Most law firms began the new year with high confidence in their financial plan, trust in their budgeting process and comfort in their ability to expertly manage strategic issues under a variety of scenarios. Faith in their plans will be tested thoroughly if the economy slips into recession. Economic recession occurs with regularity, popping up about once every decade. In the history of the United States there have been 50 recessions. There have been eight in the last five decades alone. Without a doubt, all law firms will eventually be tested on their ability to survive a contracting economy. Not all firms will pass the test.
The technical methods of defining a recession have changed slightly over the years, but generally if the economy suffers a period of decline for two consecutive quarters, we are in a recession. While certain advance indicators may warn of a slowing economy, we are often months into our well-planned fiscal year when the penny finally drops. Pivoting from a growth economy to a shrinking economy can be difficult. Declining margins can lure financial managers down the wrong path of quick-fix solutions. Automatic responses can create bigger problems down the road.
Most firms put significant effort into their expense and revenue budget plans. Expense budgets are usually more precise because most expenditures are based on current and planned obligations. In legal, these are easier to map out because the largest spending categories are predictable big-ticket items, like payroll and rent. Revenue budgets on the other hand are often aspirational. We have various planning tools to help us predict revenue scenarios, with some still based on old-school production models. Many firms project revenue by calculating total expected hours billed, valued at a standard rate and adjusted by an assumed realization percentage.
There are countless examples of firms that spun out of control when their standard playbook was complicated by a dipping economy. When revenue streams become a trickle and the timeline for recovery is unclear, cash flow becomes a critical concern. With few solutions to choose from, firms often slash expenses. People are expensive, so the personnel category is often the first target. Margin goals drive decisions because the partners are expecting a defined compensation range by the end of the year. Administrators are keen to meet those goals but need cash to fund operations. At year end after a final partner distribution, some firms leave just enough liquidity in the coffers to pay the minimal operating expenses to kickstart the new year. They assume revenue flows will resume and refill their bank accounts in the first quarter. But what if it does not?
Rough waters are often full of sharks. Well-capitalized firms are particularly adept at finding advantage as other firms falter in a bad economy. Without clarity on a plan and a timeline for recovery, smaller firms are at risk if their partners explore options with competitors perceived to be safer and more financially secure. Losing revenue producers and rainmakers makes a tough situation even worse. This is why in times of risk and volatility; good management is mission critical.
Most law firms do not have expense problems, they have revenue problems. When revenue slips and expense cuts are unavoidable, we should use a scalpel, not a machete. Cutting marketing funds may seem to be an easy solution, but reducing the effectiveness of your business development efforts in a declining market creates additional risks. Cutting the administrative staff may seem like a money-saving proposition, but not if the attorneys end up spending more time managing operational issues and less time on billing clients.
The best time to craft a recession plan is before a recession hits. We can proactively prepare, and the effort should start at the top. Regular and honest communication from leadership can help build trust in the plan forward. Trust in leadership is critical when dramatic course changes are required.
Good practice management can help ensure a diversified practice mix is maintained as a hedge against sector or client volatility. Ensuring that each practice member knows their role in the mission is just as important. Transparency on how success is defined and measured can help remove confusion on the metrics and doubt from the plan.
Good fiscal management and regular reporting will help everyone understand the variables that matter and bring clarity to the firm’s priorities. A willingness to answer tough questions helps increase understanding of the firm’s financial situation and goals. When the goals are not met and adjustments are required, no one should be surprised.
Setting honest expectations and reporting real-time results reduces the shock when the economic news is unexpected or unpleasant. Communicating clear evaluations on job performance and providing regular, honest assessments will keep the team better aligned to expectations. At the end of each day, everyone needs to go home with awareness of their role in the firm’s success. When we ask more from them, they need to know their contributions and sacrifices will be noted and rewarded in better times.
That same commitment should extend outward. Treating outside service providers more like partners and less like vendors can help identify solutions to restructure or reprice services or contracts if needed.
Hiding within every challenge is an opportunity. Firms who prepare for the worst are often well suited to survive when times are tough and best suited to thrive then the inevitable recovery returns.
Charles Gillis is the executive director of Platt Richmond. He has worked in law firm administration and management for more than thirty years.