If you ask former partners from Dewey, Howrey, and Heller how important it is to look “under the hood” they will implore you to do so, to the extent you can. While you can never know the nitty gritty details there are things you can ask to get a good sense of whether the tires need more kicking and whether warning signs are present.
Due diligence on a firm’s financial health/stability includes:
- Any recent departure trends of practice group leaders or partners who controlled significant amounts of business?
- Do any clients make up more than 5%-10% of the firm’s revenue? If so, is that on a yearly basis or does it rotate between various clients such that there is healthy variability?
- Are the firm’s major clients focused on a particular sector(s) that may be more vulnerable to swings in the economy?
- What is the three-year trend of both Profits-Per-Partner and Revenue-Per-Lawyer? (RPL is much more difficult to manipulate so this should not be overlooked. )
- What’s the amount of the capital contribution, and is this funded by the partner directly at the outset (via a bank loan with a personal guarantee) or taken out from the back-end of compensation?
- How often does the firm pay its equity partner their distributions during the year? How much is held until the next year? And how much is ballooned towards the end versus fairly evenly distributed after the first quarter of the year?
- Does the firm have short- or long-term debt? If yes, and it’s short term, by when is the debt usually paid off?
- Has the firm skipped or deferred any distributions within the past few years?
- Does the firm pay major expenses promptly?
- Does the firm have an unfunded pension plan for retired partners? If so, this can sometimes be a burden for younger partners and breed resentment.
- Does the firm have significant guaranteed compensation packages that are funded by a line of credit?
- Real estate/lease obligations?
The benefits of these questions are two-fold:
- You will get good information.
- The firm will respect you for asking these appropriate and not-asked-enough questions.
Lastly, if you would like an additional resource ways to perform due diligence on a firm, read Valerie Fontaine and Barbara Mayden’s article regarding a concept they coined the “LFQ (Law Firm Questionnaire)”.