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Category: Partner

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Apr 25, 2017

When Should a Law Firm Partner Compensation System Be Changed?

Question: 

I am a partner in a fourteen attorney business litigation law firm in New Orleans. There are five partners in the firm. We are a first generation firm and all of the five partners are the original founders. Each of the partners have equal ownership interests and are compensated based upon ownership points. While this approach to compensation worked for many years this system is no longer working for us. Performance used to be pretty close but this is no longer the case. Your suggestions are welcomed.

Response: 

This is a common problem that new law firms eventually face. Here are a few thoughts:

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John W. Olmstead, MBA, Ph.D, CMC

Feb 07, 2017

Law Firm Partner Compensation – Collaborative Team Practice

Question: 

Our firm is a 25 attorney firm based in San Antonio, Texas. We have 15 equity partners. We are equal partners and have equal ownership interests. Our partners are paid based upon ownership shares. Thus, each are paid the same. The system has worked well for us for many years and has supported our team-based collaborative culture. However, we are having issues with non-productive partners and some of the productive partners feel that the compensation system is no longer fair.  Some of the partners have suggested that we more to a formulaic system. Other partners in the firm feel that such as system would destroy the collaborative culture that we have built. We would appreciate your thoughts.

Response: 

I agree that the compensation system must shift to a system that rewards performance and overall contribution to the firm and yet preserve the culture that you have built over the years. I think that a pure formulaic system would shift your culture to a “lone ranger” culture with everyone out for themselves. I believe that for your firm a subjective or a hybrid system incorporating quantitative and qualitative performance factors would be the best approach.

In order to implement such a system you will need to set up a compensation committee that will made partner compensation decisions. I suggest a three member committee elected by the partners on three-year staggered terms. The committee will determine and publish performance factors that will be considered, conduct annual face-to-face performance evaluations, approve each partner’s annual personal goal plan for the following year, and make their partner compensation recommendation to the partnership regarding the upcoming year salary and bonus for the year ending year.

The partnership agreement or other compensation policy document should specify the procedure and what happens when the partnership does not approve the recommendation of the compensation committee or when a partner requests reconsideration.

A system such as this requires more time and work but usually yields better results, especially in a team-based collaborative practice. More and more larger firms are using subjective or hybrid systems.

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John W. Olmstead, MBA, Ph.D, CMC

May 17, 2016

Law Firm Equity Partner Capital Contribution

Question:

I am the sole owner of a twenty-five attorney litigation boutique firm in Los Angeles. I am the only equity partner with nine non-equity partners and fifteen associates. I am concerned that if I don't provide a path to equity partnership some of my senior talent many gradually defect to other firms or split off to create their own law firms. I also believe that providing a path to equity partner for deserving non-equity partners is the right thing to do. Therefore, I am planning on admitting two non- equity members this year. Should I require capital contributions?

Response:

I believe that all new partners should be expected to contribute capital and have some "skin in the game." Whenever a firm admits a new partner, the firm should require the new partner to contribute capital. Increasingly, a partner's capital requirement should bear a relationship to the partner's share of profits. You may want to allow new partners a reasonable period of time to fund their capital accounts – say one or two years via a capital note or help them arrange favorable terms at your bank to finance their capital accounts. Usually capital accounts are tied to working capital needed to operate the firm and the percentage of ownership/income that each partner will have.

While capital contributions are all over the board ranging from zero to $100,000 in firm's your size I often see capital contributions ranging from $25,000 to $50,000. 

There are only three ways to increase a firm's working capital to cover cash flow requirements and fund growth:

1. Have partners put more money in
2. Have partners take less money out
3. Borrow

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Mar 22, 2016

Law Firm Partner Retirement Buyouts – How to Keep from Breaking the Bank

Question:

Our firm is a 14 lawyer firm in the Boston suburbs with 4 founding partners and 10 associates. Two of the partners are in their 50s and two are in their 60s. Several years ago we adopted a retirement buyout plan for the founding partners where each partner upon retirement is paid the balance of his cash-based capital account and a multiple of one times an average of his last three years earnings paid out over a five year period. I am concerned that when partners begin to retire the retirement payouts will place undue stress on operating funds and the firm's ability to continue to be successful. I would appreciate your thoughts.

Response:

If nothing else you should consider a cap that places a limit on how much can be paid out in a single year where aggregate payments to all retired partners in any one year are capped at 10 percent or less of distributable net income. Any obligations that cannot be paid in one year as a result of the cap would be rolled forward to the next year also subject to the same cap.

Unfunded plans can present problems down the road if they become unaffordable for the next generation of attorneys as they have to be funded out of future earnings. You should look into ways to fund your partner's retirements as much as possible through 401k and other retirements plans, life insurance policies (on each of the partners that can fund the buyout in the event of death or where paid up cash values can be used upon retirement to apply toward buyouts, and sinking funds (Rabbi Trusts, etc.) where funds have been set aside out of current earnings.

We all have been witnessing what is happening with governmental unfunded pension programs. The same thing is happening with law firms that have unfunded retirement programs as baby boomers are retiring in record numbers.

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John W. Olmstead, MBA, Ph.D, CMC

Feb 23, 2016

Law Firm Partner Capital Contributions – How Much?

Question:

Our firm is an 18 attorney firm in Chicago that was formed by the existing four equity partners ten years ago. We have four equity partners (founders), eight income (non-equity partners), and six associates. The income partners are not required to contribute capital. We are considering admitting a couple of the income partners as equity partners and also approaching possible laterals. What should we require in the form of buy-in or capital contribution?

Response:

While capital contributions are all over the board ranging from zero to $100,000 in firm's your size I often see capital contributions ranging from $25,000 to $50,000. All depends upon the number of ownership shares being offered. I am seeing firm's requiring more as many firms are resisting the temptation to take on bank debt to finance their short-term working capital requirements. Citibank's Private Law Firm Group reports that between 2004 and 2007 capital contributions averaged 20 to 25 percent of a partner's income. Citibank's recent survey reports that partners are now contributing an average of 30 to 35 percent of their earnings. Thus, a newly admitted partner that will be earning $150,000 upon admission would be expected to contribute $45,000. Contributed capital is returned when a partner leaves the firm in full upon withdrawal or more commonly according to an incremental installment payment schedule.

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John W. Olmstead, MBA, Ph.D, CMC

Jan 20, 2016

Law Firm Partner Compensation – Setting Up an Eat What You Kill System

Question:

I am a solo practitioner in Orlando, Florida with two secretaries and I am planning on merging my practice with another attorney in the same office location. He has three staff members. We have both been on our own for twenty years and have enjoyed our independence. We have decided that we want to setup an eat-what-you kill type of compensation sytem. We would appreciate your thoughts.

Response:

While I am not found of such systems as they lead to separate silos – separate firms within a firm - there are situations where they are appropriate. In some situations, the approach is to simply allocate revenue and use the percentage of fee revenue collected to determine a partners interest in the profit for the year. A determination must be made as to what the firm means by revenue collected for each attorney – working attorney allocated dollars, originated attorney dollars, or responsible attorney dollars, or a weighting of all of these. This only works if each consumes overhead at the same level.

If you are not consuming overhead at the same level some form of cost allocation must be made and included in the mix. Direct overhead items such as bar dues, auto expenses, CLE seminars, etc. could be allocated directly to each partner with each sharing equally in the rest of the indirect overhead. Then a net figure would be calculated to determine each partner's compensation based upon their share of the profit.

If you want to really get detailed your can setup a separate profit center for each of you in your accounting system, allocate all revenue and expenses using an agreed to allocation formula, Click here for sample allocation guidelines and then have the ability of generating a separate profit and loss statement for each of you. If you are using QuickBooks Pro you can setup classes to accomplish this. Your compensation would be the profit from your profit and loss statement. 

Good luck with your merger.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

 

 

 

Dec 01, 2015

Law Firm Partner Compensation – Arrangement When Buying a Senior Partner’s Interest

Question:

I am the owner of a solo practice family law firm in Jackson, Mississippi. I  have been in practice four years. I have been approached by a senior solo attorney that has a well established family law practice that generates $800,000 annually and is looking to sell his practice. We envision a merger where I would make an initial payment upon merging my firm with his and then buyout his interest over a five year period. We have agreed on a fixed price for his ownership interest. However, we are not sure how to handle compensation. He wants to continue to work for another five to seven years. We would appreciate your thoughts.

Response:

Your approach will depend upon how you are going to structure your initial ownership percentages and whether the other attorney plans on continuing to work fulltime or whether he plans on scaling back. Are you going in with a minority interest and then acquiring additional interest as you make the agreed payments?

Here are a few ideas:

  1. Base compensation totally on ownership interests. As you acquire additional interest your compensation would increase.
  2. Agree to a base salary for each of you and then allocate excess firm profits after your salaries based on ownership interest percentages.
  3. Create two profit pools. One pool would be 70% of total profit called performance profit pool and the other pool would be 30% of total profit. The 70% pool would be allocated to each partner based upon individual performance as determined by a weighted average of each partner's origination/working attorney collected fee receipts. The 30% pool would be allocated to each partner in accordance with ownership interest percentages.
  4. Create two profit centers (one for each partner) and allocate income and expenses to each profit center. Each partner's compensation would be based upon their individual profit center.
There are as many different approaches are there are law firms.
 
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John W. Olmstead, MBA, Ph.D, CMC

Jun 02, 2015

Law Firm Partner Compensation and Client Origination Credit

Question:

Our firm is an 8 attorney general practice law firm located in Kansas City, Missouri. Five of the attorneys are equity partners and the other three are associates. The two founding partners are the only ones in the firm that bring in clients – the other partners are just workers. Currently the partners are paid based upon their collections for cases/matters to which they are assigned. They are also credited for work that others do on their assigned matters as well. We are concerned that in a general practice firm such as ours, everyone must be bringing in clients and we are considering changing our compensation system to factor in credit for client origination – bringing in clients. I would appreciate your thoughts.

Response:

All law firms need a mix of finders, minders, and grinders. Finders (client originators) are needed to provide sufficient work to keep the workers busy. Minders (responsible matter attorneys) are needed to manage the portfolio of client work. Grinders (working attorneys) are needed to service and produce client services.  While there are exceptions, in most firms partners must hit on all three of these cylinders. In other words, most of the partners must do well at finding, minding, and grinding. Partners may perform some of these roles better than others, however overall they should be competently performing each of the roles. Very few firms can afford the luxury of having several senior partners only bringing in business without being required to maintain personal production levels as well. Partner compensation research concludes that the most a law firm can afford to pay a rainmaker – over and above his or her own billable hours (fee collections) is the marginal profit derived from the associates the rainmaker can keep busy, regardless of how many partners he or she occupies. The most valuable partners are those who offer a balance of skills: worker, delegator, supervisor, and rainmaker.

Since origination of new clients is the lifeblood of any firm it is a key factor that should be recognized in any compensation system. The exact weight that it is given will depend upon the firm and how dependent it is upon constant client replacement, only a few institutional clients, turnover of clients, leverage ratio, etc. A firm that has a well diversified base of institutional long time clients will typically weigh client origination much lower than a firm that has to constantly replace individual clients.

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John W. Olmstead, MBA, Ph.D, CMC

 

Nov 25, 2014

Law Firm Partner Compensation – Individual vs. Firm Based

Question:

I am the managing partner of a 9 attorney firm in Cincinnati. We have four equity partners and five associates. Partners are compensated on the basis of their ownership shares which are currently 25% each. In the past the system worked well – but now we are having problems. The two senior partners are working and contributing less and are taking out half of the compensation which is causing dissatisfaction and division within the firm. We have been discussing alternative approaches. Should we consider a system total focused on individual partner performance and production – an eat-what-you kill if you will?

Response:

I agree that personal production and performance should have a relationship and a tie to compensation. However, a move to a total eat-what-you-kill system might be a drastic first-step move. Eat-what-you-kill approaches can often destroy teamwork in firms that desire to be team-based firms. For firms that want to be lone ranger firms eat-what-you-kill is fine.

Since I don't know what you have done so far it is hard to identify the first step. Sometimes all that is needed is a frank and open discussion and a realignment of percentages tied to recent performance. In other cases is might be appropriate to have different percentages for compensation (participating compensation percentages) based upon say a three years rolling performance average/ratio. One approach would be to use this instead of ownership percentages for allocating profit to the partners. Another approach might be to create two profit pools – say 70% of firm profit and allocate this profit to the partners based upon participating percentages and 30% of firm profit and allocate this profit to the partners based upon ownership percentages.

Obviously there are many of approaches that you can take. This approach moves closer to individual performance but retains firm participation as well.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Sep 30, 2014

Law Firm Capitalization – What is the Proper Level for Partner Capital Accounts

Question:

I am the chair of the finance committee for our firm – 17 attorney firm in Chicago. We have 6 equity partners in the firm. We are in the process of admitting a new equity partner and are reviewing our capital accounts and trying to determine our capital needs. I would appreciate your ideas and thoughts.

Response:

There are two categories of capital – short-term or working capital which is used to fund daily operations and long term capital which is used to pay for capital assets such as furniture and fixtures, computers and other office equipment. I guess I am old school but I believe that short term working capital should be funded as much as possible with partner capital and long term capital funded with bank borrowing or leases. I have more and more clients that are funding working capital with partner capital and have no bank debt at all. I have other clients that finance all working capital with their bank line of credit – these firms could find themselves in dire straits if bank credit should tighten in the future.

The amount of working capital needed by a firm depends upon your practice, billing and collection cycles, whether you do contingency fee work, and whether the firm is growing and adding attorneys and staff. As a rule of thumb I suggest that a firm have three times one month's expenses excluding draws in working capital. This would need to be increased if the firm has lengthy billing and collection cycles, does contingency fee work, and is in a growth mode.

Partner capital contributions are usually made proportionately based on partner earnings or ownership percentages.

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John W. Olmstead, MBA, Ph.D, CMC

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