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Law Firms Put A Lot Of Eggs In One Basket... And That Basket Is Looking Iffy

Thomson Reuters unveiled the Q1 Law Firm Financial Index and there are some potentially problematic findings.

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Look at all those transactional attorneys!

Law firms racked up big revenue numbers and massive profits throughout the pandemic. With fundamentals still relatively strong and overall demand still up, there are a lot of reasons for firms to remain pleased. Sure, expenses are way up — a combination of associate salary bumps and the return of travel expenses largely absent over the last couple years, but firms are still thriving.

Thomson Reuters put out its latest Law Firm Financial Index (check out the full report by signing up here) — the artist formerly known as the Peer Monitor Index for folks who’ve followed this for a while. And while the LFFI continues to reflect a market with sound fundamentals, there’s some risk on the horizon.

While demand for most practice areas continued to grow, M&A demand was down 5.7 percent over the last quarter compared with last year. That wouldn’t be as big a development if firms hadn’t spent years putting an increasing amount of their financial eggs in the transactional basket.

“The practice balance has shifted toward transactional over the last several years. Any relative slowdown will have more dramatic impact than in years past,” said William Josten of the Thomson Reuters Institute. That decline isn’t evenly distributed amongst firms. “The 5.7 decline is not to the same extent for top tier firms. It’s being driven by Am Law second 100 and midsized firms.”

Will this hit spill up to the Am Law 100? Is this just a matter of work rebalancing itself or a real economic slowdown? Firms need to be particularly sensitive to this because while there’s still a lot of money to be made in legal services, if firms are carrying a glut of transactional attorneys when the world shifts to litigation there will be some painful conversations.

Putting aside the possibility of being overweighted in the transactional space, things are still looking pretty good for law firms — though don’t expect the soaring profitability figures to continue in the post-COVID environment:

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“The first quarter saw strength in demand and rates that would be the envy of almost any pre-pandemic quarter,” said Mike Abbott, head of the Thomson Reuters Institute. “But last year’s sharply reduced overhead expenses provided a significant tailwind that boosted profitability. As those expenses return towards historically normal levels, profitability continues to grow, but at levels nowhere near the outsized gains seen in 2021. The ongoing competition for talent is also contributing to the drag on profits.”

Direct expenses were up 13.1 percent, driven in large part by the merry-go-round of associate raises. Meanwhile overhead was up 9.9 percent with recruiting expenses tied to the hot lateral market contributing to the hike.

And those expense numbers probably haven’t hit their ceiling yet. Josten pointed out that events are still rolling out. “Events are still not back to their top yet so the potential for increase is still there. As things continue to come back to that basis point — events, client meetings — those expenditure categories are going to continue to come back up.”

Will revenue continue to outpace the sharp upturn in expenses? Will there be enough deals to keep the corporate department busy? Not to sour a generally positive report, but those are the questions that will keep law firm leaders up at night for the rest of the year.

Law Firm transactional demand slows, while lawyer pay jumps in Q1 2022, Law Firm Financial Index (LFFI) finds [Thomson Reuters]

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HeadshotJoe Patrice is a senior editor at Above the Law and co-host of Thinking Like A Lawyer. Feel free to email any tips, questions, or comments. Follow him on Twitter if you’re interested in law, politics, and a healthy dose of college sports news. Joe also serves as a Managing Director at RPN Executive Search.

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