Business of Law Firms
Forecasting the effects of the economic slowdown on law firms​

By Jake Rickman​

What do you need to know this week?

Over the course of the past several months, we have considered in overview how markers of a poor economy like recessions, eroding consumer confidence, and increased insolvency proceedings may affect law firms.

In this week’s series on the Business of Law Firms, a recent article published by the FT entitled “Watch law firms, not banks, to judge the City’s deep freeze” gives us a chance to further consider how deteriorating economic conditions impact law firms and the strategies senior management are likely to pursue to offset the effects.

Effects of an economic slowdown on law firms

The general effect of declining market conditions on commercial law firms can be explained like this:
  • Poor economic conditions typically translate to a lower volume of market transactions like M&A deals and debt financings as businesses react to the uncertainty by postponing their expansion plans and financial sponsors (e.g., private equity) struggle to find appropriately valued businesses to buy and sell.
  • Given that most of the largest law firms generate most of their fees from advising on these transactions, it follows that they generate less revenue when dealmaking declines.
  • However, most law firms also have counter-cyclical practice areas like restructuring, litigation, and employment practices, which can partially offset declining transaction fees. In practice, surging activity in these areas is unlikely to fully insulate law firms from the wider market conditions.
Today’s economic slowdown

This general cause-effect relationship is arguably true for all economic downturns, such as the 2007-08 Global Financial Crisis and the dotcom boom of the early 2000s. But what makes this downturn arguably distinct is the fervour with which most law firms had expanded their hiring and increased salaries from 2020 through 2022 in response to the dramatic increase in dealmaking in the roughly 18-month period beginning in 2020 and lasting through to early 2022.

As the FT article points out, the fear is that most law firms have greatly over-expanded their headcount even though global deal volumes in H2 2022 have decreased by a third in what is the most dramatic swing in activity since the 1980s when record-keeping began. The nightmare scenario would be one where law firms follow the lead of investment bank Goldman Sachs, which slashed thousands of advisory jobs last month following poor quarterly performance due to evaporating deal activity.

However, there is reason to believe that law firms are less likely to act as aggressively.

The article points to the balancing effect of the counter-cyclical practice areas mentioned above as one reason. Another factor is that transactional teams in law firms retain on balance more work than banks even in a downturn because deals concluded months ago still require the input of legal teams to ensure relevant parties manage post-consummation issues like regulatory compliance.

Additionally, senior management in most global law firms are keen to avoid being among the first to pull the trigger on mass redundancies, with legal recruiters noting that “people still talk about who cut first after the dotcom bust and financial crisis.”

Nonetheless, when faced with eroding profit margins due to declining revenue, often the only short-term option available to senior management is to cut expenses. Given the vast portion of a law firm’s working capital is tied up in the salaries of its employees, slashing jobs may very well still be on the table. But rather than slash lawyers and risk being under-deployed when the business cycle rebounds, law firms may instead seek to reduce overhead in less core areas of business such as technology and support staff.

Considerations for trainee applicants

As hopeful solicitors, you may wonder what all this means for you. Is it even worth applying given the bleak omens?

Fortunately, as a profession, law firms have their eye on the long-term ball when it comes to recruiting junior talent. In London especially, the extent to which firms recruit trainee applicants is seen as a proxy for their long-term confidence in their own business strategy. As a result, only firms actively in financial distress even consider slashing the number of trainee seats they offer — and even then, cutting underperforming mid-level and senior talent is the preferred first choice. This means that both current and hopeful trainees alike can breathe easier over the coming months.