I am a partner in a firm in Los Angeles. We have nine attorneys – four partners and five associates. We are a young firm in that we have only been in business for four years. The four partners started the firm together, we are equal partners, and we split the profits equally. When we started the firm we each made equal capital contributions. We do not have a partnership agreement. We are thinking about bringing in two associates as equity partners and are trying to think through the mechanics and one of our questions is whether there should be a buy-in and if so how should we determine it. We would appreciate your thoughts.
Law firms have different viewpoints on this subject. I have worked with some larger firms that are in second generation or later that do not require a capital contribution at all. They use end of the year distribution hold backs and credit lines to fund their working capital requirements. Other firms do require capital contributions upon being admitted as a partner and additional contributions over time when additional capital is needed or when partners acquire additional capital interests.
Smaller firms tend to require new partners/shareholders to pay for their interest in the firm. The buy-in can provide additional capital for the firm or can be used to compensate the existing partners/shareholders for their investment and sweat equity in creating the law firm or in growing it to its present size. One approach that some firms use it to include in the partnership/shareholder agreement the formula for determining the value of the firm, to which the new partner’s/shareholder’s percentage interest can be applied. This could include non cash-based assets such as accounts receivable, unbilled work in process, and goodwill. Another approach is to base the buy-in or capital contribution upon a the cash-based capital based upon the number of ownership shares a partner receives. Most firms allow for a buy-in over several years. Firms that do have a buy-in provision also typically provide for a payment to partners/shareholders upon departure for the value of their capital account. In recent years, an increasing number of large firms have adopted a free buy-in. Under that approach, there are no payments to departing partners/shareholders.
I believe that you should require at least a capital buy-in based upon the cash-based capital on the books and the number of ownership offered. This assumes that the partners still have capital accounts on the books. I also think you might consider them buying into the accounts receivable and unbilled work in process as well or be excluded from participating in compensation from those receipts. You should also get a partnership agreement in place as well.
John W. Olmstead, MBA, Ph.D, CMC
I am a partner in a four attorney personal injury plaintiff in downstate Illinois. Three of us are partners and we have one associate attorney. We handle run of the mill slip and fall, vehicle and premises accidents, and products liability cases as well as workers’ compensation cases. We have a very aggressive advertising and marketing program. We are having issues with reduced case flow and dwindling and diminishing profits and earnings. For the past year the partners have been living off our credit line. We believe that we need to be thinking about doing something different and are not sure as to what that should be. However, we have agreed to start doing some long term planning. We would appreciate your thoughts.
I believe that the very process of developing a strategic plan would be very helpful, beneficial, and enlightening. Strategic planning does not need to be the involved and complicated process that sometimes it becomes. It a nutshell it is nothing more than a series of logical steps. The process is often more important than the written plan. Most workable strategic plans are put in writing at the end of the process, and then often in summary or outline form. Generally, the steps include:
Your first step will be the mission statement – you should take a hard look at who are you as a firm and who are you serving as clients? Many of our personal injury law firm clients across the country are facing similar problems that you are and they have been forced to take a hard look at their their practice and geographic area segments. Some firm’s have tried to balance the cash flow ups and downs of contingency fee work by adding time billing practice areas that provide consistent cash flow such as employment, family law, criminal, and bankruptcy. Other firms are extending their geographical reach through additional offices and some are getting involved in mass-tort cases.
I think this is the most important step if you don’t do anything else. You may have to consider expanding and diversifying your practice.
John W. Olmstead, MBA, Ph.D, CMC