Editors' Blog

Deleveraging, legal-style

Posted 21/11/2008 by Alex Novarese

Once in a while a business story catches the eye because it goes right against the grain. One that passes that test is news that DLA Piper’s US arm is set to vote on a substantive restructuring of its partnership that will brings hundreds of salaried partners into its equity ranks.

The outline of the deal to be voted on next month is that around 275 non-equity partners will be asked to contribute capital and move from salaried status to take a direct profit share. At a stroke it promises to reverse a 10-year trend that has seen large law firms continually stretch leverage through the creation of massed ranks of salaried partners.

Radical stuff, but there is an undeniable logic to the firm’s stated reasoning. By cutting back salaries of its most expensive employees, fixed costs are slashed. Capital that partners contribute would provide a substantial cash boost and cut reliance on increasingly expensive bank debt. It should also more fully align incentives of the partnership as partners only get paid if the firm profits – perhaps Eversheds’ cash collection issues would have been less pressing had the firm had more equity partners.

Others may now be tempted to go down a similar route; particularly in the US, where partner remuneration, which often ranges widely from the lowest bands to top-of-equity, is conducive with such a move. If your plateau partners take home 10 times the stake of the lowest-drawing partners, in theory it is not dilutive to convert salaried partners to equity (in contrast, most lockstep-derived firms in the UK would find the move tricky as even junior equity partners earn much more than salaried equivalents).

Still, a few questions remain unanswered. Having expressed a desire to give all partners some kind of equity stake, it is not clear what happens to those that do not want the new status. And in such challenging economic times, mediocre partners at DLA must be feeling a little nervous right now.

There have also been some confusing statements over whether the converting partners would gain the same status as existing equity partners. What has also received less attention than the idea of handing out equity stakes is the related plan to reduce the payouts of some senior equity partners, who in some cases have been reported to earn as much as $5m (£3.3m) a year.

Of course, a lot of lawyers on this side of the pond will be wondering if DLA Piper’s European partnership will pursue a similar strategy. Since more than two thirds of DLA Piper’s European partners are on salaried status - contributing to the firm’s thumping 10.6:1 lawyer:equity partner leverage - the logic of such a move should be even more compelling than it is to the less-leveraged US business. At present, UK partners are keen to stress that they have no plans to follow suit, though at least one US partner at DLA Piper believed that this is something that the European practice may consider in future.

What is certain is that many firms – in the US and beyond – will be watching DLA Piper’s success or failure, particularly if the global economy continues to languish. Because there is one characteristic that leverage in a legal context shares with its better-known cousin in banking: the model super-charges returns on equity in the good times but sure isn’t built for downturns. The legal market could be set for a little deleveraging of its own.