Law Firm Partner Compensation

THE NEWSLETTER FOR LEGAL OFFICE MANAGERS
LAW OFFICE ADMINISTRATOR
Volume XX / Number 4 APRIL 2011
(Reprinted with permission of Ardmore Publishing Company)
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Law Firm Partner Compensation Has to Meet the Firm’s Goals
EVERY FIRM NEEDS ITS OWN PAY SYSTEM – LAW FIRM PARTNER COMPENSATION
What’s the perfect law firm partner compensation system?

“It hasn’t been invented,” says Robert J. Henderson, founder of RJH Consulting & a Jackson Hole, WY, law firm consultant. There are as many compensation systems as there are law firms, and no two are 100% the same.

So how does a firm set the right type of law firm partner compensation?

By deciding what behavior the firm wants to motivate.

“All compensation plans are designed to motivate a certain type of behavior,” Henderson says. A firm that has all the business it can handle needs a system that motivates quality and efficiency. A law firm that wants to develop new business needs one that motivates origination. A firm that wants to increase revenues needs to reward billable hours and collections.

Personality comes into play too. If the partners place great value on lifestyle priorities, a system that rewards billed hours and increased revenues isn’t going to work.

Here are the four main law firm partner compensation systems along with their advantages and disadvantages. Choose one and then add and subtract to it to encourage the specific behavior the firm wants to see.

THE LOCKSTEP SYSTEM
The simplest of partner compensations is the lockstep system. It’s also the least effective.

There the partners are rewarded strictly on their years of service, so partners with, say, one to five years with the firm get $X, those with six to 10 years get a percentage more, and so on, though there is a ceiling.

What are the advantages of it?

None, Henderson says. No matter how hard anybody works or how much business anybody brings in, the reward is no more than what the people on the other end of the scale get. Thus, “there’s no motivation for performance, client origination, or collecting.”

Worse, “there’s a disincentive to excel,” because industry brings no reward. There’s no incentive to be anything but average.

More bad news: It’s a turn-off to any lateral hires the firm wants to attract because they see immediately that their efforts will only go toward supporting the do-nothings. Similarly, it drives away the best attorneys, “because they don’t want to stick around while the deadbeats get compensated.”

THE EQUAL DISTRIBUTION SYSTEM
Another simple approach and one far more workable than lock-step is the equal distribution of the profits.

It’s well suited for small firms, and it’s often the best choice for two attorneys who open a firm and decide to split the profits. “If the two are of equal ability and work equally hard,” the system works well, Henderson says. What’s more, “it’s simple and avoids what most partners hate, which is competition for compensation.”

It also promotes teamwork. The two attorneys have no hesitation to pass business to one another.

As the firm adds partners, however, equal distribution becomes less desirable. The newcomers don’t always make the same contributions as do the founders, yet they get paid the same.

What’s more, with just the two attorneys, it’s obvious when one is slacking off, and the more hardworking of the two can demand a change in the compensation structure. But as more attorneys come in, it’s not so apparent when one attorney is not performing up to par. It’s easy to hide in the crowd.

THE BENEVOLENT DICTATOR
Then there’s the benevolent dictator setup where everybody’s compensation is determined by one person – often the managing partner – or by a management committee.

It’s a subjective system. Everybody gets what the decision maker thinks is appropriate, albeit within parameters.

One advantage, Henderson says, is that it eliminates the end-of-the-year bickering about how to divvy up the profits.

But its greatest advantage is that “it’s a hybrid between a mathematical formula and something that’s purely subjective.” It rewards origination and revenues, but it also rewards contributions that can’t be measured mathematically. The firm can give weight to factors such as contributions to management, mentoring, and maintaining client relationships. In some firms, the partners even submit resumes showing what they have accomplished in marketing, practice development, mentoring, origination, billed hours, and so on, and the benevolent dictator takes them into consideration.
There’s also the advantage of flexibility.

For example, it allows the firm to pay extra as it sees fit, perhaps to a new partner who brings in a profitable practice group or whose name gives the firm clout and credibility it didn’t have before.

The problem, however, is that people are people. There will always be someone who doesn’t like whatever big-picture criteria the firm opts to follow.

EAT-WHAT-YOU-KILL
Finally, there’s eat-what-you-kill law firm partner compensation where the partners get paid according to the dollars they bill, the dollars they collect, and the work they bring in. Period.

The firm decides ahead of time how to weigh each category, and it gives more weight to the areas it wants to emphasize. If its goal is to bring in new clients, for example, it might credit the originating attorney with 25% of the fee and give the remaining 75% to the attorney who does the actual work on the matter. Or, if it has all the work it can handle, it might set the origination credit at only 10% of the fee.

The advantage of eat-what-you-kill is that there’s no subjectivity and thus no accusation of favoritism.

It also promotes whatever behaviors the firm wants to see. If it wants to see more billed hours, that’s where the weight goes.

Problems With EAT-WHAT-YOU-KILL Model
The problem, however, is that the eat/kill attitude discourages teamwork and encourages the partners to “hog the files.” Suppose origination by itself generates a 25% of the fee and the attorney who does the work gets 75%. A partner who brings in a client is going to keep the file and get 100%.

The partners don’t turn work over to other partners who are more qualified to handle it, and the outcome can be client dissatisfaction as well as an increased risk for malpractice.

Also, when more than one partner participates in bringing in a client, there can be severe controversy over who gets how much of the origination credit. “Firms have broken up over that.”

Firms best suited to that type of law firm partner compensation, Henderson says, are those whose attorneys, for the most part, do the same type of work and charge the same types of fees – hourly, contingency, or whatever. In that setting, it’s possible to make apples-to-apples comparisons of who brings in what.

Contrariwise, in firms where some attorneys are billing hourly and others are working on contingencies, the picture gets murky. And making matters worse, the common perception is that hourly attorneys have to put in more hours than the contingency attorneys to produce the same amount of recovery.

Also, he says, there is often an argument about how long a partner should get credit for business origination. In the past, it has not been uncommon for there to be any cap, which means a partner could pull the origination credit indefinitely.

There needs to be a cap. For a contingency fee, it can be a percentage of the total fee. But for an ongoing client, he says, the credit might stop at 18 months or maybe continue for as long as three years.

A SHARE FOR THE ASSOCIATES TOO
Along with law firm partner compensation is the question of associate compensation, and there Henderson advocates a pay system few firms follow.

Instead of giving the associates bonuses based on the number of hours billed and collected, include them in the profit sharing at the end of the year, he says.

A bonus that rewards hours by nature generates “a lot of problems with inflated hours.” And if the associates simply split an amount, there’s no reward for personal performance.

With a sharing system, the associates are paid a salary plus a share of the net profits. The firm allots a certain level of the profits to the partners and whatever is above that is divided among the associates.
They can share in the profits equally or according to some qualifier such as the number of years with the firm.

In most cases, there is a cap at 30% to 35% of the associate’s salary.

A participation system “gets everybody on the same page working together for firm profitability,” he says. That makes the associates “start thinking like partners.” They see the value their work produces for the firm and for themselves personally.