Do the sums before making a lateral hire because many fail to live up to the hype, and are corroding firms from within
Some poker experts maintain the difference between a good player and a poor one is that the good player knows when to fold a hand the poor player thinks is a winner.
“Law firms don’t know when to fold when trying to hire lateral partners,” says one experienced hirer at a leading global firm. “So they hang on to partners in the recruitment process for far too long and end up going with a pair of sixes when they really need a full house or, at the very least, three of a kind.”
A managing partner at another Top 50 global firm calls the resulting hires “drizzlemakers”, lawyers whose client followings are enough to make the ground wet, but not sufficient to properly irrigate the crops. When the chief operating officer at one leading UK practice analysed his firm’s lateral hires he found that 80 per cent of them failed to meet the figures stated in their initial business plans. My experience suggests this is not uncommon.
One HR director at a Top 30 firm confessed to me that he never re-examines laterals’ original business plans because to do so would be “politically unacceptable”. Another admits that his firm – another top City practice – does no analysis whatever on whether laterals break even, preferring to take a “gut feel” view of success. Partners I have worked with confess they have manipulated a lateral’s business plan to get it past the management board, reckoning things would work out all right in the end.
I have no problem, per se, with any of those admissions. After all, firms are complex organisations and difficult to analyse meaningfully. However, my research into nearly 3,000 lateral hires in the London market featured in the 18 March issue of The Lawyer shows that lateral hiring seems not to work out an awful lot of the time; in fact, UK and US law firms in London can expect around half their hires to leave within five years.
It set me wondering whether a more analytical approach might yield better results for firms. And yet, given the complexity we all recognise, is not a more rough-and-ready approach preferable to some Byzantine set of mathematical formulae that will have everyone’s head spinning? Law firms seem to think so.
There is a pernicious side to taking a relaxed approach to laterals, namely the effect it has on the firm’s internal workings and, in particular, on incumbent partners. It is all very well not to attempt to properly calculate the point at which lateral hires break even, but if you are
simultaneously putting incumbent partners’ revenue under the microscope as part of a de-equitisation exercise there is no level playing field, and that is going to upset some people.
To inject an element of systemic injustice into such a subtle and complex web of personal relationships that is the modern law firm is a risk that seems to be unrecognised, even though it could corrode the entire firm from within. And, I would humbly submit, that is exactly what has happened in some firms, with incumbent partners feeling laterals get an easy ride, or that management seems incapable of facing up to its lateral hire mistakes.
Am I exaggerating? I think not. Many things you may take for granted or count as just part of the normal run of things are not what they seem. Firms unwittingly subsidise or penalise both incumbent and lateral partners via their various systems, which only serves to drive certain types of behaviour and, ultimately, define the culture of the firm. This may make it more difficult to hire or retain certain types of individual, and may create toxic internal competition.
Yes, being transparent about lateral hire break-even may make it more difficult for lateral partners to pay their way, and more difficult for firms to hire. However, the upside is that the likelihood of profitability being degraded in the pursuit of a hiring campaign driven largely by politics, vanity and perceived rather than properly analysed need is much reduced.
Running the numbers
So, what are we talking about in real terms? Well, let’s imagine an example partner, we’ll call him Bob. A fixed-share equity partner in a mid-tier firm, Bob reckons he has a following of about £1m. He is earning about £300,000, which looks a fraction under par, but the firm is struggling a bit so he has a couple of good reasons to look around.
He goes to see a recruiter who reckons our Bob is underpaid and senses a nice, placeable candidate. He reckons he can get Bob £350,000 realistically, although our man is hoping for more like £400,000. He goes to see a few firms and gets an offer of £330,000, plus a potential bonus if he overperforms. Recruiter thinks “result” and, after a little gritting of teeth, we have a deal and Bob joins the new firm.
The firm is thinking that, if Bob is good for his stated following, his recruitment will neatly cover all the bases according to the traditional Rule of Three by which many firms still assess the viability of hires. One third of Bob’s revenue will cover his remuneration; a third for costs, such as property, staff and riotously expensive chocolate biscuits for the client meeting rooms; and a third for profit. It all sounds great. Let’s call it £330,000 for Bob; £330,000 for attached costs, including any staff, property and so on; and £340,000 for profit.
Except Bob, like many lateral partners, fails to hit his revenue target in his first year. Actually, he doesn’t bill anything in the first six months, but then a couple of chunky jobs come in and he finishes the year at a decent run rate, billing a total of £500,000, or about half his stated following – not an uncommon experience among lateral partners.
Still, people at the firm are pleased. Bob’s run rate in the last couple of months of Year One is above the rate he needs to bill £1m per year. In many firms, that would most probably be the end of that. At the start of the new financial year, the account would effectively be zeroed and Bob’s healthy new run rate would mean the first-year loss would not be accounted for.
In fact, if we are going to judge the hire fairly we should roll over that loss into the next year and add it to his target, making his Year Two target £1.5m – three times what he billed in Year One – and that is not including any cost inflation, any salary increase for Bob (unlikely, admittedly) or any increase caused by higher profit targets. Bob’s chances of meeting that? Hmm.
Let’s imagine he puts in a sterling effort in Year Two and bills £900,000. Now, that would cover his salary and costs quite comfortably and make a small contribution to profit – if we were starting at zero. But, of course, we are not starting at zero. So instead we have a £600,000 undershoot on our combined Year One and Year Two expected revenue. Bundle a bit of cost inflation into that and so forth, and you have Bob needing to double his projected following in Year Three just to break even across the three years, even if we don’t increase his billing target at all over the four years.
Looked at another way, if we assume Bob’s remuneration is not going to rise over, say, four years (as we’ve pegged his billing target this seems fair), but that cost inflation will be around 3 per cent, and target firm profitability will be 5 per cent-plus year-on-year, our Bob is going to have to bring in around £4.2m in his first four years just to cover his costs and make an average contribution to profit.
This starts to look brutal. If Bob bills £500,000 in Year One, that leaves £3.7m to bring in over three years, or £1.2m-plus a year. If he bills £900,000 in Year Two, that leaves £2.8m for the last two years, or £1.4m a year. And let’s not forget that, at this level, Bob is merely maintaining, not enhancing, firm profitability, which is not quite the point of lateral hires.
Bob is a classic drizzlemaker, the kind everyone thinks/hopes/prays is going to come good in Year Three and beyond and start making
decent contributions to profitability. But hire a few Bobs in a year and it is not difficult to see how you can quickly degrade your profits.
In fact, any kind of drag on Bob’s part due to undershooting the basic calculation of properly apportioned costs plus contribution to target profitability is going to make some difference to the firm’s financial health. And this has to be paid for somehow, whether through lower profit distribution, increased borrowing or increased need to trim costs. Ignoring it should never be an option.
Ah, you may say, but why roll things over at all? Surely, firms work on the basis of distributing profits every year. Whatever is in the kitty goes out and every partner’s account is effectively zeroed at the start of the year.
Well, in theory, yes. But looking at the levels of overdraft in many firms and noting that average profit per equity partner – which does not equal distribution by any means but has to be something of a guide – has remained constant in many firms, it is not difficult to draw the conclusion that a lot of firms are juggling to keep paying out profits that are not really there. In that scenario, not rolling over Bob’s losses to the next year is a problem.
Moreover, fudging the figures to cushion Bob’s entry into the firm and not putting undue pressure on him – an excellent idea in principle – is fine, but may not be fair. If you are simultaneously grilling incumbent partners such as Clive and Derek over their less-than-great figures, you are not operating a level playing field. If you are prepared to gift Bob what is, in effect, an invisible subsidy, should not Clive and Derek receive the same?
Examples of invisible subsidy include not rolling over losses from one year to the next; applying supposedly ‘sunk’ costs, such as property, to laterals in their first year or even two; double-counting the work brought in by laterals and referred to other partners, both in terms of double-counting the hours but also double-counting for the purposes of bonus payments; and referring work to laterals that may be better or more profitably undertaken by someone else in the firm.
Let us look at just one of these, by way of illustration: the notion of ‘spare desks’. The firm has paid the rent for the building, already has the furniture and is already committed to lighting and heating the space, so slotting a new partner in is just using up sunk costs, yes?
True, but failing to apportion any part of that cost to the new partner is gifting them an invisible subsidy. Clive and Derek have a right to expect that Bob contribute his share of costs, otherwise they are simply paying for the newbie. To look at it another way, perhaps the partner you are busy de-equitising because he is not profitable enough would be more profitable if he did not have to bear a share of the costs of the 12 laterals you took on last year who are busily draining your war chest through underperformance.
Investing in new lateral partners may be what the firm needs but if you have not outlined exactly what the cost will be, your equity partners have a right to ask a) why you have not done so and b) how this is fair to incumbents who, after all, may have given blood, sweat and tears to the firm since they were trainees.
Ignoring these issues will only stoke up resentment and corrode the ties that bind the firm. Not only that, but if, for example, you have to issue a cash call, don’t the partners have a right to know why? If you are having to raise cash because you have hired partners who are not making a proper contribution to profit, are you not obliged at the very least to attempt to run the numbers in a sensible way?
Alas, many firm partners seem possessed of an imperative to invest at all costs. It is almost as if they believe that doing nothing is worse than doing something, anything, and possibly making the wrong decision in the process. Some go even further. One partner friend of mine relates how her firm would sometimes walk away from potential laterals because they “weren’t expensive enough”, a classic case of being wowed by prestige and one, I wager, many a firm has run into when taking on ex-magic circle trophy hires who fail to bring home the bacon.
I am not a gambling man, but my understanding of betting is that the more information you have, the more likely it is you will come out ahead. Not bothering to calculate when lateral hires will break even, or even if they might, and basing your decision on the promise of largely unverified and unverifiable figures you are never going to re-examine strikes me as being rather like kissing a lucky rabbit’s foot before you lay your bet. Hey, it might work.
Worse than laying a bet without much of an idea of whether you have a winning hand is surely doing so without properly assessing the impact on your own partners, who may well have contributed to your stake in the first place.
Hire by numbers
There is, of course, another way – more of a policy if you like. It is not difficult, although it is a little complex and involves one thing lawyers are not very good at: numbers.
That policy involves putting potential laterals under the microscope, scrutinising the business plan, calculating when they are likely to break even on best-guess and adjusting all calculations accordingly. It also, probably, involves auditing your past few years of lateral hires with the same microscope and facing up to some hard truths. Finally, it involves laying down some rules as to when and how things can progress so half-winning hands are folded more often.
Yes, doing this probably means you will make fewer lateral hires. You may miss out on ‘golden’ opportunities. But you will recruit fewer drizzlemakers and your profitability will be better. It will take courage. It will take rigour. And it will take discipline to stick to your guns in the face of howls of protest from group heads looking for quick-fix hires and to face down partners who just don’t want to do the hard work and face the tough conclusions.
Do that and you’ll be a firm I’d take a bet on, gambling man or no.
Mark Brandon is managing director of Motive Legal Consulting
…and when it’s right as rain
Happy arrivals: the most acquisitive law firms since May
The lateral recruitment market is thriving, with many quality hires being made by private practice firms looking to boost their coverage of key areas, and many of the moves shown below hit
the headlines on TheLawyer.com. According to data provided by search consultants Deacon Search, in the May to September period there was a total of 137 partner moves (the number
also includes the odd senior consultant).
The firms that hired more than three partners in this time period include: Shepherd & Wedderburn, Bryan Cave, Field Fisher Waterhouse (FFW), Shearman & Sterling, CMS Cameron McKenna, Stephenson Harwood, Covington & Burling, Macfarlanes, Mishcon de Reya, Allen & Overy, Olswang and Davenport Lyons.
FFW leads the pack, with
a total of five partner laterals.
In corporate, the firm took on David Kemp from Taylor Wessing and Neil Matthews from Eversheds. In tax litigation it hired George Gilham from Pinsent Masons and in finance it took on Robin Spender from SJ Berwin and Alex Campbell from Berwin Leighton Paisner (BLP), both of whom were associates at their previous firms.
Addleshaw Goddard was also prolific, taking on four partners. Two of them were corporate partners from Shepherd & Wedderburn, Angus Rollo and Guy Winter; other hires included BLP restructuring partner Simon Thomas and litigator Kambiz Larizadeh, who had been of counsel at Skadden Arps Slate, Meagher & Flom.
Olswang hired white-collar crime litigator Bernard O’Sullivan from Byrne & Partners, patents specialist Justin Hill from Ipulse and two partners to boost its pensions and employee benefits team: Ron Burgess from Lawrence Graham and Andrew Quayle from Eversheds.
Bryan Cave, Covington & Burling and Shearman & Sterling were among the most acquisitive US firms in London. Bryan Cave hired Dentons corporate partner Dan Larkin, Penningtons restructuring partner Abraham Ezekiel and Speechly Bircham competition partner Robert Bell.
For Covington & Burling it was a focus on financial services and litigation – for the former, it took on Charlotte Hill from Stephenson Harwood and added two CMS Cameron McKenna energy litigation partners, Ben Holland and Jeremy Wilson.
Shearman & Sterling continued to boost its corporate pedigree, all at the expense of Weil Gotshal & Manges. It took on private equity partner Mark Soundy, tax partner Sarah Priestly and corporate associate Simon Burrows, who came in as partner.
How to hire a lateral partner: the law firm view
Pinsent Masons has grown significantly recently, appointing around 40 partners in the past financial year. One of the themes that consistently comes through in feedback from new joiners is an appreciation of our culture. Terms such as ‘culture’ and ‘values’ can be overused but, particularly during a period of internationalisation, this is the glue that binds us together.
It is something our clients like and benefit from. For that reason we take the development of the culture seriously and go to significant lengths to help our lateral hires adapt in their first 18 months. We do this as part of a partner coaching programme. This may seem unusual, given the common misconception that coaching is about fixing something that is broken, but we see it as an investment in helping people maintain performance in a period of change.
Sophie Turner, learning and development coach,
It is rare nowadays that you see a business case for a lateral hire built solely around their ability to bring a book of business with them. The whole process has become more strategically aligned with an emphasis on how someone will fit in to the firm or sector’s broader business development objectives.
The planning process should identify when a practice and/or sector needs to broaden its services, deepen relationships with a client or provide a new dimension in terms of geographic reach to win or retain work. The hire should achieve that. Bringing in John Gilbert from BP, for example, gave us further depth in international energy disputes work. Similarly, Paul Ranson and his team from Fasken Martineau gave us broader contentious and non-contentious capability across our life sciences team.
We are also seeing people moving as a result of shrinking panels. A client may have a trusted adviser relationship with an individual lawyer, but be getting the message from their procurement function that this is not reason enough to keep them on the panel. The lawyer faces a choice between competing for off-panel work or moving on.
Once a new joiner arrives, BD support swings into action along with operational cover, helping ensure the market knows they have moved and the offering they are providing in their new home.
Gaius Powell, director of business development, Pinsent Masons