What Law Firms Can Expect in a ‘Grueling’ Second Half of 2020

Welcome back to the Big Law Business column on the changing legal marketplace written by me, Roy Strom. This week, we look at trends that are likely to shape the second half of the year for Big Law. Sign up to receive this column in your inbox on Thursday mornings.

Law firms’ first half financial results are in, and they are much better than most partners would have predicted a few months ago. That’s especially true for the largest U.S. firms, which may be gearing up for a lateral partner shopping spree in the New Year.

Firms among the AmLaw 50 grew revenue by 7.1% over the first half of the year, according to Citi Private Bank’s Law Firm Group, which surveyed 196 law firms. Those within the next 50 largest grew revenue by 3.4%, and the AmLaw Second Hundred saw revenue rise by only 1.4%.

The top-heavy results are not an entirely new phenomenon. The biggest, richest firms have been the best performers in most years since the Great Recession. But the performance gap in the first half was not normal, said Jeff Grossman, head of business development and client strategy at Citi Private Bank’s Law Firm Group.

That should be concerning for leaders of smaller, under-performing firms. They may struggle to retain and compensate their most marketable partners if they can’t bolster their firm’s finances by the end of the year.

“The story still needs to be told, but we do think we will go into a greater period of lateral turnover after the end of the year just because of the disruption and volatility in the industry,” Grossman said.

Here are some other themes managing partners can expect to develop through the rest of 2020 and beyond.

Lower inventory and client pushback may impede growth.

The first half started strong, but the industry’s momentum is fading.

The top 50 firms increased revenue by 9% in the first three months of 2020 compared to 5.9% in the second quarter, according to Citi.

A good portion of that was driven by an inventory build-up (read: a mountain of uncollected bills) at the end of a strong 2019. That inventory cushion is wearing thin. Inventory growth in the first quarter was 7.4%, which slowed to around 5% in the second quarter for the AmLaw100, Citi says. The Second Hundred grew inventory at 3.3%, putting more pressure on performance in the third quarter.

The longer those bills go uncollected, the more likely it is that firms won’t see all the money. Discounts, write-offs, and clients’ overall health are concerns, Grossman said.

“We still have some momentum, but there is not as much gas in the tank as there was going into the second quarter,” he said.

Focus on cutting expenses will continue.

When law firm leaders made decisions to cut salaries earlier in the year, they did it based on projections that revenue could decline anywhere from 25% to 35%, Grossman said.

“It was based on them having no past evidence or data to even try to forecast,” he said. “Thankfully their fears have been allayed.”

But firms are far from out of the woods. Law firm leaders were expecting demand for their lawyers’ time to start to rebound during the summer, but Grossman said that hasn’t panned out. He’s now looking for a post-Labor Day pick-up.

The longer demand stays depressed, the more likely law firm leaders will focus on cutting or maintaining expenses. Second Hundred firms have posted growth in profitability through six months, largely thanks to their ability to cut expenses, Grossman said. He doesn’t expect that profit growth will last through the end of the year.

“The bar is higher for the second half of the year, and the third quarter we don’t think is going to help drive the result,” he said. “We’re going to really rely on the fourth quarter, and that is going to be a big challenge.”

“Bonuses” may emerge at firms that perform well.

In April, when some firms were promising that equity partners would shoulder the biggest burden from salary cuts, I wrote:

“There could come a time when firms will need to revisit their egalitarian promise. If a law firm’s revenue projection doesn’t fall as far as leadership anticipates when announcing today’s salary cuts, and partners don’t end up taking a bigger hit than associates, will the law firm retroactively keep its promise to associates?”

That has been happening at some firms, Grossman said. In cases where the firms outperformed their initial forecast, leadership has “clawed back” some of the wage reductions for lawyers and staff, he said. Some firms, like Sheppard Mullin and Fox Rothschild this week, have announced gradual rollbacks of salary cuts.

Grossman said some of the firms that announced they would be delaying payments to partners have also gone ahead and made distributions. The goal of the cuts was to preserve liquidity, and Grossman said the industry has built up a fairly robust cash pile.

Firms will need that cash to take on what Grossman expects to be a “challenging” second half of the year.

“If you’re two laps into the race, and the race is going to be grueling, at least you started with good momentum,” he said.

Worth Your Time

On Litigation Finance: Litigation funders this year have raised more than $1 billion in new capital after Pravati Capital raised $200 million this week. Some in the industry think even the new influx of cash won’t be enough to meet demand caused by the coronavirus pandemic.

On the ABA: The American Bar Association is facing fears that law firms will reduce or eliminate membership dues for their lawyers, Melissa Heelan Stanzione reports. The association’s membership dues have already fallen nearly $20 million since 2010, and Covid-19 isn’t helping matters.

On Regulatory Change: The Utah Supreme Court voted to establish a regulatory “sandbox” that could result in broad changes in how law is practiced in the state.

On Law Firm Leaders: Is it “new managing partner season” in Big Law? Littler Mendelson elected Erin Webber as its new managing director and president, and Dykema elected Leonard Wolfe as its chairman and CEO.

That’s it for this week! Thanks for reading and please send me your thoughts, critiques, and tips.