K&L Gates” /> Being debt-free keeps destiny out of bankers’ hands
As expected, the partners at Carolina firm Kennedy Covington Lobdell & Hickman voted unanimously in favour of joining forces with K&L Gates. The vote of the partners at the larger firm was equally positive. The deal goes live tomorrow (1 July).
The headline statistics reveal an expanded firm with more than 1,700 lawyers in 28 offices. What the press release did not reveal was the financial prudence that lies behind K&L Gates’ latest acquisition – indeed, behind all of the firm’s recent deals in its 21st century growth spurt.
It is a proud boast of the firm, and of its chairman Peter Kalis, that not only does K&L Gates have no debt, but its recent expansion has been funded entirely out of partner capital. In the current economic environment, the argument that firms with strong balance sheets and happy bankers will be the ones that emerge healthiest when business returns to normal appears a sound one.
The Lawyer took the opportunity of the Kennedy Covington deal to quiz K&L Gates chief finance officer Glenn Graner on the pros and cons of being debt-free. The key pro, he argues, is that with no debt the partners will never sit across the table from a banker who can control the firm’s financial decisions or destiny. But according to Graner, a debt-free position is also a significant plus in the recruitment market.
“Say a partner comes to see us,” says Graner. “Pete Kalis does a great job of selling the firm and its strategic ambition. Then I can tell them about the finances and that we have no debt. Their eyes light up. We believe it sets us apart and is a significant advantage for us when recruiting.”
Graner believes K&L Gates is one of just a handful of US firms with no debt. By contrast, the firm maintains a 35m Dollars (£17.76m) line of credit – “our rainy day fund”, says Graner. This has mushroomed from 7.5m Dollars (£3.81m) in 2002, although Graner says the firm has never used it.
While he borders on the evangelical about the importance of staying out of debt, Graner does not rule out the necessity of going into the red occasionally.
“We don’t have a policy that says we forbid debt – there will be situations when it makes sense,” he argues. “In London we’re taking on a significant lease for new office space on 1 April 2011. The fit-out will cost around £20m, and when we come to financing it we’ll have choices. To pay for it in US dollars would not be wise because the currency’s so weak. So we could borrow in sterling in the UK and keep foreign exchange out of the mix.”
What is more, adds Graner, borrowing from the bank can send a positive message to the firm. “If a bank’s willing to lend you money it tells your partners you’re in good shape,” he says. “It’s a fine balance.”
As far as the mix of partner capital to debt is concerned, Graner believes a healthy balance is in the region of 90:10. A higher ratio – say 30:70 – begins to look dangerous, he says. Others, including Alan Hodgart of the H4 consultancy, believe a ratio as high as 1:0.5 can be “prudent”.
“We’ve always had the view that firms should have some debt,” Hodgart argues. “You can get more leverage by borrowing.”
This may be where US and UK law firms diverge, thanks to the cash versus accruals methods of accounting. The US’s cash-based approach may mean the need for debt is much lower than in the UK, as there is no need to finance the accrued pipeline of work in progress and debtors inventory, which can easily translate into four months’ turnover.
Of course, much also depends on the underlying health of the business. Any firm that starts losing rafts of partners but is committed to expensive overheads could easily find itself in trouble – especially if those leases are recourse to the partners.
At K&L Gates, all of the leases and most of the firm’s overheads are non-recourse, creating a protective shield for the firm’s partners.
“Our partners are obligated for zero,” says Graner. “That means the banks can’t go after them, so there’s zero risk. The only exposure to individual partners is their capital.”
That is not an inconsiderable sum, with K&L Gates partners stumping up a minimum of 35 per cent of annual earnings to fund the firm. But at least if the worst happened, their exposure would stop there. Not every firm can say the same.
Orrick stays true to structured finance with hire.
Orrick has vowed to stand by its structured finance practice despite its decline during the ongoing credit crisis. While the likes of Cadwalader Wickersham & Taft scale down their structured finance capabilities to focus on less transactional practice groups such as IP, Orrick remains committed – as demonstrated by last week’s star hire of Goldman Sachs mortgage finance group head Howard Altarescu.
The firm hired Altarescu to beef up its New York structured finance team as part of its wider strategy to bulk up in the practice area.
In the UK, Hunton & Williams partner Mark Fennessy and his team joined Orrick in May this year, bringing the total number of fee-earners in the City to 75.
“We want to get to 100 in six to nine months,” says London managing partner Martin Bartlam. “The firm’s view is that structured finance is still an innovative and valid practice area. The markets will recover and we’re committed to the team.”
The appeal is related to the expertise structured finance lawyers can bring to restructuring. Winning mandates on structured investment vehicle (SIV) restructurings is totally dependant on the knowledge of structuring SIVs in the first place.
“It’s about having the right mix of restructuring and structured finance in this climate,” says Bartlam. “There’ll certainly be more SIV restructurings ahead, so having the right capabilities is crucial for Orrick.”
Fennessy and his team advised Bank of America as a senior creditor on the Cheyne Finance SIV restructuring, as well as advising on the Rhinebridge and Whistlejacket restructurings.