Last year, Akin Gump joined the growing number of law firms asking their partners to chip in more capital — an increasingly popular strategy among firms to boost cash reserves without borrowing from banks.
The practice has become more common since the recession, which forced law firms to find new ways to grow amid flat demand for legal services and pressure to offer discounted fees. Access to cash allows firms to invest in new hires, technology upgrades and other capital-intensive efforts to grow the firm’s business.
Now, Jonathan Molot, a Georgetown law professor and co-founder of one of the fastest-growing litigation financing firms in the country, Burford Capital, is pushing for a radical change to the capital structure of law firms: a law firm IPO.
Molot argues that the current structure of law firms — equity partners putting in capital, then taking it out when they retire or leave for another firm — discourages long-term growth and that law firms would benefit from being structured like publicly traded companies. Molot, who once worked at large firms Cleary, Gottlieb, Steen & Hamilton and Kellogg, Huber, Hansen, Todd, Evans & Figel, plans to release an academic paper on the topic this week in the Southern California Law Review, the law journal of the USC Gould School of Law.
Molot’s proposal runs counter to traditional legal thinking that frowns on outside investors and the potential for their interests — making money — to undermine attorney-client relationships.
Jonathan Molot, Georgetown Law professor and Burford Capital co-founder, in his office on campus in 2011. (Jeffrey MacMillan/The Washington Post) At most law firms, equity partners — sometimes called shareholders — are called on to contribute capital in exchange for a piece of the firm, an amount that typically is a percentage of their earnings that can vary depending on their book of business. Capital contributions are usually one-time contributions that get returned when an attorney leaves the firm, either through retirement or for another job. The way partners make money is by splitting whatever profits the firm makes each year after expenses are paid. That is their compensation, or “draw.”
When most firms were on a lockstep compensation model, individual partners’ books of business were less important because everyone was paid based on how long they had worked at the firm. But over the past decade or two, that has given way to an eat-what-you-kill model. The way most firms pay partners today often is based, at least in part, on how much business they personally generate. That means partners can more easily jump ship and bring their clients — in which case they would take their capital with them, leaving the firm with that much less cash.
Molot says this model encourages partners to fixate on short-term gains rather than the long-term success of the firm.
“The problem with law firms is there is no permanent equity, no long-term value,” Molot said. “All there is is the current year. Every year, a law firm takes what it earns and invests none in the future. Instead, it pays its partners in compensation.”
A senior partner nearing retirement, for example, has little incentive to experiment with fee structures because that partner will not personally benefit from potential gains that may not come until years after he or she has retired, Molot said.
However, if partners were to keep their capital in the firm even after they retired — and if outside investors, such as pension funds and other institutional investors, bought shares of the firm — that would give the firm permanent equity and give retired shareholders incentive to invest in younger lawyers to maximize the firm’s long-term success, Molot said.
“The retiring partners would continue to own stock in the firm after they retired,” he said. “They would no longer get a salary and bonus, but they would earn dividends, so they’d care about making sure the business they helped build would remain vibrant in the future because they would share in that business.
“It would be like when you go work for a normal [public] company, you get stock options as part of your compensation package, and when you retire, you still own that stock — you can sell it or keep it; that’s what I’d want for retiring partners.”
Publicly traded law firms are still a ways away in the United States. Rules on whether non-lawyers can own law firms are regulated by state judiciaries — in most cases, the supreme court in each state — and there are no states considering changes that would come close to allowing a law firm to be publicly traded. D.C. is the only jurisdiction that even allows non-lawyers to be part-owners of a law firm. That exception was established decades ago because many firms in Washington also lobby, and many lobbyists are not attorneys but have senior roles and equity stake in their firms.
In 2013, the American Bar Association’s Commission on Ethics 20/20 considered expanding D.C.’s non-lawyer rule to other jurisdictions but ultimately decided not to recommend the changes.
However, law firms in Australia have been pioneering the change. In 2007, Slater & Gordon became the first law firm in the world to be publicly traded, listing shares on the Australian Stock Exchange. Since then, three other Australian firms have followed suit: Integrated Legal Holdings (IAW) in 2007, Shine Lawyers (SHJ) in 2013 and IPH Ltd. in 2014. In 2013, Slater & Gordon struck deals to acquire three smaller British law firms for a combined $35 million.
“They have been successful and expanded dramatically, in no small part because they were able to go public because of the cash infusion,” said Andrew Perlman, a law professor at Suffolk University in Boston. Perlman was an adviser to the ABA Commission on Ethics 20/20 but said he does not speak on behalf of the ABA on the issue.
The idea of lawyers reporting to shareholders is controversial. One of the biggest concerns is that it could compromise an attorney’s professional independence, Perlman said.
“If lawyers have to report to shareholders and explain their profits, then they may be more inclined to cater to the interest of shareholders than the interest of clients,” he said.