Photo by Fredrik Broden
In 2006 Dechert was facing a potentially budget-busting task: During the next 18 months, it would need to relocate its three largest offices. Capital expenses were expected to skyrocket from single-digit percentages to a third of annual earnings. But instead of turning to a bank loan to cover the cost of the moves and gut renovations, the firm went to its partners. For three years before the moves, partners kicked in more capital, producing a surge in cash on Dechert's balance sheet. The firm didn't have to borrow a penny.
Dechert's fixed-asset expenses returned to normal levels in 2008. But the firm held on to its higher capital requirement, evidence of the lengths to which it still goes to avoid bank debt. Today, equity partners must maintain 44 percent of their current compensation level in their capital accounts, up from 30 percent in 2002. That capital cushion, combined with other cyclical cash management techniques, has allowed the firm to avoid even short-term borrowing during a period of high growth. "We were going to cancel our line of credit, but the bank convinced us to keep it," says Andrew Levander, chair of the firm's policy committee.
If you think Dechert's pay-as-you-go approach is unique, you'd be wrong. Attitudes have shifted remarkably since a decade ago, when borrowing by firms was on the rise, and banks found a willing audience for sales pitches. After 2008, in particular, many firm leaders began to question the whole idea of bank debt. "After all the firms started to fail, starting with Brobeck, then Heller, we stopped borrowing from the bank," says Perkins Coie managing partner Robert Giles.
Giles and others have long eschewed debt, relying instead on partner capital and other cash management techniques. "I sleep better knowing we are not borrowing money," says Barry Wolf, executive partner of Weil, Gotshal & Manges, where 5 percent of each partner's pretax earnings each year goes into an interest-paying capital account. With the help of that capital, Wolf says, "we've always had enough to fund our hard assets, and we've always had a big cash cushion. We've never been caught short."
This past fall, The American Lawyer spoke with dozens of leaders of Am Law 200 firms about their partner paid-in capital programs. We asked how firms are financing their businesses and whether their debt-to-equity mix has changed. Of 20 firms for which details could be confirmed, six had bumped up or broadened capital requirements in the past few years. Several more said they were considering doing so in the near future. Seven, including Dechert; Weil; K&L Gates; Day Pitney; Perkins Coie; Morgan, Lewis & Bockius; and Gibson, Dunn & Crutcher, said they do not borrow at all, either for long-term expenses or for seasonal cash flow needs. Others have kept both kinds of borrowing at very low levels.
Our findings mirror data collected by Citi Private Bank's Law Firm Group. Citi's most recent survey of 171 firms, 122 of which are Am Law 200 firms, shows that, after an increase in 2008, debt levels fell steadily between 2009 and 2011.
Meanwhile, the privilege of partnership has become increasingly expensive, according to Citi's data. Between 2007 and 2011, partner paid-in capital shot up by a third, from an average of $229,000 to $303,000 per equity partner; as a percent of net earnings, paid-in capital on the balance sheet went up from 21 percent to 26 percent. Equity partners at the 20 most profitable firms that participated in Citi's survey were not exempt from the trend. They were asked to ante up more than $500,000, on average, in 2011, up from $423,000 in 2007.
Our findings indicate that partner capital on firm balance sheets ranged from single-digit percentages to 52 percent of firm earnings, with most firms in the middle. But individual partner obligations at one firm with a graduated capital contribution system, K&L Gates, topped out at 60 percent of a partner's previous year's compensation. Several had 40 percent or more of the previous year's earnings tied up in the firm.
Surprisingly, the recession did not spark the upswing in capital contributions. In fact, partners began paying more capital into their firms in 2006 and 2007, when business was booming, profits were surging, and capital raisings were met with little resistance, according to Bradford Hildebrandt, chair of Hildebrandt Consulting. But the recession, and the resulting firm failures, intensified the trend. "With every firm dissolution, a few [other] firms will say, 'We have too much debt,' " Hildebrandt says. "It rattles the market, prompting them to up capital." Indeed, the biggest bump in paid-in capital was in 200910a time when the recession was hitting firms' earnings the hardestand it coincided with the sharpest drop in debt. Firms "continued raising capital even when net income dropped in 2009," notes Citi's Michael McKenney, who heads credit origination at the Law Firm Group.