Acquisition of a Foreclosure Practice: Does It Make Sense?

by Joel A. Rose
 

The managing partner of a 47-attorney, growth-oriented Philadelphia firm recently wrote to me and asking whether it makes economic sense for his firm to acquire as a lateral hire a senior attorney with a foreclosure practice.

The managing partner expressed uncertainty about the feasibility of this acquisition for financial and cultural reasons. However, several of his partners who endorse the acquisition of this senior attorney believe that any additional fees are a good thing, as long as the direct labor and incremental costs are covered.

According to the limited information provided by the managing partner, this Philadelphia firm:

  • Has a general practice with expertise in corporate, business and insurance defense litigation, real estate, and labor and employment law;
  • Has a lawyer complement of 27 partners and 20 associates;
  • Expects partners to produce a minimum of 1,650 billed and collected hours, and associates are expected to produce a minimum of 1,800 billed and collected hours; and
  • Has an overhead percentage of 42 percent. (The percentage of revenue paid as compensation to all attorneys is 58 percent.)

The prospective lateral hire, the firm estimated, would generate approximately 100 foreclosures per year, yielding approximately $125,000 to $200,000 in additional fees per year, based upon anticipated hourly rates that will be charged.

He would be paid approximately $120,000 annually, based upon the idea that the fees will be split 50/50 between himself and the firm.

My Response

The following is the letter I wrote in response to the managing partner:

There is some quite interesting math going on here. First, a 50/50 split should yield no more than $100,000 in compensation, assuming fees reach the upper end of the projected range. In addition, assuming your firm will have some responsibility for payroll taxes and some benefits, it should project an additional 20 percent above the $120,000 salary.

Overhead to operate the foreclosure practice is another issue to be considered. I have rarely encountered a profitable foreclosure practice that does not rely heavily on secretarial support, given the paper intensive nature of this work. I believe that the files will require a substantial portion of a secretary's time. Also, I am fairly confident there will be additional marginal costs incurred, including a professional liability insurance premium, bar dues, CLE costs, some marketing costs, furniture and equipment, photocopying, telephone usage, postage fees, etc.

Regarding your partners who have the attitude that any additional fees are a good thing as long as the direct labor and incremental costs are covered: this is an attitude of many attorneys who are not familiar with the economics of operating a law firm. There is nothing wrong with such an attitude. However, it is hardly the basis, long-term, for building a profitable law practice without having the attributes described above, including highly leveraged, low operating costs, and a significant volume of foreclosure work. Further, there is real danger in evaluating this practice on an incremental cost basis. Lots of less than profitable practices would appear profitable when there is no allocation of general overhead.

Your firm is contemplating adding the lateral attorney (full-time) when the prospect of generating additional fees is only $125,000 to $200,000. At a presumed billed and collected 1,650 hours, the effective hourly rate would range from $75-$120 per hour. Logically, why would your firm consider hiring an experienced lawyer (whom you are considering paying approximately $120,000 per year) when the economics are so poor? Are you thinking that additional work or higher-paying work may also follow as a result of being retained by this new client? Please explain this to me.

You indicated in your letter that the percentage of revenue that is paid as compensation for all of your attorneys is 58 percent, which at first glance appeared to be too high for a Philadelphia-based firm. Then, I looked more closely at how you described this calculation. "Compensation" includes wages, retirement and health insurance (the typical stuff). You also mentioned that it includes travel and entertainment. Additionally, it further includes et cetera (It would be nice to know what is included here). Suffice it to say, these calculations are a bit too overly generalized to my liking.

Based upon the information that you provided, I don't understand the attraction your partners feel about acquiring this foreclosure practice. I certainly understand the notion of not wanting to look a gift horse in the mouth with a six-figure volume of incremental fees from a new client. However, rarely have I seen a profitable foreclosure practice exist in a firm that has your type of practice and leverage factor (ratio of associates and non-lawyers to partners.) Most profitable foreclosure practices rely on significant leverage utilizing non-lawyers and technology in conjunction with relatively low operating costs. Based upon the description of your firm in your letter, I'm not convinced that your firm operates under this economic model for doing business. As indicated above, your firm's billable hourly expectations are 1,650 billed and collected hours for partners and 1,800 billed and collected hours for associates. This is another indication of not requiring a high volume practice.

In order to develop a profitable foreclosure practice, there needs to be a significant volume of work being generated. Based upon your estimate of 100 foreclosures generating $125,000 to $200,000 in incremental fees annually, that means that an average file generates less than $2,000. If that is so, I would expect that a lawyer could spend very little time handling the file if the work is expected to generate a profit. Like most commodity work, the cost to complete the work must be low to generate any profit. Overall, the practice cannot be expected to generate any meaningful profit without a substantial volume. The profit margin on this work is slim, at best.

Based upon my understanding of the facts, I see little rationale for adding this foreclosure practice to be serviced by a fulltime lateral hire who would be paid $120,000. I do not see how this practice could generate a level of profit that would be worth the investment. It is not a good business practice to evaluate the financial contribution of a practice area simply on an incremental cost basis. At some point, your firm should compare the profitability of each of its areas of practice, and I suspect the foreclosure work would end up being one of the least profitable practices, given the current facts.

Hopefully, my above comments about the feasibility of acquiring the proposed foreclosure practice will assist you in persuading your partners to pass on this foreclosure acquisition. Please let me know what the partners decide to do.

Outcome

The managing partner called my office to inform me that after extensive discussions, the overwhelming number of partners decided not to acquire this foreclosure practice.

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