Realistic Expectations of a Well-Conceived Partner Compensation System

by Joel A. Rose
 

A well conceived and implemented compensation system must meet the needs of its law firm as it exists today and looking forward to the next year or so. Further, the compensation system must be fair and reward partners for their total contribution, and it should encourage by incentives, those behaviors/activities the firm wants to encourage, then “correct” those it wishes to discourage. I am firmly convinced that a firm cannot move in a particular direction unless the compensation system goes in that direction too.

Activities that most financially and professional successful firms wish to promote through their compensation system include the following:

  • New business development;
  • High hourly production;
  • Emphasis on increasing firm revenue;
  • Maintaining key client relationships;
  • Delegation of work to others in the firm;
  • Assuming management responsibilities on the administrative and substantive sides of the practice;
  • Training associates;
  • Marketing the firm; and
  • Encouraging the senior partners to transition their clients to other attorneys.

Tensions can develop when the direction of the firm’s compensation system is unclear, or only receives “lip service.” Examples of these tensions surface most frequently when:

  • The firm verbally encourages partners to “delegate client work to others within the firm,” but in practice, it over-compensates for revenue collected from partners’ personal production rather than delegation of work.
  • The firm verbally encourages partners to work together to develop business from existing and potential clients, but rewards individuals at the expense of joint origination credit; and
  • The firm verbally encourages partners to perform consequential non-billable work-to-progress the firm, i.e., marketing, enhancing the firm’s image, training, management of the firm and its substantive practice areas, etc., but rewards those activities marginally in favor of billable hours/revenue from personal production.

Administering the System

The great majority of growth oriented, entrepreneurial type firms set their partners’ salaries/draws/percentages/units prospectively and allocate bonuses retrospectively.

Compensating partners prospectively usually results in a greater tendency to make the firm more profitable so that everyone benefits. It values a partner’s contributions over a period longer than the current year. A three year window is usually considered, with firm’s placing a somewhat heavier value on the contributions during the current year.

Using a three year performance history to assess a partner’s total performance before increasing his/her salary/draw/points/percentages may increase that partner’s compensation more slowly than by utilizing a retrospective system that rewards a partner for results achieved during the current year. However, the overwhelming majority of firms address this issue of “immediate gratification” by retrospectively allocating bonuses to deserving partners for their contributions for the current year.

Partners in many firms employing subjective and retrospective compensation systems loathe to reduce a partner’s compensation level from one year to the next, even if that partner’s contribution is lower.

Distributions

Further to compensating partners prospectively, here are three parts of a compensation system:

1. A Salary/Draw: The amount of money each partner will draw throughout the year (on a cash available basis) against his/her anticipated earnings based upon the firm’s income budget for the current year. A partner’s draw is the dollar amount of his/her bi-weekly or monthly pay based upon the firm’s anticipated income budget. The ultimate value of a unit or point varies with the firm’s actual distributable profits. To equalize cash flow, the total amount of draws are usually calculated as a percentage of the anticipated profits as shown on the income budget. This is accomplished in one of two ways:

  1. Draws for individual partners may be set on a sliding scale, depending upon the compensation level of partners; and
  2. Draws for individual partners are based upon the same percentage of their anticipated compensation.

2. Quarterly Distributions: This distribution is the difference between the draws and anticipated compensation. These distributions are paid quarterly, if funds are available. Since in the above example, the most highly compensated partners receive a lower percentage of their compensation as a draw, distributions up to the project income budget are usually based upon the percentage being deferred.

3. Extraordinary Pool: Amount set prospectively, awards determined retrospectively, based upon each partner’s performance for the current year. This bonus pool is to provide an incentive for each partner to perform beyond the acceptable minimum contribution level (of partners). A partner who does not meet his/her expectations will not participate in this fund. For this fund to be meaningful, the minimum level is usually 10% of compensation. Further, since this extraordinary pool is reserved for extraordinary performance, it need not be rewarded. Any of the funds not rewarded would be distributed to all of the partners based upon their unit/point allocations.

Personal Business Plan

I recommend using a personal business plan of expected performance for each partner to define his/her minimum acceptable contribution. In effect, each partner “contracts” with the firm for what his/her contribution for the following year will be. Establish minimum billable and nonbillable hour and production expectations (collections at standard rates) for all partners. Different partners may have different goals based upon their interests, talents, abilities, etc. Each partner’s plan should:

  • Customize his/her billable and nonbillable hour and production expectations prospectively;
  • Recognize extraordinary management, marketing, training, etc. hours;
  • Recognize only quality time, recording time is not enough; and
  • Include a projection of production (collections at standard rate), billable hours, specified nonbillable projects, and extraordinary origination expected.

Allocation of Credits

An origination credit of 20% to 25% is within the range paid by many firms. However, some pay as low as 15% and others as high as 30% to 33-1/3%. The amount of available cash, along with what percentage will motivate partners determines the appropriate percentage.

Most firms that place a premium on revenue from partners’ personal production find that partners tend to hold their client relationships too close to their vests; they frequently hoard client work rather than spread it around to other partners – because the former wants to receive full credit; partners perform work that could be performed by associates because the former wants to receive full credit; partners do billable work when their higher and better use for the law firm is to generate additional business from existing and potential clients; and lawyers may perform work outside of their principle areas of expertise that others in the firm could perform more effectively and efficiently.

Rather than placing as high a priority on rewarding collections from personal time, partners should be rewarded for billing and collecting for the work for which they are the responsible or billing partner, if this partner is not the originating partner. This designation motivates partners to develop and delegate client work to the others within and outside of their area of expertise. By doing this, partners will be motivated to focus their attention on increasing firm revenue and profitability, thereby enhancing the value of each point/unit, rather than on maximizing their personal income by emphasizing collections from personal time. This being said, 45-50% of collection credit is within the range paid for the responsible or billing partner.

The firm should define the expected intangibles for each partner, as described above. Also, very few entrepreneurial type firms pay much for seniority. In most entrepreneurial type firms, seniority is not age alone, nor is it only the number of years a partner has been with the firm. Rather it means the number of years the partner has spent developing and maintaining clients, building and enhancing the firm’s reputation and participating in the training and developing of a cadre of younger and mid-level attorneys who produce for the benefit of all of the partners in the firm. That being said, 25-30% paid for the listed intangibles are within the range paid.

Conclusion

When considering various types of compensation plans, partners are cautioned that the lawyer compensation practices of other firms may not be satisfactory for their own offices. The fact the certain plans are in use does not indicate that they may be suitable elsewhere or even that they work well for the offices that use them.

As any firm evolves, time will bring changes in its personnel and in the values and goals of the partners. What pleased the founding partners may not necessarily be welcomed by the new order. This is a natural and inevitable course of events. The firm that succeeds in establishing a sound compensation plan is one in which partners view decision-making as a dynamic process and understand that the plan is not etched in stone.

©1999-2017 Joel A. Rose & Associates