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Payback time Hundreds of thousands of pounds worth of debt: some UK equity partners are near to bursting with massive personal liabilities. The consequences of a credit culture must be addressed head on: but few want to follow Clifford Chance’s $150m private placement
DEBT: IT HURTS. THE CONSEQUENCES of a global boom that so affected English law firm strategy as the 1990s progressed are now being felt. Where once a law firm was a law firm, now a series of large international legal businesses are becoming polarised by their attitudes to debt and partner capital. Firms are beginning to be distinguished as much by their financial positioning as by their brand. As ever, Clifford Chance is in the spotlight – the world’s largest firm has some of the biggest question marks hanging over its choices of debt. Legal Business set out to see what has changed in terms of law firm finance, and how a firm like Clifford Chance compares to some of its smaller rivals.
RICHARD LLOYD
If you want the world, you have to pay for it. Just ask a Clifford Chance equity partner: the firm’s debt currently equates to more than £250,000 for every one of them. What’s more, since last autumn, the partners have been asked to guarantee a quarter of their profit share as security for further borrowings. One senior CC source sums up his firm’s dilemma: ‘To finance a law firm you can either go to the bank and borrow it, go to the partners and ask them to borrow, or
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NATIONAL: ADDLESHAW GODDARD
Managing partner Mark Jones
Turnover: £122m PEP: £289,000 Average partner capital: £200,000
Context: The firm is financed by a mixture of partner capital and bank borrowings. Average partner contribution to the business is £200,000. The firm’s lockstep runs from 50 to 150 points – partners on 50 to 60 points contribute £150,000; those up to 100 points pay £200,000; and from 100 to plateau £250,000. The firm has fixed bank facilities that must not exceed 15% of turnover – borrowings currently stand at around £4m.
> hold on to profits that are due to be paid to partners.’ Summing up last autumn’s uturn, when partners were once again requested to guarantee their own money to secure further loans for the firm, the source continues: ‘Over time the CC model has shifted to and fro, and recently we’ve decided that it’s best for the partners to contribute more personally.’ Frankly, there didn’t seem to be much choice. A $150m private placement had been set up for the firm in 2002. The conditions of the 10- and 15-year facilities were stringent – Legal Business has seen them, and the highlights are printed here (see p35). When Clifford Chance needed more cash, and quickly, at the end of last year, its management turned back to the equity partners and demanded that they guarantee the support to borrow yet more. A huge tax bill loomed in January, and the private placement stipulated a level of capital below which the firm’s coffers could not sink.
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Four years ago, Clifford Chance boasted that, after the über-mergers in New York and Germany, the firm would be financially managed solely through bank borrowings and existing revenue streams. ‘Four years on and it’s another broken promise of the merger,’ is the dismal assessment of one source who has recently left the firm. Profits this year are set to fall. Partners can stomach most things – including capital calls – as long as they’re getting richer, so Clifford Chance must move carefully. The giddy days of 1999’s riches – as the firm stood on the cusp of global domination – seem ever more distant a memory. Here’s what changed.
Out with the old After four years of operating without partner capital, last autumn Clifford Chance asked its partners to back a new £30m cash injection into the business. Hardly the play of a confident £1bn business, argue the critics, although Clifford Chance insists it’s simply a realignment of capital funding. The alignment was skewed in 1999. Then, the biggest, brashest player was enjoying the fruits of the late 1990s boom: asking a partnership to stump up cash to pay into the firm didn’t make sense when there was millions of revenue in the bank. Profits were rocketing (Clifford Chance’s average PEP was second only to Slaughter and May’s figures in the Legal Business 100 for 1999). Partners’ paid-in capital stood at £54m – just over £200,000 per equity partner. But having partner borrowings in the business just didn’t add up. ‘The firm realised that the traditional partner capital model isn’t great in boom time,’ recalls one former partner. ‘CC had a lot of collected bills sitting in the bank which were distributed quarterly
‘In terms of admin it’s much easier not to have partner capital, and it’s cheaper.’ John Mullins, Herbert Smith while the partners were borrowing millions of pounds.’ So in 1999, the firm negotiated an umbrella facility with Barclays. The partners’ £54m of capital was converted into a term facility and flexible overdraft, which was expected to cover the firm’s capital needs.
First in Clifford Chance has always lived by the principle of first mover advantage, and the firm took a further, unprecedented step away from partner capital contributions
MAGIC CIRCLE: ALLEN & OVERY
Managing partner David Morley
Turnover: £647m PEP: £675,000 Average partner capital: £350,000
Context: For the past four years A&O has been withholding approximately 5% of each partner’s profits (an average of £33,000 per partner) to pay half of the firm’s £100m move to Spitalfields in 2006. Monthly drawings are set at the beginning of the financial year with surplus profits paid out over 12 months, starting from August of the following year.
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straints of debt Clifford Chance: the con
e’s $150m private entation of Clifford Chanc um doc al gin ails ori the n s some of the stringent det Legal Business has see l, and exclusively reveal pita Ca ys rcla Ba by ed placement, arrang tied. to which the firm is now
MAGIC CIRCLE: CLIFFORD CHANCE
. Key conditions: ds to be less than £160m permit equity partner fun e tim any capitalisation. at l not tota l of wil The firm firm to exceed 60% the of t deb net mit per e tim The firm will not at any Affirmative covenants vide to noteholders: rmation the firm must pro cates m and compliance certifi Financial and business info tements of the World Fir sta ial anc r of fin ice ) off ited d aud ise Quarterly (un tified by an author each quarterly period cer of end the r afte s day within 90 nce certificates within the firm. World Firm and complia the of s ent tem sta ial nt certified public Annual (audited) financ h an opinion of independe wit r yea al fisc h eac of 120 days after the end accountants. Notice of default. matters. Notice regarding ERISA occur and be Events of default ditions or events should any of the following con if st exi ll sha t aul def of An event . continuing: pal of any note when due the payment of any princi in ts more than five aul for def due firm e en Th wh e ■ interest on any not any of nt me pay the in The firm defaults ■ itation business days. Funds covenant, the lim e of the Equity Partners anc erv obs the in firm Failure of the ■ merger covenant. tinues on debt covenant or the nt or other term which con ance of any other covena erv obs in firm the of e Failur ■ or unstayed by appeal unremedied for 30 days. m which remain unpaid £10 ing eed exc s ent gm The firm has final jud ■ or otherwise for 30 days. th 60-day grace period in Standard ERISA defaults. ■ /liquidation of the firm (wi tion isa gan eor y/r enc olv Bankruptcy/ins ■ the involuntary context). le ns of a proporPartners payment schedu receive quarterly distributio n the ey Th t. oun am ly nth nths after the end Partners receive a set mo ment deferred to three mo pay h wit t (bu ned ear as fits ding December. Thus tion (70%) of actual pro fits paid out in the succee pro net the of e anc bal fits have normally been of the quarter), with the le less than 50% of the pro litt a r, yea s ial anc fin ’s cember payment represent by the end of the firm July to December: the De m fro d pai is der ain rem distributed. The r’s profits, net of tax. the final 30% of the yea
three years later, in 2002. Having acquired US law firm Rogers & Wells, and found the price of global pre-eminence in the size scales far from cheap, Clifford Chance hired Barclays Capital to put in place a $150m facility (50% more than had been the original borrowing intention). The cash was spread over tranches of 10 and 15 years, to be paid back by the firm at a fixed rate of 5.5%. With such a loan comes covenants –
conditions – far stricter than would accompany a normal overdraft. For example, Clifford Chance has to retain equity partner funds of £160m in the business; it must not allow net debt of the firm to exceed 60% of total capitalisation. In the autumn of 2003, in the face of a continued downturn in
Senior partner Stuart Popham
Turnover: £978m PEP: £639,000 Average partner debt: £250,000
Context: The firm raised $150m through a US private placement in 2002 and then raised a further £30m from Citibank in autumn 2003. The firm repaid its partner paid-in capital in 1999, replacing it with an umbrella facility arranged with Barclays. The total owed divided by the number of CC equity partners gives an average of £250,000.
the global economy, there was a worry within CC that it was in danger of not being able to sensibly pay the tax bill due in January of this year. This led to management’s decision to ease such pressures, and in doing so the firm made a major u-turn – it turned back to its partners for extra capital. A £30m loan facility was consequently organised with Citibank. Clifford Chance partners were asked to guarantee 25% of the value of their equity points. With top of equity this year expected to be in the region of £625,000 (some £50,000 less, incidentally, than in 1999), the capital call equates to a commitment of around £156,000 for each plateau partner.
Footing the bill Clifford Chance is by no means alone in looking to new sources of capital. Allen & Overy is currently weighing up the appropriate options to finance its new Spitalfields office. The firm must find £100m to fit out the building, which it plans to move into in 2006. For the past four years it has retained
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‘It’s a big psychological factor; partners feel more a part of the firm if they put their capital into it.’ Tony Angel, Linklaters
> around 5% of partner profits per annum year, amassing £50m up front. The remaining £50m will be raised through a bank loan or a private placement – at press time, the firm had yet to decide. This remains a relatively novel state of affairs: law firms generally are not cash – hungry businesses; when faced with one-off bills they can more often than not cover any expenditure through their existing finance facilities. Linklaters, for example, paid for the bulk of its new global IT system through its existing overdraft facilities –
CITY: ASHURST
Senior partner Geoffrey Green
Turnover: £197m PEP: £590,000 Average partner capital: none
Context: No partner borrowings and limited bank debt. Capital retained in the business by slower profit distribution with payments spread over two years. The first profits an Ashurst partner will see from this year will hit their account at the beginning of the 20052006 financial year.
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this despite the bill being a reported £30m. A&O, Freshfields Bruckhaus Deringer and Linklaters also utilise capital from partner borrowings, along with the system of withholding a proportion of the profits due to partners in a particular year. Law firm managers like the idea of having partner capital in the business – one Magic Circle senior partner describes it as ‘keeping them on the hook’. For Linklaters managing partner Tony Angel, it’s a question of mind games. ‘It’s a big psychological factor; partners feel more a part of the firm if they put their capital into it,’ he says. Partners appreciate that they have made a personal commitment to the business – or so the theory goes. Angel also claims that the firm’s mix of partner borrowings and withheld profits gives Linklaters greater flexibility, compared to being tied to longer-term debt repayments. A private placement along the lines of CC’s may be cheaper, but Angel would rather the business was backed by the partners than any covenantimposing investors. Given the conditions of CC’s document, some will doubtless argue.
Breaking the bank As ever, several firms have followed Clifford Chance’s earlier lead in opting for straight bank borrowings rather than partner capital. Herbert Smith, for example, repaid its partner capital in 2001 and now operates solely with firm borrowings. The firm found that it was borrowing from the same bank that the partners were using to borrow their capital and therefore took the decision to consolidate its debt. ‘In terms of admin it’s much easier not to have partner capital, and it’s cheaper,’ says John Mullins, Herbert Smith’s financial director.
NATIONAL: EVERSHEDS
Managing partner David Gray
Turnover: £284.9m PEP: £308,000 Average partner capital: £189,000
Context: The national firm has a mix of fixed capital from the equity partners, withheld drawings and bank overdraft. A partner’s capital in the business depends on their position on the firm’s lockstep, with an average contribution of £189,000 per partner (giving the firm £33.6m from its 178 equity partners). ‘Partners understand the traditional approach, they appreciate that they’ve made a personal commitment to the business,’ Bob Raeburn, Eversheds’ financial director, says.
Simmons & Simmons has also opted out of partner borrowings. Three years ago it moved to a rolling bank facility along the lines of the one that Barclays put in place for Clifford Chance when it repaid partner capital. ‘It allows us to borrow at a lower cost, considerably reduces the administrative burden and all that the partners do is underwrite the facility,’ Paul Edwards, Simmons’ finance director, explains.
Dollar bills An approach like those of Herbies and Simmons would alarm many US firms. Latham & Watkins and Milbank, Tweed, Hadley & McCloy both raise capital by withholding partner profits. Milbank, for example, makes a prediction as to what it will need to spend the following year, and retains that amount of the profits: the partners never even see it. But then the US firms have a natural advantage as they account on a cash basis,
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REGIONAL: TLT SOLICITORS
Managing partner David Pester
Turnover: £15.8m PEP: £188,000 Average partner capital: £100,000
CITY: SIMMONS & SIMMONS
Managing partner David Dickinson
Turnover: £176.9m PEP: £300,000 Average partner investment: £370,000
Context: The firm moved to a bank facility underwritten by the partners three years ago and abandoned partner borrowings. Profits are paid out over 12 months. With the firm’s debt, plus capital reserves for tax and undistributed profits, each partner’s investment in the business is equivalent to £370,000. Lock up is approximately 120 days. ‘We’re on a very good monthly billing cycle so we tend to be better on WIP than on debtor days,’ says Paul Edwards, the firm’s financial director.
as opposed to the UK’s accrual method. Thus by the end of each financial year the US firms know how much cash they have to play with. For the UK firms that take account of work in progress, there’s always the possibility that they won’t even see it translate into fees. Those partners who have experience of both UK and US firms claim that the latter are more conservative in their view of funding. ‘We don’t borrow money,’ explains Latham’s finance partner Bernie Nelson when asked if his firm would ever consider doing a private placement. ‘We’re very conservative from a fiscal standpoint so I don’t get any money until everything is paid.’ This is a level of conservatism to which a dwindling number of large UK firms are able to subscribe. The exceptions are often the safest beasts. Ask Clyde & Co’s senior partner Michael Payton if the firm would ever think about borrowing for its capital requirements and he retorts: ‘What would we do with it? We’re an EC3 firm – we don’t need to
Context: Mix of partner capital and bank debt. Average partner capital in the business is £100,000. The firm has an unsecured overdraft facility which it rarely uses and will use finance for certain projects such as equipment upgrades. TLT was recapitalised after it was formed through the merger of Trumps and Lawrence Tucketts in 2000. ‘We felt we needed greater working capital so we increased partner contributions,’ David Pester, managing partner, says.
invest in new premises; IT we finance as we go along and expansion is largely selffinancing. We’re not looking for black holes to pour money into.’ Point taken. But for Payton, keeping an eye on a £90m business with offices in seven countries is a different challenge to the one facing senior partner Stuart Popham and managing partner Peter Cornell at Clifford Chance. At the moment, parts of the firm’s global network may look like black holes to them. ‘CC isn’t about to disappear in the wind,’ points out one former Magic Circle partner. ‘But in the early 1990s no one actually said “let’s build the one-stop shop” – they were built incrementally. By the late ‘90s boom the concept had developed a mind of its own.’ Clifford Chance’s equity partners are increasingly mindful of the beast they have created, which must be fed despite the cost. LB richard.lloyd@legalease.co.uk
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