Bruce MacEwen’s blog, Adam Smith, Esq., writes about “The Great De-Leveraging” and explores whether leverage (the ratio of associates to partners) is still part of a sensible business model for law firms. It turns out the answer isn’t easy.

Bruce MacEwen's blog, Adam Smith, Esq., writes about "The Great De-Leveraging" and explores whether leverage (the ratio of associates to partners) is still part of a sensible business model for law firms. It turns out the answer isn't easy.

Just as I was thinking it was about time to publish a column on the topic of “leverage” at law firms (roughly speaking, the associate to partner ratio, although there’s more than one way to calculate something that people will call “leverage”), here comes a slew of pieces on the topic, including:

Prof. Larry Ribstein on “the over-leveraging and over-regulation of the legal profession:”

In the longer run, we now see very clearly that running law firms as thinly capitalized worker cooperatives is not an equilibrium solution in this market.

The answer, as I’ve said many times before, is dropping regulatory restrictions on law firm structure and letting them be run like real businesses. This particularly includes permitting non-lawyer capitalization and perhaps even public ownership, as well as enabling firms to hold onto their intellectual property through non-competition agreements.

A piece in, of all places, The Atlantic’s blog called “There’s leverage everywhere!” with this pregnant introduction to our system:

But let’s work the argument a little further. It surely is true that unlike their current incarnations, the old Wall Street partnerships did not destroy the world with excessive leverage. But in the pre-credit-boom era, no one else was incurring much leverage either. It might be worth considering whether there are entities that are structurally similar to the old Wall Street firms (i.e., partnerships in which a substantial portion of the partners’ net worth was tied up in their employer, and could not easily be removed from same) and see whether they have taken on significant leverage in the modern age of easy credit.

As it turns out, there are such entities. We call them “big law firms.” And their example is instructive.

More than one of these new pieces has referenced something that ours truly wrote about “Leverage: Friend or Foe? (Or Noncombatant?)” back in December 2005, where I said:

Common sense would tell you that in a labor-intensive service industry, where revenue is driven primarily by sheer tonnage of hours worked, the higher the ratio of associates (and non-equity partners) to (full equity) partners, the higher the revenues and thus the profits per partner. Right? It turns out this is one of those cases where it’s not as simple as it seems.

[…] Then there’s the evil twin of high leverage: Low utilization. It doesn’t help that your leverage ratio is through the roof if nobody’s busy; indeed, welcome to the worst of both worlds.

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