by admin on June 16, 2009
We recently wrote about alternative fee structures for large law firms and their clients. A post from the WSJ law blog on Kirkland & Ellis’s foray into the field recognizes a point we’ve made before: some companies (and indeed, most law firms) don’t have good information about their usage of legal services.
Without solid data-driven analysis, both parties are stuck with the status quo: law firms are reluctant to take on the risk inherent in any other arrangement, when their superior knowledge of the process, their internal performance on prior related matters, and their ability to analyze information across all clients should allow them to take on that risk and, of course, be paid for bearing it. Companies are reluctant to accept the possibility of occasionally overpaying for services (we’re assuming, in general, that the alternative arrangement is a fixed fee, based on a stage-by-stage negotiation between the client and the law firm), but it will be unable to know whether the suite of services it purchased in times past will be sustainable under a new payment scheme.
We’ve offered a variety of analytical services to law firms and clients of such firms. There are plenty of internal hurdles, since good law firm-side analysis almost demands a profitability (FCF, actually) analysis of practice groups and senior lawyers. On the client side, firms with some bargaining power generally expect that they will be able to cram down the lawyers if necessary, and GCs with relatively pedestrian legal needs can shift retention of that talent to the company’s internal purchasing department, where the low cost provider will be more likely to be successful.
… sophisticated [parties] are reluctant to negotiate the nontraditional payment plans because they don’t have the historical data they need….
If this description fits your firm or your company, contact us to arrange a discussion; we can help you figure out how to structure an alternative fee arrangement that improves net FCF more than any other option.
Just recently, we published another post regarding stock buybacks and how the math is the math: you can change your risk profile, but in any case, at some point the usage of cash to buy stock makes sense as a low-cost way of returning value to shareholders.
Sure, there are commentators who complain that a buyback signals that management has “nothing better to do with its cash,” but that’s a simplistic position, designed to play well in sound bites. There’s no scenario in which we would expect one of these businesses to put all their eggs in one basket, to put all their resources into a single product. Apple didn’t turn its entire company into an iPhone factory; Nike sells more than just sneakers; even Google is more than just search.
We should want companies to use their cash in a variety of ways; doing this reduces overall risk by mitigating volatility. Putting some portion of cash into buybacks is the corporate equivalent of principal-guaranteed investing. (In a guaranteed principal investment, the fund takes investor money, buys sufficient zero coupon bonds to pay back the principal on the desired date, and invests the rest.) Putting some cash into buybacks, as part of the portfolio of uses of cash, gives shareholders a tax-favored return over dividends; the reduction in cash on the balance sheet improves ROIC by reducing invested capital in the business; and other investments stand ready to provide the returns sought by investors.
To us, returning capital to investors isn’t a sign of weakness: it’s a rejection of the hubris that can lead to hoarding of resources that can’t be efficiently employed. We don’t have enough space here, even where it’s free, to list some of the companies we’ve analyzed where they’ve destroyed value by not earning back the cost of capital, let alone some arbitrary hurdle rate. And that’s not just in the “current economic environment:” it happens in all markets, in all industries, across all types of companies. It’s hard to create value, it really is. We keep trying to develop the tools that make it easier for companies to understand, and then to manage, how they actually create free cash flow on a day-to-day basis.