Why So Many New Law Firms Collapse
Why do law firms collapse? The dream of starting a law firm is a common aspiration for new lawyers. However, like every industry, legal professions come with growth obstacles.
From big law firms that seem to be conquering the world to brand new ones that barely lasted a year, it seems like no one is immune to the risk of closure.
Once you know why they collapse, you can prevent yours from succumbing to the same fate. More than that, a lot of this information can show you what it takes to truly succeed, not just survive.
Top Reasons Law Firms Collapse
There are some obvious and some not-so-obvious reasons law firms collapse. It isn’t always due to poor management. In fact, some firms that fold are doing everything that normal law firms do daily.
These are the most common reasons that new law firms collapse - and what you can do to avoid it.
Law Firms Are Owned by Partners
One of the main reasons law firms collapse is because they are owned by the partners, not by investors. Large companies like Apple are owned by investors and run by board members. The CEO and managers all earn base salaries plus bonuses.
Law firms, on the other hand, are owned by partners. The partners equally split the risks, liabilities (costs), and profits.
The problem with this model is that each partner receives a profit share rather than a fixed salary. When profits decrease, partners will leave in search of better opportunities.
Since partners don’t receive a fixed salary, this leaves them open to personal liability from debtors, too. They are personally invested in the law firm, so when it doesn’t do well, they do the smart thing financially and leave before it becomes too bad.
This also affects the partners left behind. They are all residual risk-bearers. That means they don’t receive their profit share until after the fees are paid. When one partner departs from the firm, all that liability rests on the ledgers of the remaining partners, which cuts even more in their profits.
They Don’t Cut Costs
The high cost of overhead fees, like downtown high-rise offices and insurance plans, negatively affect the bottom line.
When the money going out is equal to or more than the money coming in, partners depart and the firm will be on the brink of collapse.
There are a lot of different ways that costs can increase in law firms. Wining and dining potential clients, purchasing pricey transportation for the firm, and hiring a large staff are just a few common examples.
Mismanaging liabilities like these puts more financial stress on the partners, which makes the firm more likely to collapse.
They Grow Too Quickly
Some firms spend so much on that overhead because they were doing so well, they believed they could handle it. Growing quickly might seem like a brag-worthy accomplishment for law firms, but fast growth is a sign that you should be extra careful.
As the law firm expands, the costs increase. Therefore, a firm might not be able to sustain or could even outgrow the factors that led to its success.
With fast growth, costs can easily increase faster than profits. It’s better to grow at a safe rate and carefully maintain profits so partners don’t feel burdened by debtors.
Clients Leave With the Partners
Another reason that many new law firms collapse is because clients tend to be more loyal to the partners than the firm.
When a partner leaves, they often take their clients with them. This results in a significant loss of revenue. As the revenue decreases, there is more pressure on the remaining partners to obtain more high-paying clients - which can be difficult when they are already busy with their current clients.
Weak Bonding Capital
Another risk for a law firm collapsing is how loyal and trustworthy the partners are to each other. Sociologists call these emotional ties “bonding capital.”
When partners have a strong bonding capital, they might respect and value their colleagues more, giving them grace and even helping them through hard times. It becomes more about the relationships and the strength of the firm as a whole and less about the balance sheets.
In fact, signs of low bonding capital are things that make a law firm more likely to collapse. This includes distrust, stressing the importance of bringing in higher-paying clients, and prioritizing the bottom line over the personhood of the partners.
Any time it becomes more about the money and less about working together as a firm, the partners will be more likely to leave in search of a better work environment.
How to Prevent Collapse
Even though there is no way to completely ensure a new law firm will never collapse, there are a few things you can do to make it less likely. These are the things that make a law firm healthy.
Keep It About People
It is extremely important to create a work environment that values the lives of the partners. When you establish a healthy atmosphere within your law firm, you will decrease the likelihood of partners leaving for another firm.
Make your firm a place that associates want to become partners in and partners are proud to support.
This kind of loyalty might also overflow to potential clients. As they witness how proud everyone is to represent your firm, they will be proud to hire you as their legal representation.
There will be less of a financial burden on the partners when your overall costs are lower. Yes, that showy office complex is tempting, but it is better to work from a place that is affordable and provides more profits for the partners.
When you come together as partners, make maintaining low costs a constant topic of conversation. Grow at a rate that you can maintain without cutting into your partner’s income.
Set Up a Reliable Salary for Partners
Instead of paying partners with a profit-sharing model, consider base salaries and bonuses. This could increase retention and won’t put as much strain on the remaining partners when one leaves.
Contact a Financial Advisor
Anytime that you are making important financial decisions - whether personal or professional - look into financial planning for lawyers. They will help you determine whether purchasing decisions might help your business grow or whether it is more prudent to delay them.
With intelligence and strategy, a financial advisor can support your professional efforts to grow and give you financial advice about investments and liabilities.