Law Firm Capital-What You See is Not What You Get

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Simply stated, partners in many large law firms have been focused on a fictional capital model that has become increasingly divorced from economic reality. There is no direct ownership interest in most large law firms by “equity” partners. Partners only have a contractual relationship which explicitly waives any interest in firm equity. A partner pays in $X, receives a percent of net revenues, and if she leaves, receives a return of $X, probably over a term of years (with or without interest). Thus individual partners don't necessarily pay attention to the fact that the true value of a partner share in the firm is nowhere near the capital amount contributed. If they did, partners would realize that most of their paid in capital was gone the moment it was contributed. In many firms, if the firm were liquidated off the balance sheet, most or all of the capital accounts would not be realized by the partners. As we saw with Dewey, the liabilities significantly exceed the assets. What makes this even more uncomfortable is that there can be a lot of “off balance sheet financing” with furnishings and equipment leasing that increase the liabilities by millions, and the real property office leases are typically significant long term obligations aggregating tens of millions more in liabilities.

(Reprinted with permission of Daily Journal Corp, 2012)

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Edwin B. Reeser, A Professional Law Corporation on:

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