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February 11, 2011 12:30 PM

The $5 Million Man

Posted by Steven Harper

On Tuesday, The Wall Street Journal reported that litigator Jamie Wareham, just hired by DLA Piper, "will make about $5 million a year, a significant raise from his pay at Paul, Hastings, Janofsky & Walker, where he has been one of the highest paid partners."

This phenomenon--superstar lateral hiring--is nothing new, but in recent years it has become more common. For those who remember the 1980s, it's vaguely reminiscent of the period when ill-fated Finley Kumble turned that strategy into a losing business model.

Of course, Finley failed for many reasons that may distinguish it from current trends. Still, those running that firm into extinction as they signed up marquee players who couldn't carry their own economic weight had an obligation to ask themselves the question that I now pose for DLA Piper's latest lateral partner acquisition:

When is a lawyer worth $5 million?

Reserved for another day are the broader implications for the affected institutions, including the challenges that significant lateral departures and hires at the top of big firms present to the very concept of law firm partnership. This article focuses solely on underlying financial considerations associated with the superstar lateral hire.

Presumably, bringing in a big-name player makes economic sense for a firm operating under the prevailing business model, which means that at least one of the following conditions are met:

First, the proposed lateral has an independent book of business suitable for delivery to the new firm. That would be simple, but for the clients themselves. Even if they have hired and regularly use a particular partner, they probably are also sold, to some degree, on the attorney's package of assembled talent. Consequently, the lateral must bring along a team of capable junior lawyers. Alternatively, the new firm may have excess attorney inventory that it can deploy, but that requires the lateral partner to persuade clients to use lawyers with whom they've never worked--ones who can quickly and efficiently follow a learning curve.

Second, even absent a short-term economic justification, a firm could rationally conclude that anticipated events make the talent investment worthwhile for its future strategic positioning. Recent examples include firms that loaded up on bankruptcy attorneys when the economy was still strong. The crash of 2008 made them look like buckets of cash. More speculative are the "if you hire them, clients will come" bets that law firm leaders sometimes make. Former government employees, along with high-profile attorneys who lack a portable client following but are on everyone's short-list of best lawyers, fall into this category.

For the first category, short-term value comes down to simple arithmetic. According to the most recent Am Law 100 survey of the highest grossing law firms in the U.S., Wareham's old firm, Paul Hastings, had a 41 percent profit margin in 2009. If his earnings at Paul Hastings--described by the WSJ as "substantially less" than $5 million he'll make at DLA Piper--were, say, $4 million, he would have had to bring in revenues of $10 million to earn his keep, assuming no other equity partners could claim a part of that gross. Assuming a total blended rate of $500/hour--for all the attorneys on Wareham's client matters--that gross translates into 20,000 billable hours per year.

But at DLA Piper and its reportedly lower profit margin (26 percent), Wareham will have to produce almost $20 million to support a $5 million share of firm profits. Again, at a blended hourly rate of $500, that means more than 40,000 hours. (And if he is selling clients on a move that will result in lower hourly rates, the billables requirement at DLA Piper would become even higher.)

If one of the 20 or so attorneys on Wareham's team is another equity partner earning, say, $1 million, then the minimum break-even billables bogey moves proportionately higher. (Assuming a 26 percent profit ratio, it takes about $4 million gross--8,000 hours at a blended rate of $500/hour - to net $1 million.)

Insofar as the lateral acquisition's value relates to the second category--future payoff--big-name players get a grace period. But at some point, the economic imperatives of the first category will surface. When that happens, they'll feel the revenue-and-related-billable-hours heat even more than everyone else--except, of course, the attorneys working for them.

Such is the economically successful lateral hire outcome. Failure on a sufficiently large scale produces Finley Kumble.

 

Steven J. Harper is an adjunct professor at Northwestern University. He recently retired as a partner at Kirkland & Ellis, after 30 years in private practice. His blog about the legal profession, The Belly of the Beast, can be found at www.thebellyofthebeast.wordpress.com. A version of the column above was first published on The Belly of the Beast.

 

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Reminiscent of Louis Brandeis and, later, John Bogle: Perhaps the firm is "obsessed with the delusion that two plus two make five," but risking falling "victim of the relentless rules of humble arithmetic."

"When is a lawyer worth $5 million?" I like the easy question - when he adds the first marginal dollar of value to partner's equity.

If partners can shop themselves to the highest bidder, one can expect regular incidences of "buyer's remorse" and that the firms who don't play the lateral-hiring game do best for themselves.

I think it is good that someone is looking at the actual economics of these deals. I had two reactions. One is that a 26% profit margin is truly frightening. The other is that, at these numbers, I tend to wonder about the margin of error - i.e., if it would not take too many clients staying with Paul Hastings before it might see the earnings of its other partners go up with the departure of a highly paid partner, even as PPP might dip.

This article is simply reflective of the fact that lawyers at the AmLaw 100 firms are no longer professionals in the historical sense of the word. They are nothing more than an overly paid consultants grapping for the last dollar, every day of the week. The sense of being a professional working for clients as well as for one's community does not exist any more at these firms.

Ah, the Gordon Geckoism of our profession. No sympathy here if any firm goes under following this type of business model and kowtowing to an ego (and sense of worth) all out-of-control.

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