How to prepare for an economic downturn
Contrary to the expectations at the onset of the pandemic, 2020 and 2021 turned out to be the best years on record for the legal industry. Almost without exception law firms reported their highest profits ever. Hiring activity was also at an all time high, as demand for both experienced and junior lawyers soared. Some firms went as far as paying over $200.000 for a starting lawyer fresh out of university.
The main driver of the activity was Quantitative Easing. Unlike the 2008 financial crisis, this time governments poured unprecedented amounts of liquidity in the market. With so much money available and with interest rates near zero or negative, it is no surprise that investors went looking for yield. During the last two years there have been record levels of IPO’s and M&A activity. In some markets SPAC’s became hugely popular. In order to let capital work, anything would go.
Swamped with work and scrambling to find the lawyers to handle it, partners worked to exhaustion over the past two years. 2022 looked like starting off strong and continuing the trend. Maybe not as good as the previous years, but still better than average. Then the war started and almost overnight the mood changed.
Global dealmaking fell to its lowest level since the start of the coronavirus pandemic as surging inflation, tougher regulation and the war in Ukraine led to a slowdown in what had been a record period of mergers and acquisitions. Just over $1tn worth of deals were struck in the first quarter of 2022, 23 per cent lower than the same period last year, with all continents facing a decline in M&A activity. Also the number of IPO’s has started to drop significantly.
As inflation rises sharply and Central Banks are testing raising interest rates and are winding down their bond buying programs, economic optimism is fading quickly. Global supply chain problems and China’s strict zero-Covid policy are further adding to the woes.
2022 will not be as good
Given the economic outlook, the legal industry should prepare for 2022 to be less booming than the past two years and expect a decline in revenue. While there is no reason whatsoever to be worried, law firm leaders are well advised to start managing their partners' expectations, while taking precautionary measures at the same time.
When there is no growth or if revenue drops, law firm partners get nervous. If the firm is doing well and revenue grows, partners tend to believe that their firm is doing better than the competition. If business is good, this creates a false sense of confidence and optimism. The past two years partners were happy even if competing law firms grew more.
As soon as things slow down the exact opposite happens. Partners feel that all other firms are doing better. If business is slow, there is a misguided feeling of being hit harder than the market.
Law firm leaders should anticipate their partners getting more critical on management and strategy. Expect a strong tendency for partners to get more hands-on involved in the management of the firm. This will particularly be true for the M&A partners who are expected to get uneasy and insecure due to the reduced amount of work. As M&A partners typically have a significant contribution to the firm’s overall results, they have lots of clout and their opinions cannot be neglected.
In the Dutch language we have a phrase that translates as ‘panic football’. It’s when you’re playing football, and you panic because you’re behind the other team, and you’re so desperate for a goal that everyone is kicking the ball and it’s going in all different directions. Any law firm leader will recognize this and know this is likely to happen as partners start throwing in ideas how to reduce costs and how to regain revenue. Just like in football, this behavior leads nowhere.
Strong leadership required
It is in times of headwind and adverse conditions, that the capable managing partners are separated from the rest. When the going gets tough, strong leadership is required. Only law firm leaders with a vision and a steady strategy will be able to calm down their partners. Weak managing partners get eaten for breakfast and will soon be a ‘puppet’ dancing on the strings that are being pulled in contradicting directions by the rainmakers in the firm.
While this might be the right time to cool down the recruitment frenzy and become more critical to whom you are hiring, instead of just hiring anyone at any prize, it would not be smart strategy to stop hiring altogether. The same goes for cost cutting, don’t get zealous, there is no reason to panic. Yes, it is entirely feasible that profitability declines a bit, but that is no reason to panic. Especially right now, after the pandemic, it is important that law firms keep investing. During the pandemic there have been huge reductions in the cost of marketing and travel. When business is down, these are the areas to invest.
We at TGO Consulting advise law firm leaders on all strategic matters. We can help you in avoiding falling victim to the side effects of the economic recession. Especially right now it is important to stay strong and to keep steady.