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The 10 Processes Private Equity Firms Can Use To Control Legal Costs

A recent analysis of legal spending by private equity (PE) firms by Apperio shows mid-sized PE firms have a head start over larger competitors in effectively managing legal expenses. For reference, in this analysis, firms with between $3-10 billion in assets under management (AUM) are classified as mid-sized, while those with more than $10 billion in AUM are classified as large.

While larger PE firms enjoy the benefits of scale in negotiating legal prices initially, those advantages are lost in the aggregate. In fact, one in five are “often shocked” by the size of legal invoices – and seven in ten reported being billed for legal work that was, in hindsight, considered unnecessary or redundant.

The difference in approaches to legal costs is most pronounced in organizational process maturity. For example, when asked about ten conventional processes for managing legal engagements, mid-sized firms edged out large firms in seven out of the ten named processes; below are those 10 processes mid-sized PE firms are more likely to have implemented to actively manage legal costs.

1. External advisor performance tracking.

Many PE firms establish outside billing guidelines but then neglect to track adherence. Some level of performance tracking is essential to understand how well things are going.

It doesn’t have to be complicated. You can get started by tracking what your law firm advisors are doing and score that activity against key performance indicators (KPIs). Some of the initial areas we see PE firms begin to measure include:

  • the shape of the advisory team,
  • invoice frequency and accuracy,
  • time entry hygiene,
  • responsiveness, and
  • blended hourly billing rate.

2. Matter cost benchmarking.

Every business will have work they do more than once. Benchmarking the cost of that work is how you can get a sense of the average expense – and potential deviations. 

This isn’t about nickel and diming your law firms. Rather, it’s about understanding the typical costs, and size and composition of the law firm team, to prevent problems before they happen.

For example, on a due diligence matter for a merger and acquisition (M&A) transaction, you might expect less partner involvement because this work tends to rely on brute force, so to speak. However, you can’t know that until you’ve established your benchmark.

3. Active real-time tracking of costs. 

Active real-time tracking of costs is the chance to capitalize on the benchmarking work you’ve done. You know what “normal” looks like and so you can spot anomalies and take corrective action.

Think about it this way: most of your portfolio companies do accrual reporting quarterly so they can anticipate costs. Similarly, PE firms should do this for legal expenses, or risk guessing on expenses that can easily run in the millions.

For example, many law firms take 90 days to invoice, which means a PE firm always has an entire fiscal quarter’s worth of legal expenses due. If your PE firm spends $12 million annually on outside legal costs, then you have $3 million in law firm invoices coming due next quarter.

If that cost is going to deviate, as it often does with the cyclical nature of PE, it’s better to know about higher costs now rather than wait three months for a surprise invoice.

Image removed.
Nicholas d'Adhemar

4. Retrospective matter analysis.

A retrospective analysis means digging into the details of a matter to understand how you arrived at an outcome. It could be an outcome you wish to replicate or one you want to avoid. For example, a retrospective analysis is necessary when a matter significantly exceeds the budget, and you want to prevent this from happening again. 

It’s not hard to do, but most PE firms are busy and so when a transaction is closed, it’s all too easy to move on to the next one. However, the legal costs quickly add up over time, so it’s important to be disciplined about setting time for analysis. 

5. Longitudinal analysis.

Where retrospective analysis tends to look at individual matters, a longitudinal analysis looks at the total legal spend over time. For example, if your PE firm spends $15 million on outside counsel annually, a longitudinal analysis examines where that budget went.

A PE firm I spoke with recently did such an analysis and found they were spending $2 million on employment law in one European Union (EU) country. When they tallied up the numbers, it became obvious they have enough work there to merit hiring an in-house lawyer that specializes in those matters. 

Another PE firm did a similar analysis and found they were distributing routine compliance work across a handful of law firms. The insights gleaned allowed them to consolidate all that work to a single law firm in exchange for more favorable hourly billing rates.

6. Formal authorization to instruct legal counsel.

Formal authorization to instruct legal counsel is a guardrail that helps prevent anomalies – like invoices for matters that exceed the expected cost. Funneling this process through one person or department brings structure and standardization that sets expectations across the PE organization.

It answers questions including:

  • Can we complete this internally?
  • Is this the right law firm for this type of work?
  • Is the matter properly scoped?
  • Are we instructing the firm at the right time – not too early and not too late?

This process is uniquely suitable for PE firms because the investment teams sometimes prefer to instruct law firms directly. However, when this occurs, no one has a comprehensive view of the matters and costs across the organization. It invariably leads to cost overruns.

When I ask general counsels (GCs) at PE organizations about when the time is right to implement this process, many put the benchmark at $3 billion AUM. At that size, a PE firm typically has so much legal work that costs mushroom in the absence of a formal process to instruct legal counsel.

7. Regular tracking of accruals and clear responsibility for tracking.

When everyone has their heads down working on a deal, it’s easy to lose track of the legal budget. One PE firm we recently spoke with noted, when this happens the deal team would be shocked when they saw the final numbers after the deal closed. Even worse, the deal team must go back to the investment committee and ask for more money, which makes it look like they aren’t managing their numbers.

This process helps to clarify the responsibilities – and data collaboration – among the deal, finance and in-house legal teams. Typically, the deal team owns the relationship with the law firm, the finance team tracks the costs, and the in-house lawyers have the knowledge to keep projects on track and within budget.

8. Bench or panel of preferred law firms.

Consolidating legal work with fewer law firms is a proven way to lower costs. PE firms that do this are trading guaranteed income for a discount. It can also improve the relationship because your outside legal advisors get to know your unique organization in greater detail.

In the U.S., 47% of PE firms work with between 6-10 law firms, but 75% of their total legal spend goes to just 4-6 law firms. Similarly, in the U.K., 60% work with between 1-5 law firms, but 75% of their total legal spend goes to just 2-3 law firms.

However, things can change; for example, there might be employee turnover within your preferred law firm partner, or your fund sees an evolution in the types of deals you are pursuing, which requires different legal expertise. Therefore, you ought to have a process in place to methodically evaluate your law firm partners periodically.

9. External advisor value measurement.

Any lawyer will tell you that proving the value of legal is difficult. For example, it’s nearly impossible to quantify the money saved by avoiding litigation – but we know it’s inherently valuable. Value measurement is a process aimed at identifying the overall value, and sometimes less quantifiable aspects, of legal work.

Some considerations might include:

  • Does the law firm take a brief call without billing every six-minute block every time?
  • Is the firm transparent with activities and costs?
  • Will the law firm proactively carry out value-added work that prevents further costs in future?
  • Is there a contribution to business outcomes that don’t show up in KPIs?

10. Formal legal budget approval.

Some PE firms don’t prescribe a formal legal budget because it can be hard to predict what you’ll spend. Force majeure issues like Brexit and the COVID-19 pandemic are prime examples. However, not having a budget is a surefire way to spend even more.

A formal budget process adds rigor and consistency. It forces analysis and stimulates discussion about assumptions. A formal budget draws a line in the sand, so you can begin to determine when costs become abnormal. Even a thoughtful estimate is better than no budget at all.

Data Collection is the Key to Getting Started

Getting your arms around legal spending can be daunting, especially if there’s little in the way of existing processes. The first step is to start collecting, recording and curating data about matters, legal spend, and law firms – even if the best tool you have is a spreadsheet. Focus on the big picture first – the longitudinal variety – and then strive to split your totals into subcategories as your dataset grows.


Nicholas d'Adhemar is the founder and CEO of Apperio


The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group

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