Farewell, Firm Overhead: How Forming Alliances Gives Small Firms Big Savings

04/01/2012
Published in Association of Legal Administrators (ALA), April/May 2012

After a recession-induced slowdown, law firm mergers are again in vogue. According to the Altman Weil consulting firm, there were 60 U.S. law firm mergers and acquisitions in 2011, up more than 50 percent from 2010 and the most since 2008. Such transactions have a single idea: grow, whether that's by way of expanding, better serving existing clients or getting new clients to use existing services. The available candidates are identified, the transaction is completed and the firm has a general “mission accomplished” feeling. But is it truly justified? Often clients may not be better served if the expected economies of scale and enhanced collaboration do not materialize.

One of the keys to a successful law practice of any size is communication among staff and colleagues and communication with clients. Smaller law firms have the advantage of being more transparent and having less bureaucracy than larger ones. Clients of such firms typically expect to, and do, receive more personal service. But small or solo firms do not have to be at a resource disadvantage to larger firms that bulk up through formal mergers. Instead, they can achieve their own economies of scale through alliances, from simple to complex, with their peer practitioners. Alliances can give small firms big advantages. Law firm alliances using everything from shared space to shared engagements can help smaller firms leverage capabilities without spending on additional overhead or personnel. The decision to pursue an alliance depends on qualitative factors, such as whether the practice lends itself to collaboration with other lawyers, whether the firm’s culture is too individualistic to integrate with outsiders and whether clients will be comfortable if "their" lawyer suddenly starts working with others. Equally important, however, are the substantial financial advantages various types of alliances can offer.

Shared Space Alliances

The simplest level of alliance is shared space. Most law firms lease their office facilities, either in an office tower or a strip mall. Rented office space is one of a firm’s largest fixed expenses, typically running from 9 to 12 percent of revenue. The decision of legal practitioners to share rented space to spread out the cost should begin with a macro analysis of the firms' economics (revenues, expenses, profitability) within the context of the projected lease expense. Then take a micro view and analyze the economics of each practice and book of business, considering whether they are sustainable under the projected joint lease. Finally, assess potential colleagues from the standpoint of whether you would like working with them.

If the answers to these questions are positive, the options for shared space are varied. Some small firm or solo practitioners like being in a diverse professional environment, sharing space with accountants, brokers and other non-lawyers. Others may be comfortable with a "Fegen Suite," where lawyers share the expense of a reception area, conference rooms, clerical staff and office equipment. The same concept can be applied to shared computer technology, enabling smaller firms to spend on shared upgrades every three years rather than a more typical six-plus year small firm cycle.

Beyond these straightforward options, another strategy is renting an office in a larger law firm on a month-to-month basis. The larger firm reduces its cost of operation this way, and depending on the practice areas of both the subtenant (small firm) and the tenant (large firm), there may be an opportunity to refer work back and forth. Also, in this arrangement the small firm lawyer may be able to offer a certain number of hours per month (10 for example) in exchange for the space. This approach not only reduces monthly cash outlay, it can be a prime business development strategy — particularly if the small firm increases its marketplace "weight" by publicizing its relationship with the larger one.

One-Time Alliances

Many small firms hire contract lawyers to provide legal counsel on a specific matter beyond their practice or geographic scope. In such a situation, the contracting firm should contribute oversight of the outsourced legal work and communicate with the client on how the work is applied. The lawyer who initiates the contract arrangement becomes responsible — in a malpractice sense — for any errors committed even in a seemingly simple case.

When a firm creates a one-time alliance, how is the client billed? This issue has been litigated and the conclusion is that the contract attorney is not an out-of-pocket cost for billing purposes. Firms are not required to bill the client at the cost to them for the contract attorney's time. They may bill at an "attorney’s rate," a standard flat rate, or any rate that is established in the engagement agreement and is acceptable to the client. The rate can be high enough to cover overhead expenses of the firm's own staff, such as secretarial help, paralegals, word processors and so on. Such an arrangement can be subject to the pitfalls of "fee-splitting," and thus, covered under the Code of Professional Conduct Model Rule 1.5 declares that fee-splitting is acceptable if both lawyers involved contribute something of value, if the client agrees in writing and if the total fee is reasonable. It is a given that such an arrangement must also be agreed upon in writing between the lawyers. Many courts have ruled that referral or split fees cannot be collected in full if there is not complete documentation from either the client or the attorney.

Collaborative Alliances

A more sophisticated strategy for growth beyond a one-time alliance is a continuing one, which can be a tremendous advantage in supporting retainer client relationships. An ongoing alliance with another small firm gives the firm that establishes the arrangement a tremendous advantage. From a cost perspective, the expenses involved in direct hiring are eliminated. Allied lawyers are not an out-of-pocket expense for billing purposes and the firm can customize the billing arrangements as needed, provided that the client knows of and approves them. An excellent example is how two small law firms from the Chicago area — nine-lawyer Varga Berger Ledsky Hayes & Casey, PC and 10-lawyer The Collins Law Firm, PC — have for more than a decade partnered to represent plaintiffs in environmental pollution cases using four key lawyers, two from each firm. The four lawyers retain their firm affiliations but operate as a team, trying matters jointly and publicizing their capabilities with their own websites.

Beyond a focused alliance, firms can maintain joint retainer arrangements. Target clients are often small businesses that have a variety of ongoing legal needs, but are reluctant to commit to putting a single firm on retainer without being sure the counsel can indeed handle every issue that comes up. The lawyer does not do himself or herself a favor by offhandedly saying, "Of course I can," if the he or she is unable to come through on a time-sensitive issue. The ideal arrangement for the lawyer is to offer assurance of being able to call on other allied lawyers for help if a need outside the normal field of expertise arises. This, of course, requires a substantial level of trust between lawyer and client and among the lawyers. The lawyer creating the alliance in effect functions as a general counsel to the small business, drawing on other “outside counsel” as needed. Such contract arrangements can contribute to work and cost efficiencies if used correctly, particularly if the lawyers involved bill at different rates.

Virtual Alliances

Computer technology makes it possible to create virtual online alliances with lawyers in other cities or countries for provision of legal services as needed. Firms making such alliances must directly bear the expense of secure, encrypted computer communication, but using a contracting agency puts the burden on the service provider. These are typical virtual alliances.

Offshoring Alliances: Alliances with highly educated talent in countries where the use of English is widespread — India being the prime example — can reduce costs by up to 80 percent on work delivered electronically and produced under the contracting firm's supervision. The credentials of new hires can be vetted online, particularly if they are graduates of a top 10 Indian law school, and the pay scale can be similar to that of U.S. paralegals, which is still equal to substantially higher pay for the Indian lawyers.

Onshoring Alliances: Outsourcing firms are creating "onshoring" jobs for lawyers in the United States. These lawyers can be added to a legal team as needed on a virtual basis. Often they are based in lower-cost states like West Virginia and North Dakota, and the low operating costs make them perfect for commodity legal services. Entrepreneur Alliances: Groups of lawyer-entrepreneurs, such as Virtual Law Partners, are ventures that employ lawyers who work at home, saving on overhead and costing clients less in legal fees. The lawyers are available for contract arrangements, overhead expenses are minimal, and the lawyers keep a percentage of what they bill.

Value For The Client

No law firm needs to remain an island when there are so many alternatives to merging. Firms can combine their strengths in a variety of informal arrangements that support better service to existing and potential clients. But whatever they contribute in cost saving and capability expansion, such alliances must enhance client service. If clients are informed about and accepting of the cost and service advantages, both sides in the lawyer-client relationship can benefit from alliance arrangements.

Ultimately the value of an alliance is determined by the client, not the law firm. Clients look for performance in the firms they hire, no matter the size of the firm. Performance is a factor of communication, understanding and focusing on the client's objectives, use of technology and specialized knowledge. Small and solo firms that can use alliances to enhance performance not only stand an excellent chance of surviving, but thriving in a legal marketplace shaped by ever-higher client expectations.

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