Leverage, realization, risk, and accounting—each of these concepts plays a key role in both a law firm’s economics and your life as a young associate. Picture a horde of newly hatched baby sea turtles on a beach. Their mother is nowhere to be seen, and they are striving to make it to the water for safety, relying on numbers to ensure that some escape the grip of predators. Now, imagine a baby elephant, standing close to its mother for protection, where it will remain for the first few years of its life. What does this have to do with law firm economics? Just wait—it’ll make sense by the end.
What is Law Firm Economics, and Why Should I Care?
Though law firms have many differences in focus and strategy, they have one thing in common: they are for-profit providers of legal services. The individual approaches and strategies used by law firms to achieve and measure their profitability have a direct impact on the type of experience and training that an associate will receive over the course of their career. That’s why having a general understanding of law firm economics should matter to law students and associates. Below, I’ll give an overview of some of the more common principles of law firm economics, as well as tactful questions you could ask potential employers to tease out how their model might affect you.
1. Leverage. “Leverage” refers to the ratio of associates to partners. Read “associates,” for this purpose, as non-profit-sharing attorneys. Matters or practice groups with a “low leverage” model mean there are fewer associates relative to partners. A high-leverage model means that there are more associates for every partner.
What does this mean for you? Refer back to my sea turtle/elephant analogy. In a high-leverage model, there are more associates staffed on a matter as compared to the number of partners. This means that the chances of junior associates working directly with partners are lower, and the structure is more hierarchical. On a given matter, first-year associates could report to third-year associates who report to six-year associates who report to senior associates who report to the partner. This is similar to a baby sea turtle who is left by its mother to develop on its own. In a low-leverage model, there are fewer associates working with the partner. As such, each associate gets more partner time and training. That’s more like the baby elephant model. Certain firms (and practice areas) are lower leverage and certain are higher leverage. Gibson Dunn, for example, operates on a lower leverage model than many of its peer firms. This means associates have the opportunity to gain more experience and responsibility early on.
The trick is to compare apples to apples across firms. Both models are profitable to a firm, but the type of leverage model impacts your experience. In interviews, you can ask how a partner typically staffs a deal and whether you would work directly for a senior associate, junior or mid-level associate, or partner. This will give you a good indication of the leverage model.
2. Realization. Realization is the difference between what a firm would charge at full rates minus discounts, write-downs of time, and collection risk. Basically, it’s the difference between what is charged at full rates and what is actually collected. When clients focus on bottom-line fees, there is more pressure on firms to lower their rates or write-off associate time. Fixed fee arrangements make efficiency even more important because no matter how much work is actually done, the fees are capped at an agreed amount. The best firms have answered the pressures on realization with a classic strategy: train associates to be more efficient and to generate great work product that is worth their rate. That keeps realization high while ensuring associates get the internal and external credit for the work they have done.
In a baby sea turtle environment, you have to be careful that you are given room to learn and are not pressured to not bill all your time. In interviews, you can ask about how the firm trains associates and what resources are available to help associates work more efficiently. You can also ask whether clients let first-year associates charge on their matters.
3. Law Firm Risk. Law firms are dependent on the demand for services. A diversified client base, by industry and practice group, helps mitigate risk when demand in a particular sector or practice drops. So does a prudent hiring and expansion model that keeps a firm from growing faster than its business. For example, during the 2008 financial crisis, many lending and capital markets transactions slowed down significantly. As a result, firms had to conduct attorney layoffs if they were too heavy in the related practice groups, were overleveraged (less profitable), or if their expenses and/or debt outpaced their anticipated business.
What does this mean for you? If you are a baby elephant, even in a downturn, you are less fungible! In interviews, do your diligence and see if the firm does both transactional and litigation work. Try to find out if they are diversified across industries (tech only versus multiple industries, for example). Figure out too if the firm has a history of financial stability (say, 23 consecutive years of revenue growth and 22 of profitability) or whether they had to conduct attorney layoffs in response to the most recent recession.
4. Law Firm Accounting. A law firm with multiple offices and practice areas has its own way of assessing profitability for a particular office or practice area. Some firms subdivide into silos based on office geography or practice areas. Others aggregate financial performance among regions, countries or globally. This impacts you because if a firm measures success based on a silo approach, you will work with lawyers within that silo. There could be resources available in other offices, but access to those resources is more constrained. While a firm’s accounting structure is probably not something you should raise directly in an interview, you can ask whether you can work with lawyers across offices and practice groups and whether you work with one assigned partner or you can approach multiple partners for work across offices. A “one-firm” approach provides more opportunities to gain a variety of experience.
5. Know Yourself. Go into interviews with a sense of whether you want to be more like the sea turtle or the elephant. Think about how you best work. It could be that you do prefer to be part of a large team with other team members who are at your same level. If so, certain firms or practice groups may be a good fit. In contrast, you may really value partner involvement and training on matters with leaner staffing. Do you prefer to be part of an incoming class of 50 or of 15? Do you want to work with lawyers across all of the firm’s offices, or do you prefer to work with one office or just one or two partners? Ask yourself these questions first. Then, you can confidently walk into your interviews knowing how law firm economics affect you!
Shalla Prichard, Partner—Gibson, Dunn & Crutcher LLP