Freshfields equity cull pays off as PEP doubles in three years

Freshfields equity cull pays off as PEP doubles in three years For magic circle firm Freshfields Bruckhaus Deringer, any fears of slumping profitability are well and truly in the past – for the time being anyway. The firm may have hit a rocky patch between 2003 and 2005, but in the three years since it has recorded a massive 106 per cent rise in average profit per equity partner (PEP).

An 18-month programme launched in 2006 – the year finances started to recover – saw around 100 partners leave the equity, both voluntarily and via a partner cull, with the specific aim of improving profitability. That certainly seems to have paid off, and with the firm bearing the full £55m partnership restructuring cost during 2006-07, in the last financial year alone PEP has risen by 39 per cent to hit £1.44m. Pretty impressive considering that at the end of the 2004-05 financial year partners were pocketing on average £700,000.

The firm’s chief executive Ted Burke says the restructuring had a big effect on boosting profitability. Notably, this year’s profits have been shared between 415 partners while last year they were distributed among 470.

Another factor that contributed to the massive hike, says Burke, was the strength seen in the first two months of the financial year, while exchange rate movements also played a small role in boosting profits in sterling terms – though not quite so much as has been claimed.

While profit at the firm has risen sharply over the past three years, turnover growth has been less dramatic, with revenue rising from £780m in 2004-05 to £1.18bn in the last financial year – an increase of 51 per cent.

According to the firm the disparity between turnover growth and profit growth has been distorted by the fact that profit had lagged behind for a number of years at the start of the decade.

“So many of our people, lawyers and non-lawyers alike, worked extremely hard to produce our results and all credit to them,” says Burke. “Still, a number of factors make this an unusual one-year increase – one we wouldn’t expect to see again.”

Looking at the firm geographically, Burke says China, Moscow and the Middle East did particularly well over the past year, with Germany and France also putting in strong performances.

He adds that the US practice was the most impacted by the global slowdown, although its US arbitration and infrastructure finance groups have done well.

Clifford Chance is the only other magic circle firm to have announced its financial results so far this year and, although the firm’s performance has been more muted than Freshfields’, on a three-year view it has been more steady.

Between 2005 to 2008 Clifford Chance has seen turnover rise 46 per cent – up from £914m to £1.33bn. Over the same period, PEP has gone from £615,000 to £1.15m – a rise of 87 per cent.

Like Freshfields, Clifford Chance experienced some financial difficulty at the beginning of the decade and, like Freshfields, it sought to cut its cost base.

Global managing partner David Childs achieved this by axing hundreds of business support jobs and offshoring a number of internal business functions.

The management at both firms are in agreement that the coming 12 months will be far more difficult than the past 12.

Childs says: “Generally speaking, the transactional practices are quieter in the US and London, they have gone quieter in Spain and Italy and there are early signs of it quietening down in Singapore and Tokyo.”

With Childs foreseeing a slowdown across the globe, Burke believes that growth of any kind would be an achievement in the coming year. Your responses to news that Freshfields Bruckhaus Deringer had posted an average profit per equity partner (PEP) figure of £1.44m – a 39 per cent increase on last yearCall me a cynic, but has the fact that Freshfields’ PEP has gone up 39 per cent got anything to do with getting rid of 100 equity partners?Remember… that if you take the exchange rate from last year, then the percentage increase on turnover is only around 9-10 per cent.

Very impressive results, especially when you consider that Freshfields don’t massage their numbers by making a huge chunk of their partnership non-equity, like some of the other usual suspects (Herbert Smith and Clifford Chance being the worst offenders).

Of course the cut in equity partners has had an effect, and this argument would be very valid if the percentage was high, but the PEP figure low. I don’t think any City partner could deny that a PEP of £1.4m is pretty impressive.

Freshfields has made far too few partners up over the past few years, as well as shedding large numbers. This is a difficult model to sustain.

Any firm can boost their PEP simply by de-equitising hordes of partners or making up lots, but leaving them salaried. If you’re going to bother having a one-stop figure for comparison purposes, you may as well have revenue per partner. Unless you have a standardised measure that actually shows how much business each partner has brought in, you might as well not bother.

Freshfields may well have reduced the number of partners, but it still has a leverage of 4:1 – that is twice the likes of Herbert Smith, which is more like 8:1, and better than most, if not all, of the top UK firms. Therefore there are no tricks here, just one hell of a profit-making powerhouse.

So, to recap, the partners are making nigh on £1.5m, but they had to sack hundreds of support staff as an economy measure. And will the partners will be handing out a big bonus to the workers? No, I thought not.

I think it’s part of the firm’s commitment to social responsibility…