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The Lawyer's Financial Stages - Stage 1 - The Early Career

We work with many associates and partner attorneys in large firms. There is often a professional and financial lifecycle as lawyers progress. Here’s what we see:

Early Career: Congratulations! Graduating fresh out of law school and passing the bar exam is an accomplishment. You start at a leading firm in a practice you always wanted. Starting salaries are generous and there are usually annual bonuses of up to 30% of base. Expenses are high. Some of that is setting up a new house, often with a new spouse, and becoming familiar with regular household expenses. Housing, travel and food expenses can run as high as 50% of income (more if you’re in New York, the Bay Area or Washington).

And there’s one big and often intimidating expense. Yes, student loans. It’s best if you can consolidate these (but be careful you don't run afoul of the community property commingling principles) for nothing else than ease of repayment. You may also pay a lower rate.

Start with the basics. Create a budget. Stick to it. Start saving some cash reserves. Three months of expenses is a good number to start with. That’s mostly so you can pay for emergencies or any time off work without having liquidate investments.

Set up a low cost investment savings account. Use ETFs or low cost index funds. Invest $100 a month. Saving $100 a month at a 5% return can grow to $80,000 in 30 years and $192,000 at 10%. So save more if you can. Get into the habit of “paying yourself first”.

You’ll never miss $100 but it can grow considerably with time. If your firm offers a 401(k), invest as much as you can. It's a gift from the IRS and they are not in the habit of gifting. Do not borrow from your 401(k).

Investment and saving success is about time, discipline and patience. You may get Facebook at $5 and retire early. Or you may get Yahoo at $125 and retire late. But with either, you hear about it more than you see it. Most of what we see is consistent saving and staying in the market. So start now.

And watch your expenses. Yes, again with the expenses. You will be working 60 hours a week so simplify your life where you can. Stuff like expensive phone plans, dining out, Uber, cable bills and club memberships can run into hundreds of dollars a month. Get into the habit of managing all expenses. Sweat the small stuff.

If you have any questions on these, or would like to discuss further, please feel free to e-mail us or call 415 435 8330.

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

If you're a lawyer…3 Threats to Your Retirement

Threat 1: The law firm structure

The collapse of the venerable San Francisco-based law firm, Heller Ehrman, reminded us of the risks inherent in law firm structures. In the last few years, there have been other high-profile firms that have dissolved, such as Howrey and Dewey & LeBoeuf.

1.     The LLP structure: Many law firms are limited partnerships where the people (or “members”) are partners. Corporations can not own any part of the firm. If they do, they're an LLC. The liability is limited which means that, as a partner, you can lose your capital but no more than that.

Except...in some cases the doctrine of fraudulent transfer kicks in. This dates back to 1571 and basically says you can't move assets around to avoid creditors. For a law firm partner, this may mean that creditors demand the return of compensation made in the months before a bankruptcy. So, if you made $100,000 in January and the firm tanks in June, creditors can lay a reasonable claim on your earnings. This creates a huge incentive to get out early, which speeds up the death cycle.

2.     Why firms go bust and you lose your capital. Mostly it’s bad management. In some cases (Heller Ehrman, Brobeck Phleger & Harrison, or Thelan), a high revenue producing team leaves. In the case of Brobeck, eager M&A attorneys took company stock in tech IPOs in the late '90s. They ended up with worthless shares. Dewey Le Boeuf offered rich employment guarantees to incoming staff. Dreier was pure fraud.  

3.     The death spiral: In each case, two things happen.

1. The firm can't cover its expenses, more teams leave, and the firm blows through the terms of its line of credit (which is the only real asset). Liquidation follows.

2. Partners started to depart and the death spiral began.

Banks go down where there is a run on the bank. Law firms go down when there is a run on the partners. Bankruptcy is usually swift. There is no Chapter 11 workout route. More often, it’s a debtor-in-possession process, where your new boss is not like your old boss. She’s working for the creditors.

The common denominator is over reach and inability to manage top revenue providers. Throw in some stretched and under-capitalized finances, and many of these firms go fast. Many of the above firms were over 100 years old but folded in months.

4.     What are the warning signs?

  • High senior to junior lawyer salary ratios. In Dewey’s case it was 15:1

  • High amounts of long term debt or lines of credit…

  • And what it's secured against. In the case of Dreier it was against yachts and an Aston Martin.

  • Big reallocations of income within the firm

  • Deferred contributions to qualified plans

  • Unusual ways to define net income

  • High guarantees to incoming lawyers and teams

  • Series of big mergers

  • Firms borrow to pay partner draws

5.     So there is a “run on the bank” and I’m left as a partner: When a law firm dissolves, partners are faced with the following issues:

  • What happens to my capital?

  • Will creditors come after me?

  • Should I switch to another firm or retire now?

  • If I switch, can I transition my clients to my new firm?

  • How do I access my old retirement plan assets?

  • What benefits are provided by my new firm?

  • Should I go over to the new firm as a partner or not?

None of them particularly palatable. But this is a time when standing still is not an option. The first thing we advise is to revise the planning and retirement analysis for those clients. We presume that the capital accounts of our clients will be frozen and ultimately lost. The same for Deferred Compensation plans.

Qualified plans are, of course, protected. In the case of the Heller failure, the plans were eventually transferred intact, although with some delays and difficulties.

6.     Aftermath of a Failure: In the aftermath of a law firm failure, we re-visit retirement planning and analysis, which have to be re-done. Certain assets such as capital accounts are almost certainly no longer available. Other changes will occur. Assuming the affected partner moves to a new firm, the entire benefits and compensation structure will be different and a new capital account must be funded.

7.     What Can You Do? Focus on factors you can control. First, if you have not done so already, create a financial plan customized to you and your family (age, retirement date, spending plans, college education needs). Second, ensure your financial plan accounts for the known threats and risks you face, including those unique to your profession. Third, re-read the warning signs above.

Always, always make full use of your personal and retirement savings starting with your 401(k) plan and other retirement accounts. These will be the primary source of retirement income for you. Remember, attorneys generally do not have a business asset to cash in upon retirement. There is no capital event. What you earn is what you will need to retire on.

And a final check: invest your assets profitably and productively. And that means:

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

 

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