Are big law firms built on implicit leverage? Of course they are — but it’s operational leverage:
Over the last few decades – concurrent with the growth of leverage in the financial system – the business model of most large law firms has developed into one built on leverage as well. It is just a leverage which utilizes people rather than borrowed money. Specifically, since law firms generally bill by the hour (a system whose demise has been predicted for the near future and, in my opinion, always will be), firms increase their profitability by increasing the amount billed in respect of each equity partner. Since there is only so much time in the day, firms have tended to increase the ratio of attorneys per equity partner. Without irony, this ratio is known as…”leverage,”…Now, in times where there is an easy supply of
creditwork, this system of leverage works very well for all involved. But when the flow dries up, the firms are left with high fixed costs to be serviced – and the more leveraged the firm is, the harder it is to service those costs with reduced revenue. Sound familiar? It should be no surprise that large law firms have been laying off attorneys in far greater numbers than in previous downturns, with some doomsayers (whom I hope are less accurate than their counterparts with respect to the economy generally) predicting additional firm collapses and permanent changes to the firms’ business models. (The one saving grace to the law firm model of leverage is that they can “deleverage” far more easily than banks, as banks can’t merely fire their “troubled assets.”)