No leverage, no profit. Or at least that's how some law firms see it. "Clearly without leverage you would be deeply unprofitable," says Jim Baird, regional managing partner of Clifford Chance. "And in any case if you didn't have leverage there are some transactions that you just couldn't do."
Leverage has always been a bone of contention at law firms. On the one hand, it's the basic building block of successful firms, the structure for the ubiquitous model of 'finders, minders and grinders'. On the other hand it's a symbol of hierarchy and the distance between equity partnership and the other rungs of the ladder. It is also an indicator of profitability, and as such ratios can be jealously guarded by some firms.
Few international or local firms will reveal the leverage ratios of Asian offices. Ostensibly it's because firms are protective of their salaried partners and want clients to think that partner means partner.
As Lindsay Esler, managing partner at Deacons says: "I'm not really sure why firms in Hong Kong are so secretive - it's a historic thing but many of our partners still feel quite strongly about it.
"One other issue is that some apparently quite large firms in Hong Kong only have a handful of equity partners. They may feel that if they disclose this ratio then their salaried partners will be picked off by firms that can offer some prospect of entry to equity."
However, even as Esler says this, he refuses to divulge his firm's equity partner numbers.
But it's also because ratios in new markets can be hard to read. It's this distortion of figures that makes firms like Clifford Chance loathe to reveal exactly how many equity partners it has on the ground in Asia. "The point is that the numbers can be distorted," says Baird. "If you are in a new market it's very likely that you have three to four lawyers and that could become five or six with only one equity partner - and that would heavily distort your leverage ratio."
Distorted models
Leverage ratios in mature markets tend to sit around the same mark. For example, in Australia the leverage ratios of the major corporate firms sit comfortably between three to four. However, in less mature markets ratios can vary wildly. In China, for example, commercial firms of similar sizes can have leverage ratios of anywhere between three to eight. This is partly because in more mature markets firms pursuing the same business have practices that are closely aligned, whereas in new markets firms are less homogenous.
Comparing mature markets, there is a general trend that UK firms have slightly higher leverage ratios than their US peers. This is because, according to DLA Asia managing partner Nick Seddon, the two groups operate on different models.
"Leverage is more a focus of UK firms than it is of US firms because of the model that we operate," he says. "The most standard business model for UK firms is that they have a partner to manage a number of fee-earners and they do less direct fee-earning. The American model means that partners do the billable hours and have less of a managerial model." (DLA has one of the higher leverage ratios when compared with its UK rivals and is one of the few firms willing to divulge its local Hong Kong leverage ratio of 5.1.)
However, jurisdictional idiosyncrasies make comparisons between Asian jurisdictions difficult. For example in India, where partnership is limited to no more than 20, firms are hampered in using leverage as a strategic tool. "Keep in mind that the larger firms in India are unable to drive [leverage] as a strategy in view of the restrictions under Indian lawyers," says Rabindra Jhunjhunwala, a partner at Khaitan & Co.
And in Taiwan, for example, the bar pass rate of around 1% has led to the creation of a type of lawyer called "senior counsellor". These lawyers, who cannot appear in court and therefore cannot be an equity partner, nevertheless play the role of an equity partner in firms. "We don't have a strategic decision to keep the number of our equity partners low," says CV Chen, managing partner at Lee and Li in reference to the firm's 6.9 leverage figure. "It's true that if you exclude senior counsellors then our leverage is a bit higher, but we can't exclude them because in some practice areas they're as experienced and valuable as partners." The firm has 20 senior counsellors in addition to 19 equity partners.
But that said, a glance at the results would seem to indicate that Singapore firms such as Colin Ng & Partners and ATMD have taken the UK route with significant ratios.
At Colin Ng, partner Bill Jamieson, points to the high level of salaried partners - there are 23 at the firm - as a mitigator of its 8.7 leverage ratio. "I think that the model is not a highly leveraged one because we have a high number of salaried partners," he says. But while he adds that the partners tend to operate as lawyers doing client work, he does admit that the firm "wants to develop by getting into more complex transactional work which demands more project management skills - we believe that this work is more profitable".
At ATMD, where the firm has a leverage of 6.1, there are signs that name partner Alban Kang wants to take it in the other direction as he notes that the ideal ratio for the firm is closer to 4.1. He says: "The higher the ratio the more profitable it is for law firms. However, having a higher ratio could lead to a slip in the quality of service and higher costs. There is a need for an appropriate balance."
Driving profitability
As leverage has a direct relationship to profits the temptation has always been to take it higher. "It's an important driver of profit," says Khaitan & Co's Jhunjhunwala. "The higher the ratio, the higher the profits," he states baldly.
But every firm recognises that driving up leverage brings its own problems. For multi-jurisdictional firms it's a risk management question in terms of how many associates and hours of work one partner can supervise. "Risk management issues limit the growth," says Baird. "You can't compromise on your quality."
There's also the internal pressure to demonstrate a career path for associates (see box: The associates' view) and the external pressure to have enough partners to hold clients' hands.
But that said, where firms can leverage up, generally they will. And that is easier done in certain areas than others. Big litigation matters where reams of bodies are needed to do research are a typical area where you see larger ratios.
However, when it comes to areas of work such as taxation - where what is required is intellectual property rather than sheer numbers - these areas generally have lower ratio levels.
Beyond leverage there's value
Increasing leverage alone, however, is not enough to ensure profitability. There are a whole other set of issues that surround the relationship between leverage and profit.
"Leverage isn't essential to profitability - it depends on your business model," says Seddon. "However, we at DLA tend to regard leverage as an important part of the overall financial model," he continues. "But if you're increasing the leverage without increasing the FFE then that's not doing you any good."
This is the view echoed by Lee Suet Fern, the senior director at Stamford Law Corporation. The firm has one of the lowest leverage ratios in the jurisdiction with 10 partners and 25 other fee-earners.
Lee likens the firm's approach to Wall Street players such as Wachtell. "It depends what segment of the market you're playing in," she says. "Although our leverage ratio is lower than some firms, I know that this has not in anyway adversely affected our profitability. The work we do generally requires the hands-on input and insights of an experienced partner rather than throwing a bunch of young associates at the client."
Colin Ng's Jamieson echoes these views when he says: "Firm's don't look at issues like leverage in isolation - we look at it in terms of what the client requires in order to deliver the service. Besides, you don't get more profitable by throwing more bodies on a deal, you get more profitable if you add more value to a deal."