New Small Firm Staffing Economics: Leverage is Dead

New Small Firm Staffing Economics: Leverage is Dead

During my second year in law school, I interviewed for a part-time law clerk position with a small private firm. I think the interviewer wanted to probe whether I understood law firm economics (which I didn’t). At some point, they said, “See, we’ll pay you $7.00 an hour and then we’ll bill your time at $35.00 an hour.” My first lesson in leverage.

Before the internet, email, laptops, and smartphones, leverage was a key economic principle underlying most law firms. The firm was a pyramid and the people at the top made a good part of their money by billing out associates at way more than their salaries. As a partner, the more work you could generate for associates, the more money you could make. If you were an associate, your goal was to become a partner.

At the time, Rule 5.6 of the Model Rules of Professional Conduct, which bars nearly all types of non-compete agreements for lawyers, was little more than an honorable homage to the holy principle of client choice. Clients had to be able to choose their lawyers. Hence, when a lawyer left a firm, the firm could not prevent the lawyer or the client from continuing that relationship. But there was little risk to the law-firm leverage model from a ban on non-compete provisions because lawyer mobility was impeded by lack of technology.

Rules of Professional Conduct threaten the future of the practice of law

To leave an established firm and start your own, you would need to set up an office with typewriters, furniture, a desktop computer, server, phone system, and staff. A large bank loan would be needed to fund operations for at least the first several months. A lawyer would need to put up their house as collateral for the loan. To ask your clients to follow you to your new firm, you would have to call them one by one or send them letters by mail, each of which might have to be typed individually, probably by someone other than the lawyer, because most lawyers did not know how to type (when I started practicing in 1990, few lawyers had computers on their desks. Computers were for secretaries to use). Want to leave big law and start your firm? Good luck with that.

Today, almost all lawyers need to start a law firm is a laptop and a smartphone. Give your notice to the firm, send an e-mail blast to your clients, and keep working. Rule 5.6 renders the firm nearly powerless to stop you. They can’t bar you from contacting your clients, they can’t get lost future profits out of you, and they can’t handcuff you with financial penalties for leaving.

Sounds great, right? If you’re unhappy at your firm you can leave and take your marbles with you. This is what most lawyers think, especially newer lawyers. And when lawyers with large books of business become dissatisfied with their compensation or the management of the firm, they often do leave for another firm or to set up their firm. Freedom! Self-determination! Hasta la vista!

Compensation models are changing and firms are struggling to find a solution

This paradigm shift has had a significant impact on both large and small firms. Yes, some mega-firms thrive because they handle complex litigation and transactional matters that require large teams of lawyers to tackle and they have worldwide brands and relationships that bring in clients.

But many large and medium-sized firms have been forced to move toward “eat what you kill” compensation formulas to keep their most-productive lawyers, particularly the rainmakers, happy. This weakens the bonds between lawyers in a firm. Instead of a team with a common mission and identity, many firms have been divided into a bunch of individual book-of-business fiefdoms stitched together by a common name and shared overhead.

Firms have learned that if they don’t maximize the take-home pay of their best lawyers, those lawyers will just take their clients and leave. I have heard senior lawyers talk about not letting associates or junior partners have direct contact with valued clients because of the risk the younger lawyer will develop a close relationship with the client and take that relationship to a new firm someday.

Mobility is effecting loyalty and career trajectories

Mobility affects smaller firms slightly differently. Many associates leave after a couple of years. Part of the reason they leave is that they look at how much work they do, they look at how much they are being paid, and they conclude that they could make more money out on their own. They may not appreciate how hard it is to get new clients in the door or to keep a law firm running, but by the time they figure that out, they are long gone. As a result, leverage – the business model in which lawyers make more money by hiring young associates at a low rate and billing them out at a higher rate – is dead or dying.

Firms have a little financial incentive to hire and train new lawyers

Beyond crass compensation formulas and senior lawyers grumbling about the next generation’s lack of loyalty, there are more insidious consequences: firms don’t want to hire new lawyers. Corporate clients are becoming increasingly aggressive about refusing to pay for two lawyers to attend motions, depositions, etc. So firms have to bear that training costs themselves.

Smaller firms not only have to absorb training costs but the nature of the work at small firms often means that the associate develops a direct relationship with the client, even if the associate did not bring that client into the firm. Why invest in new lawyers if they are just going to pick up and leave just when they are starting to become profitable?

In all sizes of law firms, I see a reluctance to hire new lawyers. Lateral hiring of lawyers with three to five years’ experience and a budding book of business is increasing; firms are hiring and training paralegals to perform tasks that new lawyers used to do.

Meanwhile, new lawyers are left to figure it out for themselves in solo practices or small firms with a classmate or two. They do not receive the training and mentoring that used to be obtained through established law firms. Many of them have to feel their way through depositions, negotiations, and transactions. They get by but they’re rough around the edges.

I hear more experienced lawyers complain about short-sighted litigation tactics and missing professional courtesies. As a profession, we are not taking as good care of our own and we are all the poorer for it.

Should law firms embrace non-compete agreements?

There may be many potential solutions to these issues. But an obvious solution is our fixation with the prohibition on non-compete agreements – Rule 5.6. Nearly every other business allows non-compete agreements: medical device companies, accountants, doctors (except in California, where all noncompetes are prohibited). Have you tried to find your doctor after he or she has left the clinic they worked at? It’s like they went into a witness protection program. Your medical issues are not so sensitive that they can’t be handled by another doctor but for your legal issues, if you couldn’t choose your lawyer it would rank up there with a crime against humanity.

Non-compete policy and the effects on client experience

This commitment to client choice doesn’t make much sense. After all, lawyers fire clients all the time. A lawyer has broad discretion under Rule 1.16(b)(1) to withdraw from representing a client as long as there is not a material adverse effect on the lawyer. Lawyers drop clients when they take in-house positions, become judges, or quit practicing to raise children. Their clients survive with a new lawyer – imagine that.

What if we changed Rule 5.6 to allow limited forms of non-compete agreements or perhaps limited embargoes on soliciting clients after a lawyer left a law firm? Yes, it could strengthen the hand of law firms as institutions and put them more in control of compensation and clients. But it could also allow firms to invest in the future. Less mobility, more investment. Maybe it would tighten the bonds between lawyers at firms so that they have to give some value to the future of the institution and not just their self-interest.

The post New Small Firm Staffing Economics: Leverage is Dead appeared first on Lawyerist.com.