In part one of our Law Firm Economics in the COVID Climate series, we covered how law firms are handling collections and offering discounts in the current environment. In part two of our analysis on law firm economics, we will review our survey findings as they relate to cash flow, alternative fees, and liquidity. Read our findings on these topics below or download our law firm financial management survey for the full story.
Cash Flow Improvement is Among the Supporting Factors for an Early Payment Option
For a quarter of the participants, improving cash flow was an important justification for supporting an early payment option. “Cash flow is critical, but also because the more likely a bill is outstanding, the less likely it will be paid in full anyway," said a manager for a firm of 37 lawyers. “The quicker we get the money in, the better it is for the shareholders and the more likely it is that they would receive a bonus," added an administrator for a smaller firm.
For 43% of the participants, the choice of using this option is more focused on client service than firm economics. “It is a cost of doing business. As long as the client is happy, it doesn't matter," said a coordinator for a large firm. “It is mostly to keep the client satisfied and helps the client control its spend because for the firm, there is no real benefit. When you lose 3%, it is in addition to any other charges that they deny on the bills based on a third-party review," added the COO for another large firm. “It is a goodwill gesture and a fear that they will go somewhere else," noted an executive director for a small firm.
Use of Alternative Fees Seems to be Growing
Half of the respondents derive 90–99% of their revenue from traditional billable hours, while 37% reported that 80–89% is based on the billable hour. The remainder comes from alternative fee arrangements, such as flat fees or a hybrid model. As clients become more sophisticated and legal work continues to be managed differently, this shift seems to be moving toward an increase in new options for generating revenue.
“More general counsel are starting to ask for alternative fees; so 85% of our work is based on billable hours, and 15% is from an alternative of some sort, including flat or success fees," reported the COO for a firm of 200 lawyers. “We have seen a lot of change with respect to flat fee billing and a broad movement in the legal industry. I see it happening more down the line," said a coordinator for a firm of a similar size. “More and more of those arrangements are coming into play so we are trying to be more proactive in offering alternative fee arrangements.” said an executive director for a smaller firm.
One CFO for a firm of 200 lawyers countered, noting that “AFAs are still rare and only comprise about 5% of our work.” Another CFO for a similar-sized firm concluded, however, “Our breakdown is 80/20, but that number is growing in favor of AFAs.”
Liquidity is Not Yet a Challenge Despite COVID-19
Even though we are in the midst of a global pandemic and a gradual shift in billing practices, only 20% of respondents reported a need for additional liquidity as a result of COVID-19. “We are constantly managing liquidity and increased our line of credit in March for liquidity purposes," said a director for a large firm.
“We are always looking for liquidity and are trying to anticipate a slowdown. We have established a plan of cuts, ranging from basic to extreme, in the event that it is necessary," added a director for a firm of 100 lawyers.
While most firms did not make significant moves to secure funds at the outset, many are still cautious. “I think we are still in the thick of it and haven't seen the worst," cautioned a CFO for a firm of 75 lawyers. “I don't think law firms will feel the effects of COVID-19 for months, or possibly longer as the plaintiffs need to have the cases to file for us to defend them," explained an administrator for a small firm. “We have concerns that if our clients are impacted, it may indirectly impact us, so it is on our radar," added the CFO for a mid-sized firm.
Firms are certainly taking various steps to weather any potential storm. “We were concerned when COVID-19 first hit, but I don't know if we would borrow to increase liquidity. Rather, we might extend bonuses over several months instead of paying them in a single month," said a large firm CFO. “We extended and increased our lines of credit," added another. “The benefit of having a service business is that 60–65% of the money you spend annually is on people so if there is productivity or demand elasticity, we can adjust those numbers,” offered a third.
Despite few firms searching for additional liquidity, many firms took actions to preserve cash and cut costs. For instance, 10% of the respondents reported layoffs and 30% furloughed employees. 33% lowered pay, 33% deferred new-hire start-dates, and 53% reduced partner distributions. A few even canceled their summer programs.
One COO at a firm that reduced pay for everyone by 20% noted: “The firm may need to lay off staff members and office services employees who deal with hospitality and food.” Another expressed a similarly cautious tone. “Cash flow in March and April was down, but May was better than expected. We are virtually on plan for where we want to be, though we are still projecting some decline in the next few months," said a specialist for a firm of 170 lawyers. “There were a lot of nerves going into the crisis and we decided to maintain the status quo, which has worked out and we are continuing along that path. We will see how things evolve, but right now, we are seeing good things," reported an executive director for a mid-sized firm.
Others were much more optimistic. “We have hired four people since March 2020 and doubled the size of our summer program," said a manager for a small firm. “It seems like a number of firms have overreacted," added a mid-sized firm CFO.