Welcome back to Big Law Business ColumnI’m Roy Strom, and today we’re looking at law firms’ first-half financial results—and what’s next. Sign up to receive this column in your inbox on Thursday morning.
Large law firms have, against all expectations, reported strong financial results for the first half of the year – and the final months could be even busier.
Strong demand supported the first half’s results, even if transaction flows are not yet at full speed. This financial engine, if it kicks into gear, could lead to a busier second half.
According to a survey by Citibank’s legal group, revenues across all business segments increased by an average of 11.4 percent compared to the same period last year.
Hours worked, or demand, rose 2.9 percent, driving growth, a contrast to previous years when it was driven almost entirely by interest rate hikes, Citibank reported. The country’s 50 largest firms fared best, increasing demand by 3.3 percent.
The figures represent the best first half of the year since the booming legal market in 2021, when revenue rose 14.6% and demand for the top 50 firms rose 9.4%, Citi noted.
Law firms entered the new year with the incorrect prediction that transaction markets would rebound in the second half of 2023. Most executives braced for high interest rates and feared that they could have their typical impact: a recession. Some even predicted layoffs at law firms this year.
Instead, the economy proved robust, boosting corporate legal spending and enabling another year of strong wage increases. Law firms were largely able to avoid layoffs.
Sixty-eight percent of the 50 largest companies reported demand growth in the first half of this year, said Gretta Rusanow, head of advisory services at Citigroup, in an interview. Of this group, 29 percent reported increases of more than 5 percent.
“It will be a very positive year,” said Rusanov. “From an activity perspective, there is a lot of good news.”
According to Rusanov, processes such as litigation, investigations, antitrust and work related to funds and investment management practices are driving demand growth. While transaction activity has recovered from the lull of the past two years, it is still below the levels that companies would like to see.
That could change if the Federal Reserve meets Citi’s forecast and makes three rate cuts by year’s end. Rate cuts will likely lead to more deal activity, meaning the end of the year could be even better for the big law firms.
“In absolute terms, I expect the environment to continue to improve by the end of the year,” said Rusanov.
One caution: Year-on-year comparisons will become more difficult as the year progresses, as the second half of 2023 was a stronger growth period. There is also the possibility that transactions will slow as the U.S. presidential election approaches. But Rusanov said the election could create pent-up demand for deals that will pick up once the results are known.
So far, law firms indicate that the third quarter has started well. Citi recently surveyed 23 large firms and more than 40 percent of firms said demand in the third quarter so far has exceeded second-quarter levels, Rusanov said.
“The vast majority of them say it has stayed at least the same, if not better,” she said.
Rusanow and her team have more access than most to law firm leaders and their views on important issues, so I asked her about two other trends: the battle for talent in the big legal profession and the adoption of generative AI tools by law firms.
War of Talents
For law firm leaders, a better financial environment will only intensify the battle for talent, Rusanov said. The most profitable firms will likely use their success to expand and hire more partners.
“There is clearly a trend towards companies that have outperformed the market and are using this to further strengthen their position,” she said.
Increasing competition has prompted some firms to increase the compensation of their top partners or to redesign their leverage structures by introducing an additional layer of revenue-based or salaried partners.
The desire to retain experienced employees is the reason for introducing these new partner levels.
No longer filled by former equity partners who lost their investments, these positions now serve as a proving ground for highly motivated, successful senior associates. These younger partners can be enormously profitable while earning lower salaries and still billing long hours.
“A decade ago, we would probably have shown that partners’ income generally represents a negative net contribution to firm profitability,” Rusanov said. “Things have changed now.”
Introduction of artificial intelligence
As I’ve written before, there are two competing schools of thought about the impact of generative AI on the big law firms. One is that it will cannibalize routine work and decimate the lawyer workforce. The other is that the broader adoption of AI across the economy will generate enough legal work that lawyers will stay employed even if some aspects of the work are made more efficient.
According to Rusanow, most of the law firm leaders she speaks to fall somewhere in between. New tools could make lawyers more efficient, allowing them to spend more time on more complex matters. But the adoption of generative AI tools across the economy will also generate new legal work.
“There is a mindset in the profession that while it could eliminate routine work, it would also free up lawyers to do more interesting work,” she said. “I am not negative about generative AI and I don’t get the impression that that is the case from the firms I speak to.”
Right now, companies are testing a flood of new tools coming to market, many of which aren’t ready for market yet, she said. Not much may change in the next two years, but Rusanov said companies don’t want to be unprepared if there’s a major shift in the next decade.
Nevertheless, just as with her prediction of a strong second half of the year, she is optimistic about law firms.
“Whenever there’s a new wave of technology, there’s a sentiment in the market that robots are going to take over from lawyers and eliminate huge chunks of work,” she said. “But I haven’t seen that happen yet.”
Worth your time
About ropes and grey: The Boston-based law firm is looking to set up an office in Paris, reports Rose Walker. The firm plans to launch in the French capital with employees from competitors.
On insolvency ethics: A bankruptcy court in Texas must reconsider whether former bankruptcy judge David Jones should have recused himself from a restructuring case before his resignation amid an investigation into ethics issues.
When returning to the office: Latham & Watkins is requiring its New York lawyers to report to the office four times a week starting in January, Meghan Tribe reports.
That’s it for this week! Thanks for reading and please send me Your thoughts, criticisms and tips.
