Charles Darwin said so profoundly “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.”
Our practice is seeing an increasing number of firms tested by their ability to adapt. The news reflects a growing number of firms in obvious transition. From high-profile names to lesser-known partnerships, the leaders of each firm faces pivotal decisions. Some of these firms will restructure or otherwise embark on a turnaround strategy. Others opt for merging with another group or offering themselves as an acquisition target in an effort to avoid dissolution. History has shown far too many end in a messy liquidation.
Identifying The Path That Leads To Decline
The decline of a once vibrant partnership rarely has much to do with the quality of lawyers engaged in the practice. And though the marketplace is certainly tumultuous, what is at the heart of survival and success for some, and the dire straits of a struggle to survive for others?
In his book Corporate Turnaround, Dan Bibeault identifies four key mistakes that lead to organizational decline. These mistakes, paraphrased to the legal profession are:
- Failure to respond effectively to a changing competitive environment
- Poor control over operations
- Operating with excessive financial leverage
Let’s look at each one a bit more closely.
Failure to respond to change effectively
Every leader knows that the only constant in business is change. And no one need tell the leader of a law firm that our industry is changing at breakneck speed. Specifics of the changes virtually every firm leader must contend with include:
- Increasing mobility and declining loyalty of attorneys
- Client imposed pressure on pricing
- Non-traditional competitors and alternative service providers
- Technology’s role in driving certain lines of service to commodity status
Counsel/Advice – Effective law firm leadership establishes a formal mechanism through which change is routinely addressed. These mechanisms identify emerging changes to the business of law, and collaboratively craft appropriate responses.
Control over operations
Operational challenges are varied, and abound. If the leaders of a firm are continually surprised to find threats to profitability and stability, the firm is well on its way to a potentially painful transition process. On the other hand, keeping an eye out for these early warning signs can result in averting crisis:
- Loss of a significant client relationship resulting from continued service delivery issues, or the departure of a key partner
- Firm-threatening malpractice claims resulting from failure to engage in client problem management
- Shortage of working capital resulting from continuing cash flow deficits.
- Excess capacity in terms of space and people resulting from failure to manage attrition of clients and or lawyers
Counsel/Advice – Leadership must establish control mechanisms that spot these (and any evolving) early warning signs. These mechanisms may include:
- Operating and capital budgets
- Client feedback systems
- Attorney and non-attorney review systems such as 360 reviews that register building frustration
Imprudent growth may be the number one mistake law firm leaders make. There is a tremendous bias for numerical growth in our industry. Unfortunately, the growth in which we engage is often far from strategic, and about little more than becoming bigger. As a result, most lateral expansion is not – in the long run — beneficial to the partners of the expanding firm. Most growth changes the numbers, but adds little value. Growth is expensive, tests culture, strains the limits of the management and leadership infrastructure and is just plain risky.
- Add institutional capacity only when existing capacity has been significantly and consistently utilized. Until that threshold has been achieved, learn to use contract, temporary and outsourced solutions.
- Restrict lateral growth to individuals or groups that meet strategic criteria, and have been documented to be accretive through objective analysis. Increasingly, business that is thought to be “portable” is actually far from it. Vet relationships. Add laterals in a manner consistent with strategic direction of the firm.
The general inclination in most law firms is to maximize immediate cash flow to owners while minimizing the amount of owner cash tied up in contributed capital. The combination of these two often leads to operational stress, and — if extended too far, organizational failure. Edwin Reese has an excellent article here on law firm capital.
Counsel/Advice – Better to be safe than sorry. We recommend that firms maintain a balance of contributed capital that is equal to 25-45% of annual owner compensation and that monthly distributions to owners be based on a distribution of 60-70% of projected annual income with the balance distributed at year-end.
Follow Basic Guidelines And Avoid Crisis
Serious law firm decline can almost always be avoided if leadership understands the trajectory of its current path. To improve your firm’s odds of avoiding deterioration; monitor and proactively address change, tightly control legal and administrative operations, expand cautiously and maintain a healthy level of financial leverage.
In a statement often associated with leadership and innovation, Wayne Gretsky said “I skate to where the puck is going to be, not to where it has been.”
What might law firm leaders be doing today, to better predict where firms end up in the coming months and years?