As legal spending climbs among private funds, so too does the pressure to control costs
Sixty-four percent of lawyers polled say their investment firm is spending more on legal services this year – and 66% expect spending levels to rise again next year. That’s according to a recent survey of 300 in-house lawyers working for private equity and venture capital firms.
My company commissioned the survey which was conducted by Coleman Parkes Research. It is the fourth such survey we’ve completed, collectively polling nearly 1,000 lawyers most of whom work in private equity.
On average, lawyers responding to this survey work for organizations that manage $9 billion in assets, spend $12 million on outside counsel annually and employ five in-house lawyers.
Inflation is certainly a contributing factor to rising legal costs. However, the threat of increased compliance and regulatory requirements is a significant driver too.
Simply cutting the legal budget isn’t a viable remedy. Doing so may expose an organization to uncomfortable levels of risk. The key is to control the growth rate of costs – and ensure the investment firm is getting more value out of every dollar it spends on these services.
Although there are internal cost pressures, one of the more intriguing findings of the survey was that limited partners (LPs) have a growing interest in legal expenses. More than eight in 10 in-house lawyers (84%) say LPs are scrutinizing legal expenses some of the time. Further, about half (48%) say LPs scrutinize legal expenses “always” (21%) or “often” (27%).
This interest seems to be persistent too: 62% said the level of scrutiny LPs have exhibited over legal expenses has increased over the last three years.
Given the regulatory environment, I’ve come to believe this is as much an inquiry into risk management as it is into costs. It’s worth remembering that LPs are answerable to their investors as well. Looking into the systems and processes in place to control costs is a way for them to build confidence that the fund has the right cost controls in place.
The question that remains for private fund managers is what they should do to better control costs; I have three suggestions:
1. Start gathering and tracking data
This sounds obvious, but I talk to seasoned lawyers every week that can’t articulate what their organization spends on legal. For example, the survey found 78% of in-house lawyers working for private funds say they are surprised by the size of law firm invoices at least some of the time – and about 4 in 10 say this happens “always” (16%) or “often” (23%).
The remedy is to put a process in place to track and manage cost estimates against accruals and invoices by matter and firm. There’s a psychology to this – as Peter Drucker is credited with saying, that which gets measured gets managed.
2. Centralize legal spending
Some of the business problems investment firms face is due to the organizational structure: deal teams need to move quickly on competitive deals and have the power to initiate matters with law firms directly. This happens outside the purview of the in-house legal team. The survey found that 81% of respondents indicated that some matters are initiated without their knowledge.
The best lawyer in the world can’t manage legal expenses if they don’t even know it exists. The ideal solution is to centralize legal spend through the law department. Given that’s a sizable cultural change for many PE firms, a stepping-stone is to initiate a formal legal budget approval process for every legal matter and ensure the legal team is part of the process.
3. Review your list of preferred law firms
Finally, ensure you have an appropriate distribution of your overall legal spend – that is a balanced number of preferred law firms. Too many firms will dilute your buying power, while too few may mean you become over-reliant on a single firm.
While there are advantages to sending more work to a familiar law firm, there are also drawbacks. The goal here is to have a healthy tension that’s backed up by the data you are tracking. Collectively, these action items will help your fund control costs – and go a long way to assuage the concerns LPs have over legal expenses.
