of the operating decisions on running the firm, with only strategic decisions referred to the wider partner group, as owners of the business, for their approval.

3. Retention of cash

Firms that are growing, opening new offices, or investing in new premises, IT systems or infrastructure will often find that paying out all of the year’s profits to partners in the months following the year end does not allow for sufficient cash to be reinvested in the firm for future development.

This is quite a change from past practice, but firms need to think carefully about an appropriate drawings policy so that there is a balance between rewarding partners and retaining cash for developing the firm in future.

4. Delivering to the clients’ agenda

Traditionally, clients have given instructions to law firms, which have then carried out the work and submitted a bill that is typically calculated based on the number of hours worked and the seniority of the people involved. While there has been a gradual shift away from billing based on time, this has accelerated over the past five years due to the economic situation.

Many clients are now questioning why they are paying a fee related to the time it takes to do a project (which after all does not incentivise the law firm to do the work efficiently), and are finding different ways of managing the fees of law firms, such as fixed fees or some contingent element by reference to outcomes.

What is clear is that successful well-managed law firms are seeking to understand more about what is on their clients’ agenda and aligning their legal services to ensure they are delivering value to clients. They are also being proactive in suggesting different billing methods to clients.

5. Profit margins

Alongside the shift away from time-based billing, clients have also been looking to reduce the cost of legal advice, which has been driving down law firms’ profit margins. This in turn is meaning that, in order to survive, firms must seek more efficient ways of delivering their services.

This might be through the better use of technology to drive better processes, working from lower-cost locations (to lower both salary and property costs), or using a different mix of qualified lawyers, trainees and paralegals. In many firms, there is a real drive to achieve greater efficiencies across all areas of the business.

6. Innovation

Historically, there has been little focus on innovation in traditional partnerships. Fee earners have been constantly told throughout their careers to focus on delivering high chargeable hours, which will enable them to achieve their personal targets and, ultimately, profits for the firm.

Firms wanting to shape themselves for the future need to be seeking new ways of delivering legal services to their clients – focusing more on innovation. Clients are starting to notice this as well and are attracted to law firms that are seeking new ways of delivering legal services – providing more added value, delivered in the way their client wants and at a lower price.

7. Non-executive directors

The use of non-executive directors has grown significantly in law firms over the past ten years. Firms have found that non-executive directors can make a valuable contribution in many areas and really provide an independent sounding board to their management.

Key areas that NEDs might be consulted on include governance, complex partnership matters, areas of risk management, changing partner performance evaluation, financing and distribution policies, along with many other strategic challenges in a fast-changing business world.

For many law firms, this means adopting aspects of the governance model that is seen as best practice in the corporate world.

8. Partner performance and evaluation

Regular partner performance evaluation is now commonplace in law firms. There has historically been little evaluation or appraisal of a partner’s performance and partners would normally expect to remain in the firm for their entire professional careers.

Now, most partners can expect at least an annual performance review and, as a result, partners feel as though they have lost some degree of independence and that their performance is constantly under review.

Future of partnerships

While many well-managed law firms are making significant changes to their operating and governance structures, they are usually not changing their ownership structures from a partnership to a corporate entity, although some firms may well appear to be run along corporate lines.

The best-run firms may still use the partnership model, but more as an ownership structure that works efficiently for tax and regulatory purposes. This also allows a fair amount of flexibility as to how they are organised and run.

There is therefore a stark difference from the traditional law firm partnership of 20 or 30 years ago.

When law firms have changed their management style and governance to be run as modern firms, underneath the partnership wrapper will be efficiently and professionally-run businesses that are focused on delivering services to meet the needs of demanding clients and that have a governance oversight that is appropriate for large global businesses.

The traditional partnership model is still relevant for most firms, but more as an ownership structure rather than as a way to run a modern legal business.

Nick Carter-Pegg is a partner and head of professional services at accountancy firm BDO (www.bdo.uk.com)