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Legal Practice Management

Forum: Making alternative fee arrangements work in M&A

· 9 minute read

· 9 minute read

If any efficiency is being generated from current law firm innovation initiatives, the cost savings are certainly not being shared with the clients

This article was written for Forum magazine by Conrad Everhard and Leonard T. Nuara, Founding Partners of Flatiron Law Group LLP

We are living in the golden age of legal innovation. Not a week goes by without one legal tech start-up or another announcing a big venture capital haul, and large law firms are flooding the zone with messaging about how they are adopting and supporting innovation.

One thing that has not changed, however, is the law firm business model. Traditional law firms keep billing by the hour, increasing their hourly rates 鈥 often at a record pace in some practice areas. If any efficiency is being generated from current innovation initiatives, the cost savings are certainly not being shared with the clients, either through lower rates or through alternative fee arrangements (AFAs).

Indeed, AFAs require a law firm to make two leaps of faith. First, a firm looking to adopt viable AFAs must reimagine the delivery of legal services. Rather than marking up junior labor and selling billable hours the old-fashioned way, law firms would have to figure out how to deliver services at the same level of quality but more efficiently, maximizing profit margin rather than maximizing hours.

Second, firms would have to be willing to share financial risk with the client. All legal work is risky, and some practices, like mergers and acquisitions (M&A), carry acute risks in which negotiating deals can be a lengthy and unpredictable process. Often, the full complexity of a deal does not become known until the parties are deep into their due diligence.

For those law firms willing to make these leaps of faith, recent technology advances coupled with access to cheap computing power are enabling greater automation of many legal tasks, creating more standardized, repeatable processes and greater flexibility in the deployment of counsel. In turn, this opens the door for firms to more readily use AFAs, such as fixed fees for M&A work.

Of course, this pivot requires rethinking the law firm business model and moving away from accumulating billable hours and instead has firms focusing more on impactful inputs and outputs. These impactful inputs are centered more on deploying legal talent when and where it is most needed, rather than maintaining a stable of lawyers who are billing hours. Reimagined outputs focus on both quality and efficiency in closing deals.

Technology as a key enabler

Not surprisingly, technology is a core enabler of these changes. While collaborative workflow tools have become more commonplace in the legal industry, they can do more than simply allowing lawyers to work remotely. When incorporated within a project management framework, they can enable new models of engaging labor that are more akin to a gig economy model 鈥 providing lawyers who have senior-level experience with more agility and flexibility.

Traditional M&A deal flows offer many opportunities to create more efficient workflows.

Similarly, the ability to create bespoke software means many law firms can craft their own technology, including digital deal tools. In the M&A space, there are plenty of contract life cycle management and document management tools out there. Thanks to Moore鈥檚 Law and the rise of SaaS, cheap computing power is now available literally at one鈥檚 fingertips, making it readily accessible to create specialized, proprietary tools with advanced capabilities. It鈥檚 now possible to quickly leapfrog generations of legacy technology and enable new levels of automation.

Traditional M&A deal flows offer many opportunities to create more efficient workflows. The same data is often reused multiple times throughout every step of the deal 鈥 such as in delivering and reviewing due diligence, reviewing representations and warranties, creating and managing schedules, closing checklists, and more. In fact, the process is a constant cycle of reviewing and verifying in which every document is touched four or five times by different people. It is repetitive and time-consuming, and often results in additional charges to the client.

Automation can rationalize and organize this data at every step. Relevant data can be searched quickly with instant status checks and history trails of when a document has been viewed, verified, or modified, and by whom. This can significantly reduce repetitive steps and enable teams to focus on the end goal: delivering the deal as efficiently as possible.

A more flexible labor model

Further, automating and streamlining workflows can make costs more predictable which, in turn, makes use of AFAs more workable as a pricing model.

Adopting AFAs as the default pricing model, instead of just in those cases in which clients insist on it, requires adopting a different mindset. Traditional thinking manages and prices labor to maximize billable hours and labor markup. In contrast, pricing principally with AFAs 鈥 whether fixed fees, fee caps, risk collars, or other methods 鈥 gives firms every incentive to be as efficient as possible, which can benefit both the client and the firm.

Throughout and after the pandemic, many law firms advanced virtual lawyering and acclimated clients to interacting strictly online for certain legal matters. However, beyond enabling remote work, virtual lawyering also enables more flexible models for deploying counsel. With the traditional law firm model, legions of lawyers sit on the balance sheet incurring costs regardless of their utilization. Now, lawyers can be engaged on more of a project management or general contractor model, brought in and assigned as needed to meet the specific needs of each deal.

Automating and streamlining workflows can make costs more predictable which, in turn, makes use of AFAs more workable as a pricing model.

Because large law firms, as a rule, discard senior associates who don鈥檛 show a propensity for generating business, there is an abundant supply of highly trained, artisanal senior lawyers with pedigrees from large, prestigious firms who are readily available and eagerly willing to take on assignments on a project basis. Today, many of those lawyers are hired by ALSPs.

In a sense, labor 鈥 even highly seasoned and experienced counsel 鈥 can become more like a utility that鈥檚 flexibly deployed when and where it鈥檚 needed, but this too requires a mindset shift. This model largely runs contrary to the traditional law firm leverage model, and at the end of the day, a firm doesn鈥檛 make money strictly off its labor 鈥 it makes money off the matter.

Setting a new course, driven by technology

When we founded Flatiron Law Group, we felt the time was right to introduce the elements of this type of model to the legal market within a new firm. Our goal was to create a technology-leveraged firm that applied best practices to close deals more efficiently while maintaining quality. We mapped out a multipronged approach that included fixed fees or AFAs for most matters, a focus on cost control, agile deployment of labor, and a streamlined workflow process. Ultimately, our goal was to deliver high-quality work that exceeded client expectations.

Fixed fees would be integral in offering high-quality deal work with the predictable, value-based pricing that clients want. This introduces an elevated level of financial risk, not deal risk, for the firm, but managing deal work almost as a banker would, with deposits, progress payments, breakup fees and so on, makes the financial risks of AFAs manageable. It also means potential upside for the firm depending on how well each deal is managed.

Fixed fees would be integral in offering high-quality deal work with the predictable, value-based pricing that clients want.

We took a clean-sheet approach to reengineering and streamlining workflows. And because we knew technology would be key to enabling better data and decision-making in the deal flow, we took the step of building our own platform for extracting, processing, and delivering the reams of data needed to close a deal, as well as finding and pulling the right clauses when needed. For example, we recently closed a deal that involved more than 600 individual diligence requests. Doing that task manually would have required a lot of people going through a lot of boxes of materials multiple times. Instead, now we could enter a few search terms and answer requests in minutes instead of weeks.

Further, we鈥檝e now spun out our software, which we call 鈥淒eal Driver,鈥 into a separate company to complete its development as a commercial platform. Our vision is to eventually automate the entire M&A deal process from start to finish.

So far, we鈥檝e successfully completed more than 20 deals in the last four years at lower cost while providing the quality level that clients expect 鈥 and we have done it all while maintaining healthy profit margins. Also, our model is scalable and replicable for other practices. There鈥檚 no reason it couldn鈥檛 be applied to real estate, commercial lending, venture capital, project finance, and even litigation work.

While managing deals is professionally satisfying, at the end of the day, it鈥檚 about reinventing the law firm space. Disruptive innovation is possible with the right drive and commitment, and it can be a win-win for everyone: the firm, lawyers, and clients.

Real change only comes when it鈥檚 driven by the market 鈥 and today, the market is ready to move the industry in a direction that encourages greater use of AFAs for M&A as well as other legal work.

You can access the interactive Spring 2024 issue of the 黑料大湿Posts Institute鈥檚听.