February 8, 2023
A Modest 2022 For Most Law Firms
“Following the unusually strong performance seen in 2021, we entered 2022 expecting comparatively modest growth. 2022 became an increasingly challenging year for the law firm industry from one quarter to the next as a result of a macro environment marked by the Russia-Ukraine war, rolling lockdowns in China, an energy crisis, supply chain issues, rising interest rates, inflation and equity and bond market volatility,” noted Citi’s Private Bank 2023 Client Advisory. It was a modest year for law firms measured in both demand and revenue growth, even though average billing rates were up during the year.
“Revenue growth for the first nine months of 2022 was a modest 4.1% on average for the industry. While average lawyer rates increased by 5.8%, the modest revenue growth we saw was in large part due to the drop in demand and a longer collection cycle,” the Citi report continued. Demand was down 1.2% and the collection cycle lengthen by 3.7% in 2022. These results were sluggish when compared to 2021 when revenue grew 14.7%, while demand increased 6.6%, billing rates grew 6.5%, and collection cycle shortened by 2.1%.
“One factor driving the longer collection cycle is that law firm clients have taken longer to pay bills. This is particularly so where e-billing is involved. At the end of September 2022, we saw average inventory growth of 8%, driven in large part by 10.4% growth in accounts receivable. And with deals on hold waiting for market volatility to settle, firms are also carrying high levels of unbilled time in their inventory, up 5.8%,” said the Citi report.
Expenses increased in 2022 by 12.9% significantly outpacing revenue for the year. Most of the growth came from professional staff, business development and travel expenses. According to the Citi report, “While total lawyer headcount has grown 4.5%, equity partner headcount increased 1.2%, resulting in leverage growth of 4.3%. With the drop in demand, this leverage growth means that firms are now carrying more lawyers at higher salaries who are comparatively less productive than we saw in 2021. To address this, we have heard anecdotally that firms have been giving tougher performance reviews in 2022. In some instances, firms have told us they are addressing performance issues that would have been addressed in 2020 but for the pandemic or in 2021 but for an atypically robust demand environment.”
Hiring Outside Counsel
When and how do corporations choose outside counsel? A recent report from Leopard Solutions tries to answer that very question. “We wanted to identify the most important qualities GCs look for when evaluating outside counsel. So, how can firms stand out amongst the competition? The most desirable qualities in outside counsel are responsiveness (87% rate this as highly important) and legal expertise (85% indicating high importance). Respondents also let us know that DE&I remains a top factor in evaluating firms they work with,” said the Leopard report.
The report also noted that 83% of GCs outsource up to 50% of their legal work, and the highest demand practice areas for GCs are litigation (50% of survey respondents), corporate actions (17%), and intellectual property (10%). However, being experts in these high demand practices is not enough, GCs want more according to the Leopard report, “They're also looking for true partnership. They look for firms that can provide practical, business-oriented advice, creative solutions, and business and subject matter connections.” This means firm must learn to leverage their attorneys professional experiences and industry connections to become a true strategic partner to their clients and a valuable industry resource.
As always, fees are very important to GCs, who must content with budgetary constraints from corporate leadership. “Also important to many respondents, as noted in write-in comments, is the openness of their outside counsel to consider alternative fee arrangements and not wanting to feel as though a firm is simply 'running the meter,'" added the report.
Just how measurably important are legal costs to GCs? Leopard Solutions asked GCs about five additional factors in choosing an outside law firm (longstanding relationships, referrals, mentions in legal guides, firm name/reputation, and costs). For these additional factors, legal costs was “the factor with the highest degree of importance (42% of respondents rated it as very important), while 40% stated that mentions in legal guides were not at all important.”
"While areas such as cost and legal expertise are to be expected, firms can stand out from the crowd by focusing on soft skills like improved communication and adding value to their interactions. Beyond everything else, they're looking for firms that can be a strategic partner and help them in their role and business," concluded the report.
Litigation Finance
“Conditions are ripe for litigation financing to become more ensconced in law firms’ business models this year as capital constraints, lower revenue levels from the 2022 fiscal year and an anticipated rise in disputes are expected to prompt litigation departments to seek risk-sharing partners,” according to an article in American Lawyer.
Legal funders expect more disputes in 2023 driving increased demand for legal financing, which leaves litigation funders in the awkward position of projecting bullish financial results for them that are tied to a difficult economic environment for many businesses. “While litigation funders…report that they do not wish to revel in the misfortune of businesses that find themselves embroiled in a dispute, the ‘simple truth’ is ‘that we tend to do well in periods like these, and we have no reason to believe that this downturn will be any different,’” according to the article.
Litigation funders said everyone should expect antitrust will be an area of strong financing demand along with commercial disputes and international arbitrations. They also noted that, “litigation finance always picks up in downturns because capital is short.”
However, litigation finance is still in its infancy. “Litigation funding companies have extended their reach in the Am Law 200 and high-end litigation boutiques in recent years, but there remain educational and financial barriers to the industry’s full embrace…many law firms remain wedded to the traditional billable hour method of monetizing legal services,” noted the article.
Litigation funders believe growth opportunities for litigation finance are tied to the increased professionalization of law firm operations chiefs and non-legal business functions at law firms, who pitch for alternative funding models. “Positions like chief innovation officer, chief operating officer and heads of pricing have been receptive to the education campaigns of litigation funding companies to pitch their products as a way of appearing innovative,” concluded the article.
“Following the unusually strong performance seen in 2021, we entered 2022 expecting comparatively modest growth. 2022 became an increasingly challenging year for the law firm industry from one quarter to the next as a result of a macro environment marked by the Russia-Ukraine war, rolling lockdowns in China, an energy crisis, supply chain issues, rising interest rates, inflation and equity and bond market volatility,” noted Citi’s Private Bank 2023 Client Advisory. It was a modest year for law firms measured in both demand and revenue growth, even though average billing rates were up during the year.
“Revenue growth for the first nine months of 2022 was a modest 4.1% on average for the industry. While average lawyer rates increased by 5.8%, the modest revenue growth we saw was in large part due to the drop in demand and a longer collection cycle,” the Citi report continued. Demand was down 1.2% and the collection cycle lengthen by 3.7% in 2022. These results were sluggish when compared to 2021 when revenue grew 14.7%, while demand increased 6.6%, billing rates grew 6.5%, and collection cycle shortened by 2.1%.
“One factor driving the longer collection cycle is that law firm clients have taken longer to pay bills. This is particularly so where e-billing is involved. At the end of September 2022, we saw average inventory growth of 8%, driven in large part by 10.4% growth in accounts receivable. And with deals on hold waiting for market volatility to settle, firms are also carrying high levels of unbilled time in their inventory, up 5.8%,” said the Citi report.
Expenses increased in 2022 by 12.9% significantly outpacing revenue for the year. Most of the growth came from professional staff, business development and travel expenses. According to the Citi report, “While total lawyer headcount has grown 4.5%, equity partner headcount increased 1.2%, resulting in leverage growth of 4.3%. With the drop in demand, this leverage growth means that firms are now carrying more lawyers at higher salaries who are comparatively less productive than we saw in 2021. To address this, we have heard anecdotally that firms have been giving tougher performance reviews in 2022. In some instances, firms have told us they are addressing performance issues that would have been addressed in 2020 but for the pandemic or in 2021 but for an atypically robust demand environment.”
Hiring Outside Counsel
When and how do corporations choose outside counsel? A recent report from Leopard Solutions tries to answer that very question. “We wanted to identify the most important qualities GCs look for when evaluating outside counsel. So, how can firms stand out amongst the competition? The most desirable qualities in outside counsel are responsiveness (87% rate this as highly important) and legal expertise (85% indicating high importance). Respondents also let us know that DE&I remains a top factor in evaluating firms they work with,” said the Leopard report.
The report also noted that 83% of GCs outsource up to 50% of their legal work, and the highest demand practice areas for GCs are litigation (50% of survey respondents), corporate actions (17%), and intellectual property (10%). However, being experts in these high demand practices is not enough, GCs want more according to the Leopard report, “They're also looking for true partnership. They look for firms that can provide practical, business-oriented advice, creative solutions, and business and subject matter connections.” This means firm must learn to leverage their attorneys professional experiences and industry connections to become a true strategic partner to their clients and a valuable industry resource.
As always, fees are very important to GCs, who must content with budgetary constraints from corporate leadership. “Also important to many respondents, as noted in write-in comments, is the openness of their outside counsel to consider alternative fee arrangements and not wanting to feel as though a firm is simply 'running the meter,'" added the report.
Just how measurably important are legal costs to GCs? Leopard Solutions asked GCs about five additional factors in choosing an outside law firm (longstanding relationships, referrals, mentions in legal guides, firm name/reputation, and costs). For these additional factors, legal costs was “the factor with the highest degree of importance (42% of respondents rated it as very important), while 40% stated that mentions in legal guides were not at all important.”
"While areas such as cost and legal expertise are to be expected, firms can stand out from the crowd by focusing on soft skills like improved communication and adding value to their interactions. Beyond everything else, they're looking for firms that can be a strategic partner and help them in their role and business," concluded the report.
Litigation Finance
“Conditions are ripe for litigation financing to become more ensconced in law firms’ business models this year as capital constraints, lower revenue levels from the 2022 fiscal year and an anticipated rise in disputes are expected to prompt litigation departments to seek risk-sharing partners,” according to an article in American Lawyer.
Legal funders expect more disputes in 2023 driving increased demand for legal financing, which leaves litigation funders in the awkward position of projecting bullish financial results for them that are tied to a difficult economic environment for many businesses. “While litigation funders…report that they do not wish to revel in the misfortune of businesses that find themselves embroiled in a dispute, the ‘simple truth’ is ‘that we tend to do well in periods like these, and we have no reason to believe that this downturn will be any different,’” according to the article.
Litigation funders said everyone should expect antitrust will be an area of strong financing demand along with commercial disputes and international arbitrations. They also noted that, “litigation finance always picks up in downturns because capital is short.”
However, litigation finance is still in its infancy. “Litigation funding companies have extended their reach in the Am Law 200 and high-end litigation boutiques in recent years, but there remain educational and financial barriers to the industry’s full embrace…many law firms remain wedded to the traditional billable hour method of monetizing legal services,” noted the article.
Litigation funders believe growth opportunities for litigation finance are tied to the increased professionalization of law firm operations chiefs and non-legal business functions at law firms, who pitch for alternative funding models. “Positions like chief innovation officer, chief operating officer and heads of pricing have been receptive to the education campaigns of litigation funding companies to pitch their products as a way of appearing innovative,” concluded the article.