The law firm as a business

Dear Oracle

I know that being commercially aware means understanding how law firms work as businesses, but what does that involve specifically?

The Oracle replies

You are right that law firms are first and foremost businesses, which means that knowing how they make money is crucial – but that is a starting point which leads on to much more than you might initially think. It also involves understanding who a firm’s clients are and what services they use the firm for, which in turn means understanding what type of firm it is and how it is structured. Let’s look at all this in more detail below.

What type of firm is it?

Researching different firms is essential before deciding where to apply for a training contract or vacation scheme place. For example, do you want to work at a big commercial firm in the City, a national/regional firm or a smaller family law practice? Clearly, such different types of firm will serve different clients and operate in at least some different practice areas. You should also consider whether a firm has offices in other countries and if so, where – this will tell you a lot about its business model and where its focus lies. Clearly a firm with offices abroad is almost certain to be regularly involved in deals involving the biggest organisations, which take place over multiple jurisdictions. To serve such clients effectively, it is essential to be able to work with lawyers in other countries to get these huge transactions over the line.

Who are the firm’s clients?

This is very much tied into the question above. A City firm’s clients are likely to be large international businesses, banks, insurance companies, and even governments and other public bodies, while a national firm’s clients can range from big companies to small start-ups and private clients, to name just a few.

As legal advisers, lawyers provide expertise on how to achieve clients’ aims. Clients also need legal expertise to get things done. When a deal is agreed, the parties involved want to ensure that it is legally valid and that the terms of the deal are enforceable by law. Lawyers also play a crucial role in resolving disputes which may arise during the deal negotiations or after the deal has been struck.

Commercial lawyers also give an ongoing legal perspective to clients on how they can achieve their commercial objectives.

How does the firm make money?

Obviously, firms provide legal services to their clients in return for payment, but there is much more to know than that. Lawyers have to record each unit of time (in many cases one unit is just six minutes) that they spend on a particular piece of work for a client. From this, the partner in charge puts together a final bill for the service that the client must pay. However, clients are increasingly demanding fixed fees or an upper limit to what can be charged by firms for the work that they do, which puts pressure on firms’ profitability.

How is the firm structured?

Law firms are generally partnerships, not companies, where partners make all-important decisions on the running of the firm. Many firms choose to set up as a limited liability partnership (LLP), a partnership/company hybrid.

Some partnerships operate traditionally, where decisions are discussed and made collectively. Others operate more like companies, appointing a committee of partners to manage the firm.

Each equity partner owns a portion of the firm in return for making a significant financial investment in it when they are invited to join the partnership.

Where do the firm’s profits go?

The firm’s profits, after all salaried employees are paid, are divided up among the equity partners. However, becoming a partner does not always mean gaining a stake in the ownership of the firm – it is possible to be a partner while still on a fixed (but no doubt astronomical) salary.

Is the firm affected by wider economic conditions?

A time of prosperity and significant economic growth will of course mean lots of deals and business transactions requiring the services of lawyers, while an economic downturn could mean that there is less (or different) work to go around in cyclical practice areas, such as real estate. Meanwhile, conventional wisdom holds that there will be more work for insolvency and restructuring lawyers during a recession.

Read these five easy ways to boost your commercial awareness.

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