It’s not dead yet. It wants to go for a walk.
(Yes, the subheadings are Monty Python references, consider it a quiz.)
Monty Python might not top the list of advisors for a law firm trying to cope with the coronavirus crisis, but Bruce MacEwan should be right up there. On his website (adamsmithesq.com) and in his books, his commentary and advice to law firm leaders is at the same time practical and deeply insightful. In his 2013 book, Growth is Dead: Now What? (drawn from a series of articles from 2012 that can still be read on his site), he fired a warning shot over the bow of the legal profession still struggling to get back on track in the slow-growth environment following the 2008 financial crisis. Many of the challenges confronting firms discussed in the book – changing client demand, pricing pressures, over-capacity, partner expectations – are rearing their ugly heads again and will clearly be a feature of the road ahead. The more things change, the more they stay the same – or to borrow from another movie on people’s minds right now, Groundhog Day!
In Growth is Dead, MacEwan described the legal market as being in a transition phase with the path forward for many firms being unclear at best. With an uncertain future in a market still recovering from the events of 2008, he called upon firms to listen to clients and think differently, focusing on a range of topics including pricing, staffing, and investing in the firm. In particular, innovation and experimentation are vital to break out of old models that are past their sell-by date for many firms. The message is not about simply finding new sources of revenue growth, e.g. acquiring new practices. Experimenting to improve a firm’s performance in terms of the efficient delivery of legal services and improving client satisfaction is important. However, those goals need to go hand-in-hand with similarly new ways of improving the firm’s financial metrics both during and after this crisis.
Growth may very well be dead in the traditional sense of a firm’s fortunes rising on a wave of economic prosperity. Is there another way that “growth” can mean something for firms in a hyper-competitive market wallowing in the stagnant economic pool expected in the post-coronavirus world? If growth does still have a heartbeat, it must mean maintaining or even improving financial performance, in which case some attention must be given to revenue generation as well as improved efficiencies. Technological enhancements and better means of delivering services will be necessary and impactful, but they are still a means to an end. Towards that end, it is hard to avoid the point that innovation should be designed to produce the intertwined benefits of better value from the client’s perspective and improved financial performance for the firm. However, the innovation/cash connection needs to be explored from more than one angle.
Cash is King! But did the partners vote for that?
“Cash is King” is often the mantra of law firm leaders and those who advise them. That is completely understandable; liquidity and cash management is vital in good and bad times. However, in a disrupted economic climate, this principle usually produces an intense focus in only one direction – costs. A common complaint among law firm partners is that firm management is only focused on cost cutting rather than revenue generation. This is not surprising though given the nature of cost-cutting in a market gone pear-shaped. Something needs to be done to address the immediate problem and reducing expenses is something that a firm can control; the actions have a direct impact on the firm’s bottom line regardless of the pain and disruption that can accompany them. Less so with revenue. As a lawyer, you cannot make the client instruct you and you cannot control the economic environment in which you practice. A firm can, however, tweak its offering such that cash-strapped clients are better served while at the same time the firm’s revenue model is made more recession resistant.
Revenue and related metrics like revenue-per-lawyer do not necessarily have to stagnate in a slow or recessionary market. Alongside the efficiencies and improvements that cost control can generate, contingent fees arrangements (in the UK, damages-based agreements or DBAs), can generate greater revenue-per-lawyer for the same number of lawyers working the same hours. They are also an effective marketing tool to bring in new cases and client. Proactively offering contingent fee engagements to your litigation clients is a compelling way of responding to their own liquidity issues and sending a strong signal that the firm is invested in the client and its matters. That is what a contingent fee is – a co-investment in the client and the case. The revenue that a contingent fee investment can generate, particularly when pooled together in a risk-managed portfolio of “litigation assets”, can outperform a model solely reliant on the hourly rate. As we’ve noted previously, this is a lesson being learned even in global, multi-practice firms. The key is to build the pool of co-investments while protecting against the risks that losses will wipe out any upside.
Co-investing through contingent fees: Keep the gold and frankincense, don’t worry about the myrrh.
Like any investment, continent fees entail risk as well as the promise of reward. As we have discussed in previous articles including “Planning for the Rebound“, insurance and capital provided by a finance partner can mitigate much of the risk while allowing the firm to retain much of the reward. It may sound surprising, but insurance can be the secret to efficient financing. Insurance does not have to be all about protecting a downside risk. When coupled with a contingent fee or DBA engagement, it turns into a valuable asset. Like most financial assets, it can be an integral part of a financing strategy. Insurance can be used as security or principle-protection for cash advances and in many cases can be used in conjunction with existing bank lines. Protection against the risk of a loss is a nice bonus too. When a firm has a contingent fee engagement combined with insurance, it has an asset against which it can raise the cash needed for working capital to keep its litigation assets ticking along.
Co-investing in cases is not just an investment in the case, it is an investment in the client too. The ultimate “share the risk” message you can send to a client is to invest in them. This was one of the themes in the dotcom boom when some law firms acted like venture capitalists and took shares in their start-up clients instead of fees. But lawyers are not venture capitalists and analysing and valuing companies and share values for investment purposes is not their game. However, lawyers do know how to analyse legal claims. By investing in a client’s claim, you are both sharing the risk and expressing a strong view on the company’s claim which can be based on managements’ actions, their IP, their growth strategy, etc. Contingent fees provide the vehicle to do this. Not only can a law firm send a strong signal to their client that they take their concerns about their cash position and alternate fee arrangements seriously, it can also express a strong view about their business outlook too.
Turning the focus back to the firm, the real benefit of contingent fees is that lawyers can invest in the one asset that they know better than anyone else and in doing so they can start to build up an internal portfolio of interests in claims. Such a portfolio can significantly improve the firm’s revenue model and even provide a catalyst for making longer-term investments in the firm. By using contingent fees in conjunction with the risk management and capital raising tools that are common to other industries, law firms can invest in their own future growth.
The overall effect that the crisis will have on the legal market remains to be seen and a significant unknown is the time horizon over which any recovery will take place. The legal market has been through economic disruptions before though and it can recover over time. The speed of, and the means used to create, that recovery within individual firms will be affected by decisions that firms take now. By combining contingent fees with risk-mitigation through insurance and outside capital, even growth can recover and take on a new life. Growth will not sprint back to pre-crisis levels, but it could start walking down the road to recovery at a faster pace.