Will Your Law Firm Survive the Coming Recession?

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I’ve worked through three recessions in my career, in 1990, 2001, and 2007. Another recession will hit eventually, because they always do. Will you survive?

In the United States, over the past 100 years, there have been seventeen periods defined as recessions. Unfortunately, a recession in the U.S. often impacts the rest of the world–sorry about that.

Looking back over the past century we’ve had 17 recessions: 1920, 1923, 1926, 1929 (Great Depression), 1937, 1945, 1949, 1953, 1958, 1960, 1969, 1973, 1980, 1981, 1990, 2001, and 2007. By all accounts, we’re overdue.

When will the next recession occur?

Soon enough.

What does a recession look like for a law firm?

Some firms thrive during a recession. They’ve built practices in areas that boom in desperate economic times. The classic example is bankruptcy, but there are others as well. Foreclosures jump in a recession. Some employment law practices get busy, along with certain litigation practices. Doom can mean boom for some lawyers who are fortunate enough to be in the right practice at the right time.

But a recession can be pretty awful for lawyers in lots of other practice areas. A slowdown in the economy impacts in many ways, and many practices can quickly find their revenues trending downward, or perhaps even plummeting. A downturn will impact each firm differently, and it’s likely that some of the fallout will be entirely unexpected.

Typically, a recession is “technically” over fairly quickly. But the effects linger, sometimes for years. Large firms lay off associates, who end up competing with smaller firms. Medium-sized firms reduce prices, which impacts smaller firms, who lose business. Clients reduce their legal spend and take a long time to ramp back up. It gets ugly quickly and it stays ugly for longer than hoped.

Don’t believe your own bullshit

My favorite line is “We handle these types of cases plus these other types of cases so we’re recession-proof.” Another version is “When one practice area is down, the other is up, and vice versa.”

Some say the legal industry is recession-proof, but they mean the industry as a whole. Individual firms, lawyers, and practice areas aren’t. Even if revenue of the legal services industry overall remains constant, with increases in some areas and decreases in others, you’ll likely still feel it in your practice.

During the recessions that I struggled through, I watched a few large firms thrive. Within those firms, certain practice areas boomed, while others went bust. The revenue for the firm might have been maintained, or even improved, but the firm terminated associates and partners. Why? Because large firms tend not to integrate practice areas or cross train lawyers. A formerly productive partner, experiencing a steep revenue decline due to the economy, finds herself suddenly outside the firm as a former partner.

It’s easy, in good times, to believe that the good times won’t stop. It’s tempting to keep spending, keep expanding, and keep growing. With interest rates remaining low, it’s easy to coast along, just repaying principal, while continuing to invest in expansion of the team, the practice areas, and other growth projects. It’s logical, when revenues continue to climb, to invest today with the plan of reaping the rewards tomorrow. Extending yourself financially isn’t scary if you have a long history of turning those risks into rewards.

But a little fear is a good thing. Knowledge is power, business cycles are real, and, as Andy Grove once said, “Only the paranoid survive.” If reading these words doesn’t give you an anxious jolt, then you’re either well prepared for the downturn or you’re ignoring reality.

Be nervous: it’s good for you

I’m a risk-taker. I thrive on adrenaline. I’m always up for a heart-pumping movie or a big stock trade on margin. It doesn’t bother me to put my signature on a large bank note. I’m all in. The problem is, it’s people like me who get obliterated in a recession.

I don’t get particularly nervous about financial risk. Adopt my attitude at your peril. We’ll get crushed together when the financial wave crashes down on us and we’re rich in risk, poor in cash, and desperate for a life jacket.

It’s tempting, especially with the economy going so well right now, to push hard for growth, borrow money, maintain minimal cash, and roll the dice on adding to your team, adding practice areas, adding office space, and ramping up your marketing.

Being highly leveraged when a recession hits is the most dangerous place to be. Owing a bank and a landlord, running fast and loose on overdue payables, and living on your credit cards is death when the music stops.

The optimistic, positive, leveraged lawyer is the lawyer who gets blindsided, responds slowly, and ends up eating out of the dumpster behind the supermarket. They’ll sell off your leather furniture and fancy artwork and you won’t even be invited to the auction.

Don’t save money for the down times

The response of many lawyers, when I bring up this unpleasant topic, is to explain how they have created a big cash reserve. They’ve got it all figured out. They’re smug.

They’ll be joining us at the dumpster buffet.

Saving money for a recession is awesome. It gives you the ability to take advantage of opportunities arising out of the financial failures of others when the down period hits.

Interestingly, when the Great Depression hit, both my grandfather and my wife’s grandfather had cash on hand. Both used that cash to buy fire-sale-priced real estate, when others lost everything. They held the property for the long term and did well financially. Having cash for those opportunities makes sense.

Unfortunately, if you’re running a law firm, the cash will likely be gone by the time those opportunities arise. You’ll have wasted it by then, trying to help your firm survive the recession. Saving money just delays the inevitable and costs you money over the long haul.

Savers feel prepared, so they dip into the cash stockpile when their revenues decline. They wind up using most of the money on payroll. They keep folks on the team, even when the work is insufficient to keep everyone busy.

The next thing they know, the savings are gone. They’re meeting with employees and letting them go. Everybody is crying.

I guess those folks are better off than some others. That’s because many of the others, not having set aside cash, will draw on their line of credit. They’ll keep meeting payroll by borrowing. They’ll have even bigger tears when they terminate the team, because they’re in a hole so deep they can barely see daylight above.

Waiting until the savings run out, or the line of credit is maxed out, is the wrong approach.

The right approach is to take corrective action immediately upon seeing evidence of a downturn.

Decide on your indicator and trust it

You must set an objective indicator that warns you that business is down and it’s time to act.

If you wait for the economists to tell you we’re in a recession, you’ll lose. The economists don’t decide we’re in a recession until it’s well underway. It takes them a while to collect and analyze economic data. Sometimes it feels like we’re already through the worst of it by the time they announce it.

You need to have a canary in your coal mine. When the bird dies, you need to act. The poison gas is coming for you–fast.

You’ll be tempted to believe the canary died of old age. Then you’ll speculate that the canary had a genetic defect. You’ll wonder if maybe an employee killed the canary.

When the canary dies, you MUST take action.

You need an early warning indicator and you need to trust it, or you’ll spend down your resources, shorten your runway, and make survival far less likely.

The alarm won’t wake you up if you don’t turn it on

I use my iPhone to wake me up when I need to be out of bed at a specific time, often to catch a flight. I have it set to use this unbelievably loud klaxon sound. It’s what I assume we’ll all hear if there’s ever a nuclear attack. But guess what?

The klaxon doesn’t work if I don’t set it properly, turn it on, and leave the phone near my ears.

The same is true of your alarm.

One lawyer explained to me that she’ll take action on her expenses when she has 45 days of revenues running below her trailing 365-day average. Very cool–that sounds almost scientific.

But then we discovered that she doesn’t usually get her revenue numbers until 30 days after the close of the last month. That means she could miss her 45-day warning by about two months. That’s a lot less scientific.

She has an early warning system, but the message gets delivered too slowly. It’s like she’s using the iPhone alarm, but placing it next to the baby down the block who gets awakened, cries, wakes up the mother, who then takes a shower, gets dressed, has breakfast, goes out for a smoke break, puts the baby in the stroller, wheels down to your place and knocks on the door to wake you up.

By the time she gets to your door you’ve missed your flight.

It’s time to prepare

The recession is coming. You’ll need to weather the storm. You need to go ahead and batten down the hatches now. There’s no time like the present to prepare.

  1. Build the early warning system

    Most firms don’t realize they’ve hit a bad period early enough to react with adequate time. You need live data in front of you all of the time. I’ve built a course on how to create a dashboard for your law firm. If you don’t have live data, it’s like you’re driving the car without a speedometer.
  2. Rank your team

    Payroll is the big expense in a law firm. It has to become your focus in a downturn. Be ready to act. You need to evaluate your team and know, objectively, who’s a keeper and who needs to be made available to other employers. Rank your team, maintain a current list, and know who you need to vote off the island.
  3. Make remaining payroll variable
    Now, before the recession hits, make your payroll as close to 100% variable as possible. Come up with a plan that allows payroll to increase as revenues/profits increase, and decrease when the opposite happens. Take decision-making out of the equation. Let the system automatically trigger adjustments. If you do it right, there is no decision to make. It just happens, and you don’t have to take action. For me, moving toward variable payroll involved two approaches.

    First, we outsourced–to independent contractors–all work that would lend itself to that arrangement. We moved marketing, technology, finance, and some legal work to contractors. These folks either bill by the hour or by the project. They’re easy to amp up or down depending on your workload.

    Second, we shifted as many of the remaining employees as we could to a generous, fully commission-based system. High performers earn a substantial income. The employees can’t, however, earn nearly as much if the firm isn’t generating revenue, which protects the business in a downturn. Our approach involved no base, no guarantees, and no safety net. High risk, but also high reward, for the employee–low risk for the law firm.

  4. Stop pretending
    The recession scenario I’ve described is coming for you. Yep, you. It might be this year, next year, or a decade from now. The economy is cyclical. Recessions are unavoidable; they’re inevitable. Be ready.

When the recession hits, be ready

  1. You’ll know
    Because you’ve implemented a reliable dashboard with realtime data, you’ll know what’s happening when it happens. Taking action a month earlier than you might have otherwise will save you tens of thousands of dollars, if not more. This discussion is not academic. A recession is inevitable, but it won’t be obvious when it happens. It’ll sneak up on you if you’re not careful. Keep your eye on the canary.
  2. Don’t cut your income, blow through the credit line, or hit the savings
    The pile of cash is there for the dips you encounter from month to month. It’s not there to substitute for the kind of course correction you need when a recession hits. It’s tempting to ignore the early warning system, assume it’s like all the previous bad weeks, and hit the backup cash. Don’t do it. That’s just delaying the inevitable, and you’ll have fewer resources when you finally realize that the problem is more than a bad week.
  3. Cut expenses immediately
    Cutting expenses quickly is critical. But you probably can’t do that. Why? Because you haven’t planned to do it. Plan for it now. Make nearly all of your expenses highly responsive to change. Avoid long term agreements, leases, and commitments. Make your expenses variable. Examine your profit and loss statement, go through your vendor list, ask yourself what can be cut by simply sending an email. Then find a way to make most of your expenses instantly variable. Yes, you’ll lose long-term discounts in exchange for the ability to pivot. Is it worth it? Yep.
  4. Slash payroll
    The big expense to cut when the recession strikes is payroll, because it’s probably half of your overhead. In a recession, your payroll is where the damage is done. Unfortunately, this is where it’s most tempting to hang on to high expenses, in order to preserve your team, avoid difficult conversations, and keep your ego-driven headcount high. The best solution involves taking you out of the solution. Make it automatic.
  5. Inflict the pain
    It’s hard to inflict pain on your employees. Do it anyway. Even with a variable payroll plan, you’ll need to let some folks go in order to save the jobs of the others. Take action. Recognize that you will likely, if left to your own devices, wait too long to fire people. There will be lots of ways to rationalize keeping the payroll up while borrowing from the bank and from yourself. This is the normal, optimistic behavior of a business owner. You will wait until you can’t stand the pain before cutting. By then, you’ve wiped out your personal savings and maxed out your credit lines. You’ll spend five years paying back the price of indecision. Inflict the pain quickly.

You’ll be fine

Being prepared means taking action before the event happens–once it happens, it’s too late.

Without a plan, without early warning indicators, and without preparation, the recession will drop on you like the anvil drops on Wile E. Coyote. It will crush you.

When the recession hits, we’ll see firms breaking up, solos shutting down, and clients finding creative ways to solve their problems without paying lawyers.

Lawyers will offer their services for less, online advertising markets will be flooded with legal services advertising, and lawyers from other practice areas will suddenly make themselves available to your prospective clients. It will get ugly for a while, and it’ll last longer than anyone likes.

One bad month will turn to two, then three, then six, and the cash is gone, the team is gone, and the business has evaporated.

Prepare, and you’ll be fine. Ignore my advice, and you’ll suffer long past the end of the recession and through the recovery, as you patch the holes in your personal financial plans.

As I said at the outset, I’ve worked through three recessions in my career: 1990, 2001, and 2007. I survived each of them, but it was never easy. It took me a couple of recessions to accept their inevitability. I’m a slow learner.

Another recession will hit eventually. Can you learn from what I’ve offered above? Will you survive?

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