Tag Archives: Paul Hastings Janofsky & Walker

THE LATERAL BUBBLE

Posted on by
3

Most big law leaders say that they have to keep pushing equity partner profits higher to attract and retain rainmakers. They have repeated that mantra so often and for so long that the rest of the profession has accepted it as an article of faith.

Perhaps it’s true, but two items in the February issue of The American Lawyer prompt this heretical question:

What if the lateral hiring frenzy is creating a bubble?

Victor Li’s “This Time It’s Personal” describes the state of play: lateral hiring is way up. Law firm management consultants, including my friend Jerry Kowalski, predict more of the same for 2012 as firms counter revenue losses from departing partners to prevent the death spiral that can result. Such fear-driven behavior can easily lead to overpayment for so-called hot lateral prospects that turn out to be, well, not so hot.

As I’ve observed previously, the reasons for the lateral explosion have much to do with big law’s evolution. Its currently prevailing business model encourages partners to keep clients in individual silos away from fellow partners, lest they claim a share of billings that determine compensation. Paradoxically, such behavior also maximizes a partner’s lateral options and makes exit more likely. In other words, the institutional wounds are self-inflicted.

But the article quotes several firm leaders who emphasize that, while money was important in motivating some of the partners they acquired, the search for a global platform also mattered. Frank Burch, cochair of DLA Piper, acknowledges that enticing a lateral hire requires that the money offered be comparable. But he also says that his firm “did a lot of hiring from firms that reported higher profits per partner” than DLA Piper. The article cites four: Paul Hastings; Skadden, Arps, Slate, Meagher & Flom; White & Case; and Morgan, Lewis & Bockius.

Except “Crazy Like a Fox” by Edwin B. Reeser and Patrick J. McKenna (also in The American Lawyer February issue), makes the correct observation that a firm’s average PPP is not all that informative. The authors’ focus principally on the growing cohort of non-equity partners in a climate where clients are unwilling to pay for first- and second-year associates. But they make a telling point on a seemingly unrelated topic: the income gap within equity partnerships has exploded.

They note that a few years ago the equity partner pay spread was typically three-to-one; some places it’s now ten-to-one or even twelve-to-one:

“Over the last few years there has been a dramatic change in the balance of compensation, to a large degree undisclosed, in which increasing numbers of partners fall below the firm’s reported average profits per equity partner (PPP)…Typically, two-thirds of the equity partners earn less, and some earn only perhaps half, of the average PPP.”

(Trying to justify this trend, some firm leaders have offered silly explanations, such as geographical differences.)

Now apply this learning to Li’s article. A firm’s average PPP isn’t luring high-powered lawyers; the money at the top is. Perhaps the desire to provide clients with a better global platform plays a role in some laterals’ decisions, but most of the firms experiencing the highest number of lateral partner departures in 2011 are already worldwide players. In fact, four firms — DLA Piper, K&L Gates, Jones Day, and SNR Denton — are simultaneously on both the most departures and most hires list.

Consider an example. Last year when Jamie Wareham became big law’s highly public $5 million man, did leaving Paul Hastings for DLA Piper improve his ability to serve clients? Doubtful. But the bubble question is far more important to the firm: Has Wareham been worth it? Only he and his new partners know for sure.

That leads to a final heretical question: Where a lateral bubble develops, what happens when it bursts or, perhaps more pernicious, develops a slow profitability leak? Nothing good. For the answer, ask those who once worked at Howrey, Heller Ehrman or one of the many other now-defunct firms whose leaders thought that acquiring high-profile laterals offered only upside.

Are You Worth $5 Million?

Posted on by
14

The Wall Street Journal’s front page reported that litigator Jamie Wareham “will make about $5 million a year, a significant raise from his pay at Paul, Hastings, Janofsky & Walker LLP, where he has been one of the highest paid partners.”

This phenomenon – superstar lateral hiring – is nothing new, but in recent years it has become more common. For those who remember the 1980s, it’s vaguely reminiscent of the period when ill-fated Finley Kumble turned that strategy into a losing business model.

Of course, Finley failed for many reasons that may distinguish it from current trends. Still, those running that firm into extinction as they signed up marquee players who couldn’t carry their own economic weight probably wished they’d asked this question:

How can you determine whether a lawyer is worth $5 million?

Reserved for another day are the broader implications, including the challenges that significant lateral desertions and insertions at the top present to the very concept of firm partnership. This article focuses solely on underlying financial considerations associated with the superstar lateral hire.

Presumably, bringing in a big-name player makes economic sense for a firm operating under the prevailing business model, which means that at least one of the following conditions are met:

First, the proposed lateral has an independent book of business suitable for delivery to the new firm. That would be simple, but for the clients themselves. Even if they hired and regularly use a particular partner, they probably also like his or her package of assembled talent. Consequently, the lateral must bring along a team of capable junior lawyers. Alternatively, the new firm may have excess attorney inventory that it can deploy, but that requires the lateral to persuade clients to use new lawyers who can quickly and efficiently climb their learning curves.

Second, even absent a short-term economic justification, a firm could rationally conclude that anticipated events make the talent investment worthwhile for its future strategic positioning. Recent examples include firms that loaded up on bankruptcy attorneys when the economy was still strong. The crash of 2008 made them look like geniuses. More speculative are the “if you hire them, clients will come” bets that managers sometimes make. Former government employees, along with high-profile attorneys who lack a portable client following but are on everyone’s short-list of best lawyers, fall into this category.

For the first category, short-term value is simple arithmetic. According to the latest Am Law 100 report, Wareham’s old firm, Paul Hastings, had a 41% profit margin in 2009. If the “substantially less” than $5 million he’ll make at DLA Piper was — say, $4 million – he would have needed revenues of $10 million to earn his keep there, assuming no other equity partners claimed any part of that gross. At a total blended attorney rate for all attorneys on his client matters of $500/hour, that translates into 20,000 billable hours.

But at DLA Piper and its reportedly lower profit margin (26%), Wareham will have to produce almost $20 million to support a $5 million share of firm profits. At a blended hourly rate of $500, that means more than 40,000 hours. (If he is selling clients on a move with him on the promise of lower hourly rates, the billables requirement at DLA Piper would become even higher.)

If one of the 20 or so attorneys on Wareham’s team is another equity partner earning, say, $1 million, then the minimum break-even billables bogey moves proportionately higher. (Assuming a 26% profit ratio, it takes about $4 million gross — 8,000 hours at a blended rate of $500/hour — to net $1 million.)

Insofar as the lateral acquisition’s value relates to the second category – future payoff — big name players get a grace period. But at some point, the economic imperatives of the first category will surface. When that happens, they’ll feel the revenue and related billable hours heat even more than everyone else — except, of course, the attorneys working for them.

Such is the economically successful lateral hire outcome. Failure on a sufficiently large scale produces Finley Kumble.