What Lateral Partners Should Know Before Joining A Firm

With the recent demise of law firms (Dewey & Leboeuf and Lionel Sawyer & Collins for example), a prudent potential lateral should examine a firm’s financial documents and meet with firm leaders to gauge the firm’s overall health. Typically, a lateral partner joins a firm with a guarantee. Is the guarantee realistic? A candidate should thoroughly investigate a new firm. Changing firms is a significant decision for partners and their clients. A lateral candidate does not want to join a firm that is not financially sound and subsequently files for bankruptcy. That attorney’s clients will be the first to make a move to another attorney and more stable firm.

Because law firms are privately owned, it may be a bit more difficult to obtain independent financial information. One cannot easily run a Dun & Bradstreet inquiry to determine financial health. Lateral attorneys should ask for two years of financials compiled by an outside accounting firm. Requesting two years of tax returns is also beneficial. Many attorneys may not totally understand all the line items and the financial statement comments. Be sure to read the comments, since that is where accountants reveal possible issues of concern. Hiring an independent accounting firm to review the financials may also be prudent.

A lateral may also ask for any routine monthly and annual reports that partners receive. Ask to review aged accounts payable and accounts receivable reports. If essential expenses such as rent are not paid promptly, that’s a red flag. With respect to accounts receivables, if a large percentage of what is “on the street” is older than 180 days, that may be a problem.

Many firms publish profits per partner (PPP). This metric is easily manipulated. Before reporting PPP, a law firm can de-equitize partners to increase this number. Remember that this is an average. One or two partners may be earning multiples of what other partners are earning. Ask for a spreadsheet of what each equity partner earned in the prior two years. There is no need to obtain names. The annual compensation for each partner from lowest to highest will suffice.

A better metric which is widely published is revenue per lawyer (RPL). Again, this is an average and lawyers can be terminated before publishing this metric, but it is less easily manipulated. Requesting a spreadsheet of cash receipts by originating attorney would also be beneficial. Again, attorney identities don’t need to be disclosed, but the range of cash received per attorney is a telling barometer. If one attorney represents a large percentage of originations, that may cause some concern. If that attorney left the firm, would the firm survive?

A list of clients and the percentage of income derived from each client is telling. Ask for two annual reports on income per client. If one client represents more than 20 percent of the firm’s total revenue, this may indicate a problem. The more diverse the client mix is, the better. This report will also indicate if one client was significant in one year and not so much in another year. A lateral should inquire if the firm’s profit-sharing plan is funded on an annual basis. A lateral also should ask:

  • What obligations does the firm have to retired or terminated partners?
  • Have any of the partners individually guaranteed loans?
  • How much is the firm’s line of credit? Has that line of credit ever been used for partner compensation?

Other than addressing financial issues, a potential lateral may want to consider other factors. For example, the lateral should meet with the director of technology. Before joining a firm, a candidate should know that the firm employs best practices in data security. Widely used software applications should be current. This may not be an issue for an AmLaw 100 firm, but if an attorney is considering moving to a small to mid-sized firm, that attorney should know which version of Microsoft Office and operating system a firm is using. If the firm is still using Word 2003, that might be another red flag. The candidate should ask the IT director what major initiatives the firm has taken in the past two years, as well as whether the firm has a disaster recovery plan and when was it last updated.

Next, the candidate should meet with the executive director of the firm and inquire into the following issues:

  • The firm’s limits and retention on its professional liability insurance policy.
  • How long has the firm been with its current carrier.
  • If the firm has recently changed carriers, why?
  • The number and severity of active claims against the firm.

The lateral candidate should also ask if the firm maintains cyber liability insurance and if so, what are the limits of coverage. One major cyber attack may pose significant liability exposure. The following questions are equally important:

  • What was last year’s turnover rate for the associates and partners? What is the range of base compensation for the associates?
  • What does the firm spend on technology (including salaries) as a percent of revenue? What does the firm spend on marketing (also including salaries) as a percent of revenue? Each of these percentages should be between 3-5 percent.
  • How much does the firm spend on facilities as a percentage of revenue? If facility costs are more than 7 percent, that might be another red flag.

If the executive director does not have this data easily accessible, that is a concern. A properly maintained business would know these metrics and track them routinely. Another important request is to review the firm’s partnership agreement. This seems to be a basic premise, but not everyone asks for it. Similarly, the candidate should ask about firm governance and whether there has been recent turnover in management and why.

Finally, the candidate should meet with the most recently integrated laterals. Meeting with new laterals may provide insight into the firm’s culture that is not readily posted on the firm’s website.

In summary, laterals may be leaving their current firms for various reasons not limited to dissatisfaction with compensation, too many conflicts, firm culture and the firm’s financial stability. Anyone contemplating a change wants to be sure that he or she does not leave one firm and join another one with similar or other issues that would prevent that attorney and clients from thriving.

About the Author

Gail Ruopp is the executive director of Flaster/Greenberg P.C. Follow Gail on Twitter @gailruopp.

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