As businesses go, the business of law isn’t extremely capital intensive. Most of the capital in Biglaw is really human capital. As one bankruptcy lawyer put it, “It’s incredible how fragile law firms are. Unlike a company, the principal assets walk out the door every night.”
But law firms do need some capital. Those fabulous offices — and fabulous associates, at $160,000 and up — don’t come cheap.
Firms can obtain the capital they need to operate through borrowing; but credit needs to be used judiciously, lest a firm go the way of Dewey & LeBoeuf. And partners make capital contributions to the firm, most notably when they buy into the partnership.
But sometimes that capital isn’t enough. So firms issue capital calls to their partners, which brings us to today’s topic….
In the early months of the year, most firms cover operating expenses by using their partners’ existing capital and by drawing on a revolving line of credit from a bank (like Citigroup, which is very active in lending to law firms). As the year goes along, collections from clients fill the firm coffers, enabling the firm to pay down the bank line — and then pay bonuses out to associates, and profits out to partners.
There are several reasons why a firm might have to reach beyond these funding sources and issue a capital call to the partnership. If a firm is undercapitalized, perhaps due to problems with client collections, it might issue a capital call to improve its liquidity (although some observers argue that undercapitalization isn’t a widespread problem in the law firm world).
Sometimes bank lenders might ask a firm to make a capital call as a condition of renewing a line. Sometimes a firm might find itself short on capital after having to return capital to partners who have left the equity partnership — maybe because they got “de-equitized” by the firm, in an effort to improve the firm’s profit per partner figure, or maybe because they left for another firm. So firms with a lot of partner churn might find themselves needing to make capital calls. (This is explained in a nice primer on how partner capital works by Edwin Reeser, posted at JDSupra.)
When was the last time your current or former firm issued a capital call to the partnership? We’re interested in hearing from you, by email or by text message (646-820-8477). But we don’t expect to hear from many of you. Capital calls aren’t that common; according to consultant Bill Brennan of Altman Weil, the majority of firms do not have regular capital calls. So when a major firm makes a capital call, it makes headlines.
One firm that we do know has issued a capital call recently is Greenberg Traurig. As we mentioned yesterday, in a story about GT’s travails in the TD Bank case, the 1,700-lawyer firm is currently seeking a total of $24 million from its partners. Here’s more from Julie Kay of the Daily Business Review:
The capital call, which was announced last month during a telephonic partner meeting, requires equity shareholders to contribute 1 percent to 5 percent of their salaries, according to a Greenberg lawyer who asked not to be identified. The contributions will be based on salary levels, with lesser-paid shareholders paying 1 percent and the highest-paid principal shareholders paying 5 percent.
Dividing the number of equity partners by the capital call works out to an average payment of $76,923. The average profit per partner was $1.42 million last year, up 7 percent from the year before. The capital call would likely wipe out most of that increase.
(Well, don’t forget that the money for the call comes out of partner pockets, meaning that it’s after-tax money. So it’s a bit worse than that. Anyway….)
Richard Rosenbaum, Greenberg’s chief executive officer, said the capital call was not required by its bank and was strictly a desire by the firm to “add to our equity cushion.”
“We have not raised capital in over 10 years and have long required more modest capital than most of our peers,” he said in a statement. “In light of the current uncertainty in U.S. and global markets, we recently did announce a capital raise for our shareholders, each paying in a modest amount over several years in order to further add to our equity cushion.
“There was no current cash need or other requirement giving rise to this decision, one which is fully consistent with our conservative financial management and with what other well-managed businesses are doing in the current global economic climate.”
This explanation isn’t terribly enlightening, I’m afraid. Rosenbaum seems to be saying, “Remain calm. We’re not doing this for any particular reason.” But considering that the firm hasn’t taken this step “in over 10 years,” there really ought to be some reason for doing it now, right?
Blaming it on “current uncertainty in U.S. and global markets” seems like a bit of a stretch. All firms are affected by uncertainty in the financial system, but not all firms are making capital calls (although let us know if you know of other firms that are). And if GT truly boasts such “conservative financial management,” one would think that they’d already be prepared for whatever the world might have in store.
In fairness to Greenberg Traurig, it’s not alone. The DBR notes:
Greenberg is not the only law firm to ask for capital contributions from partners in recent years. DLA Piper, one of the nation’s largest law firms, issued a first-time capital call for its U.S. partners in 2009. At the time, the firm said the move was designed to decrease its reliance on bank credit during the recession and require partners to “have some skin in the game.”
Some observers viewed the DLA Piper move as a bit desperate. It came around the time of other cost-cutting measures at the firm, including slashing partner pay and trimming associate salaries. But three years later, DLA seems to be doing just fine (setting aside the occasional plumbing problem). Maybe these measures helped to right the ship?
Back to Greenberg Traurig. One has to wonder: what does management know about firm finances that the rest of us do not? Is it possible that collections aren’t as robust as the firm might have hoped? Will revenues come in behind budget? Has the firm been adversely affected by various recent, unfortunate developments? As the Review points out:
[T]he firm has faced a number of financial and ethical issues in recent years. Greenberg laid off dozens of secretaries earlier this year and cut expenses by moving its Miami operations to smaller space last year.
U.S. District Judge Marcia Cooke on Friday sanctioned Greenberg Traurig and TD Bank for discovery lapses in a case brought by investors with Ponzi-scheming ex-lawyer Scott Rothstein.
In June, Greenberg and Quarles & Brady agreed to pay $88 million to settle a suit by investors who claimed losses in an alleged $900 million Ponzi scheme by a mortgage company.
It seems that Greenberg is responsible for the lion’s share of that settlement sum, about $61 million. Even if most of that amount is covered by insurance, the firm might have a deductible or a co-pay, or it might face higher insurance premiums in the future.
UPDATE (2:45 PM): Here’s what an equity partner at a different major firm told us: “Most very large firms are collectively self-insured by ALAS. Greenberg is likely raising capital to cover their portion of the liability, with the rest to be paid or bargained down by ALAS.”
For additional insight into the Greenberg Traurig capital call, we reached out to our newest columnist, Anonymous Partner. Here’s what he had to say about the news:
You should be all over the GT capital call…. There is something seriously wrong if they are taking such a step in my opinion, especially since GT is not the kind of firm that anyone would consider a true partnership in the Biglaw sense. Best case is that they are trying to flush out underperformers.
I can only imagine how pissed people are over there. Anonymous Partner is happy he is not at GT today. Adding to buy-in debt or coming out of pocket for a capital call would really sting.
Is the Greenberg Traurig capital call a sign of rougher times ahead? Or is all the media coverage of it just much ado about nothing?
If you have information to share, about GT or any other firm making a capital call, we welcome it, by email or by text message (646-820-8477).
UPDATE (8/10/12): A former partner of another law firm had this comment on capital calls:
You probably already know this, but firms provide themselves with a cash cushion by paying partners only a fraction (usually somewhat more than half) of their total compensation in regular monthly payments (called draws). (If revenue is on target, partners catch up to their target compensation with special distributions.) Most large firms also rely on a line of credit to provide an additional cash cushion. Because partners have already paid a capital contribution in cash when they became partners, forever after that they expect to receive cash in large sums. The opposite is hubris.
A cash call almost certainly means that the partners are not receiving any special distributions (so they are taking a big pay cut) and now have to shell out more. Grumpiness will abound. Because loyalty is often tenuous at large firms, and the memory of Dewey is fresh, watch for the rainmakers to head for the doors.
Greenberg Traurig says capital call is buffer against uncertainty [Daily Business Review]
Greenberg Traurig confirms capital call [South Florida Business Journal]
Partner Capital: How It Really Works [JDSupra]
Undercapitalization is not the real problem in large law firm failures [JDSupra]
Capital: A Novel [Amazon (affiliate link)]