The number that makes law firms tick11 min read . Updated: 14 Apr 2015, 01:11 AM IST
Getting the ratio of partners to non-partner fee-earners right has its rewards, but it is, at best, an inexact science
Getting the ratio of partners to non-partner fee-earners right has its rewards, but it is, at best, an inexact science
Berlin: One of the most important figures in managing a law firm is leverage, or gearing. Unlike in companies where leverage/gearing is all about debt-to-equity ratios, in law firms, it is about people: the ratio of partners to non-partner fee-earners.
In the legal industry, the figure has an effect on and is affected by nearly everything, including profitability, attrition, billing rates, salaries, the type and volume of work handled and ultimately, client satisfaction.
“It’s a very complex set of parameters to work with, to try and figure out what is the ideal leverage," says Rahul Matthan, co-founder of law firm Trilegal, who sits on the firm’s managing committee with two other partners. “I don’t know whether there is a perfect answer in terms of what leverage should be."
“In the partner-associate leverage, basically we need to be very very conscious about the pyramid it should be," says Zia Mody, managing partner of Mumbai-based AZB and Partners, “because the pyramid obviously leads to more efficiency and higher profitability."
“It’s not only about profitability but also quality control," agrees Vandana Shroff, Mumbai partner of Amarchand Mangaldas Suresh A. Shroff and Co. The leverage equation is one of her favourite subjects in law firm management, she quips.
Clients are very aware of gearing, in terms of what they want, though not necessarily in the larger context that law firms’ managers think of it. All three India-based general counsel (GC) of companies spoken to for this story had a specific expectation of how leveraged the team they’re working with should be.
“Normally what I’d do is I choose a partner and I’d like them to be involved in all pre-discussions and everything else. I don’t need that to be there every call but there needs to be someone responsible available," says one GC of a finance multinational, who declined to be named.
“The partner concerned has to always be there on the deal," adds another GC of an international pharma company who also asked not to be named. “As long as a partner is there with an associate or senior associate, it doesn’t matter how many senior associates or associates are there, if they don’t over-delegate to a senior associate who doesn’t have the confidence."
Those are high expectations for partners to meet; they may have dozens of GCs making similar demands.
In reality, a partner only has so many hours in the day to actively sit on conference calls, negotiate terms of deals, answer client queries and vet contracts drafted by juniors or opposing lawyers. And on top of that, they are also responsible for bringing in new business, managing their team of associates, recovering bills and keeping an eye on the general financial health of their practice.
An effective second layer of senior associates and third layer of more junior associates to delegate large parts of the work to is important to allow most law firms to handle enough work to be profitable.
But the biggest challenge in leveraging the time of more junior fee-earners lies in delegating without a large drop in quality and without the client noticing that partners might be stretched thin working on a dozen different things.
The balance is a delicate one and a nightmare to get right.
Building the pyramids
Traditionally, leverage translates directly into equity partner profits if there is a large volume of work available. If, for example, one equity partner has two senior associates and six associates under him/her in the pyramid (a leverage of one partner to eight fee-earners), the billings from those eight associates (less salaries and other expenses) would count towards that partner’s profits, on top of the hours billed by the partner to clients.
The profits of equity partners with only one or two associates under them are much more dependent on the direct billings of the partner (low gearing such as this is roughly the case with one of the most elite New York-based corporate firms, Wachtell, Lipton, Rosen and Katz, and many other firms in the US that reduced their leverage to save costs during a dearth of work in the recession towards the end of the last decade).
In such low-leverage firms, the hourly billing rate of a partner would therefore have to be much higher for it to be as profitable as a more highly leveraged firm. Profits, other than for their own sake, are important in giving a law firm the ability to expand by attracting and retaining partners.
For a single deal, a low-leverage firm could, therefore, be more expensive to clients because an experienced partner would be spending a lot of time on work that could be done more cheaply by associates; a high-leverage firm, where more junior lawyers are doing more of the heavy lifting, could be cheaper (but give clients less partner face-time).
Similarly, a high-leverage firm would be able to act on many more transactions, since one partner delegating effectively down the pyramid can oversee many more deals.
“It can be more profitable to (run at high leverage) but only because you’re able to do more in terms of volume," says one partner about the leverage question, but claims that “it has two negative consequences: one, it brings down the price you can charge on deals, and the second thing is, it impacts your quality".
“If that is the context, each person will maintain the leverage that is necessary to give them the level of service they deem acceptable," Matthan of Trilegal explains. “Efficiency and quality of the legal advice will vary across firms, but the one constant is that each firm will produce the quality of work that meets its standard of quality."
Running at high leverage, without butchering quality, requires ensuring that the associate layer beneath each partner is reliable and competent, well-trained and strongly managed, which all require people management skills that not all partners are experienced in or are naturally comfortable with.
What’s in a partner?
Leverage is more complicated than simple math in India where partnerships are often multi-tiered structures that can include promoter-equity partners, equity partners, pseudo-equity partners and so-called salaried partners, who do not hold any equity in the firm and who might carry different designations at other law firms.
In other words, one law firm’s partner could be called a senior associate at another law firm, while at some firms, salaried partnership is the norm and becoming equity partner is the exception.
On 31 March, Khaitan and Co. announced a partnership promotion of five new equity partners and 18 retained partners, taking its total partnership to the “milestone of 100 partners", according to a statement released by the firm.
Khaitan just managed to pip Amarchand to the largely symbolic figure, mostly by virtue of the latter having delayed its official partnership announcements because of an ongoing mediation about the future of the firm (ironically, around that time, at least five Khaitan partners have announced they were leaving their firm, after having been poached by Amarchand (mintne.ws/1PD9TNM).
In a statement about the promotions, Khaitan wrote that it “continues to believe that client satisfaction and quality is paramount, which cannot be achieved without a significantly low partner to associate leverage ratio".
With 274 fee-earners, including revenue-generating non-lawyers such as accountants and other professionals, according to figures disclosed by the firm, Khaitan has a particularly low leverage ratio for Indian firms of around one to three.
But there are many ways to slice and dice the partnership in Indian law firms, and the partner tag doesn’t necessarily mean partnership in the traditional sense of designating profit-sharing senior members of a firm.
Thirty-six of Khaitan’s 98 current partners are so-called retained partners, who do not hold equity but are paid a salary—a stage they usually reach several years before making it to the equity partner level.
If calculating Khaitan’s leverage from the equity partner to non-equity fee-earner (including retained partners) perspective, its leverage would be closer to one to five.
At J. Sagar Associates (JSA), where technically 33 of the firm’s 78 partners are currently non-equity partners, all associates work under partner supervision and “to the outside world we do not make any distinctions between our partners", and everybody at the firm is portrayed as “just a partner", says Mumbai partner Akshay Chudasama.
Similarly to Khaitan, JSA operates at a gearing of around 1 equity or salaried partner to 3 fee-earners; if only counting equity partners, the gearing would rise to 1 to 5.
On the other end of the spectrum lie the pure equity partnership firms, where salaried partners could be called senior or principal associates or ‘of counsel’. Trilegal, which converted to an all-equity partnership four years ago, is now at 26 partners and operates at a leverage of around 1 to 6, with approximately 153 non-partner fee-earners, according to Matthan.
Other all-equity partnerships have similar figures, such as S&R Associates (eight partners and 47 fee-earners, giving a gearing ratio of 6) and Talwar Thakore and Associates (four partners with 20 lawyers, giving a gearing of 5).
Amarchand, with 84 equity and non-equity partners to 616 fee-earners (according to a footnote to a press release from the firm last week, though those figures are likely to be out of date), has a leverage of around 1 to 7 (when only considering its small equity partnership of 18, that rises to 1 to 43).
The firm also has India’s largest capital markets practice, a large litigation practice and a department that specializes in low-cost due diligence-style work, which provide a partial explanation for the slightly higher figure.
Piling on the bodies
“The leverage will start based on what the task at hand is," says Mody, adding that a due diligence will have more people thrown at it, for instance (with around 40 partners, of whom around half are equity, according to Mody, AZB has an approximate leverage of one partner to seven fee-earners, or 1 equity partner to 14 non-equity fee-earners).
“A firm that does domestic IPOs (initial public offerings) will need to have more associates," adds another partner. “The rates are low, the work is quite high—you need to have volume and low fees."
“Some practice areas require lots of bodies for a transaction," agrees Matthan. “In India, capital markets are an example because a lot of heavy lifting is to be done, whereas something like the sector I’m in (technology, media and telecommunications), is fairly thin because it’s advisory. You need high-level resources and there’s not that much (junior) work to be done." Litigation is another area that often requires a large work force.
On the opposite side, clients in private equity would not pay for more than a few junior lawyers besides a partner, for fees that might total ₹ 20- ₹ 30 lakh, recounts one partner.
And fees at the venture capital (VC) level may only be ₹ 3-4 lakh, because VCs have a lower appetite for legal fees but a higher appetite for risk, says the partner. “The only way a VC deal would be profitable is to have a large number of low-paid associates on it. Otherwise, we’d blow through ₹ 3 lakh (of fees) in half a due diligence or something like that."
VC deals are, therefore, required to often recycle standard templates and agreements from private equity or other VC deals, which get customized by younger associates.
But even younger associates do not work cheaply these days, with nearly all top law firms now paying ₹ 1 lakh and up in monthly salaries to fresh law graduates, excluding bonuses, as reported in Mint on 7 April (mintne.ws/1c1nUFF). Ensuring that those salaries do not eat up most profits when doing low-margin deals means partners have to ensure each associate handles a large volume of deals.
The economic fundamentals of leverage are simple, but controlling leverage and keeping it in check across an entire firm is less so, with managing partners at best being able to tweak the end of a very long stick that will affect gearing only months and sometimes years down the line.
All the numbers constantly shift and change, depending on how many associates leave any month and year and how many new ones join laterally or from law school—fresh campus recruits, for instance, are often given job offers 12 months before they will sit at their desks.
On top of that, to retain senior lawyers, law firms need to promote some to partner every year, which again radically affects gearing.
Keeping the ratio steady between associates and partners (and between equity and non-equity partners), requires an amount of prescience, and making hard decisions, such as finding new lawyers suitable for partnerships in practice areas that are over-leveraged or encouraging some partners to leverage more (or less) by tweaking the size of their teams.
“We evaluate it all the time," says Matthan, with the human resources department sending a report to management every month that “shows us the pyramid" in granular detail, while professional management staff alert them if the figure crosses a particular threshold. “The average across the firm is not that important but it’s really important to look at each practice area and we’re constantly evaluating whether we’ve got that right."
That said, leverage is only one figure among many that keep law firm managers awake at night. “We talk about productivity, we talk about how you can improve the efficiency of teams," notes Chudasama.
Matthan calls it “the realizable rate—how efficient are you on a transaction versus how much fees you’ll get out of it".
It is “not helpful to have any one number", he says. “We are all in search of the one number that makes management of the firm a lot easier—that’s the holy grail—but it is impossible because there are so many variables."
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