Law Practice Management Asked and Answered Blog

Category: Compensation

Oct 04, 2016

Law Firm Client Business Development – Motivating Lawyers to Develop New Client Business

Question:

I am the managing partner of an eighteen attorney firm in New Orleans. We have six equity founding partners, four non-equity partners, and eight associates. We represent institutional clients. Four of the six equity partners are in their sixties and two are in their late fifties. The six equity partners are concerned about the future of the firm as they approach retirement. If they retired today the firm would cease to exist – the non-equity partners would not be able to retain our existing clients and acquire new clients. We have not been successful at motivating our non-equity partners to develop and bring in new clients. We have harped on this for years and encouraged all attorneys to develop business. We implemented a component of our non-equity partner and associate compensation system to compensate them for new client origination. Unfortunately, we have not been able to motivate our non-equity partners and associates to develop new sources of business. Our non-equity partners and associates have a nine to five work ethic and an entitlement mentality. Would you share your thoughts?

Response:

Often law firms hire associates simply to bill hours and perform legal work. Then years later they are asked to develop clients. Many are unprepared and at a loss as where and how to start. I believe that if you want attorneys to develop clients you have to hire attorneys that have the personality, ability, and you have to get them started on business development in their early years.

To turn your non-equity partners and associates into rainmakers at this stage will be difficult but not impossible. Here are a few ideas:

1. Insure that your compensation system reinforces and rewards business development  results. However, don't be surprised that even if your system rewards business development behavior does not change.
2. Extrinsic motivators such as compensation often are not as impactful with professionals as intrinsic motivation that involves engaging in a behavior because it is personally and professionally rewarding – performing an activity for its own sake rather than the desire for external reward. Many law firms are requiring attorneys to submit annual personal business goal driven plans that are incorporated into annual performance reviews. I have found that these plans as or more powerful than compensation in developing new behaviors such as client development when an attorney is uncomfortable with such behaviors.
3. Integrate the compensation system with personal goal plan achievement.
4. Implement an equity partner admission program (partner track) that outlines requirements for admission. Make business development goal attainment a component. Make it clear that to become an equity partner you must be a rainmaker.
5. Provide business development training and coaching for attorneys willing to participate.
6. Have serious discussions with non-equity partners and terminate those that are not meeting production and client development goals.
7. Consider hiring lateral attorneys with books of business or merging with another firm.

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

Jul 20, 2016

Law Firm Compensation – Moving From an Eat-What-You-Kill System to a Totally Subjective System

Question:

I am a partner in a 20 attorney firm in San Francisco. We have five partners. Two of the five partners are founders and the other three were made partners five years ago. Our firm was started twenty years ago by two partners of our existing partners. From day one our compensation system has been an eat-what-you-kill compensation system based on a formula with two factors – working attorney collections and client origination. While the system worked okay for the founders, it is not working for the present firm. The newer partners are unhappy with the system and believe that it does not consider other factors that a partner contributes to the firm. Some of the partners are hoarding work, refuse to serve on committees, and don't want to do anything but bill. A couple of my partners suggested that we move to a totally subjective system. I would appreciate your thoughts.

Response:

More and more firms are moving to more subjective based systems for some of the reasons that you have outlined – especially larger firms. Success of such a system is dependent upon the compensation committee that is put in place (typically a three- member committee elected by the partnership) and the level of trust that partners have in the partners serving on the committee. With only five partners you don't have a large enough partnership to put in place such a committee. It would have to be a committee of the five which would probably not be feasible. In addition, your culture may not be conducive at this time to such a system. Your founders have grown up under the present system and will more than likely resist such a formidable change. I suggest that you make some changes to the existing system and see how that works. For example:

1. Include responsible attorney as well as working attorney and originating attorney fee collection in the equation with a possible weighting of 60% working attorney, 20% responsible attorney, 20% originating attorney.
2. Factor in overhead or if not have a reduction provision for attorneys that are consuming un-fair share of overhead.
3. Factor in effective rate/realization and reduce compensation for realization that is below a certain threshold.
4. Setup a bonus pool (15% – 25% of firm net income) for exception performance decided by the five partners. If there is no exceptional performance or the partnership cannot agree the funds are cycled back into net income and distributed in accordance with the formula.
5. Provide production credit or paid special compensation for serving on management committee or as managing partner.

Jul 13, 2016

Law Firm Financial Management – Realization Rates

Question:

Our firm is reviewing its partner compensation system and one of my partners suggested that we incorporate realization rates. This term was new to me. Is realization the percent that we collect? Your comments would be appreciated by all of us.

Response:

Not exactly. There are the following three general types of fee realization.

Overall Realization which is the relationship between the standard value of time (standard billing rate) and the actual fees collected. This is calculated by taking the value of unbilled time at the beginning of the year plus fee accounts receivable at the beginning of the year plus value of billable time worked during the year minus the value of unbilled time at the end of the year minus fee accounts receivable at the end of the year – equals potential fees to be collected. Realization (Actual fees collected/potential fees to be collected.)

Billing Realization which are actual fees billed/potential fees to be billed. This is calculated by taking the value of unbilled fees at the beginning of the year plus fees recorded during the year minus unbilled fees at the end of the year – equals potential fees to be billed. Billing realization is then calculated by dividing the actual fees billed by the potential fees to be billed.

Collection Realization which are actual fees collected/potential fees to be collected. This is calculated by taking the value of AR fees at the beginning of the year plus fees billing during the year minus AR fees at the end of the year. Collection realization is then calculated by dividing the actual fees collected by the potential fees to be collected.

All three calculations are important and tell different stories. They can be calculated at a firm level, client level, timekeeper level. Realization reports are available in the better law firm time and billing software programs.

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

Mar 30, 2016

Law Firm Compensation for TIme Spent by Partners Managing The Firm

Question:

Firm has three partners, two associates, and 2 staff members. We are a new firm and just started in practice a year ago. We are equal partners and we allocate compensation equally based upon these ownership interests. We believe the system has worked well for us but we been considering whether one person should handle all the management duties and if so how that person should be compensated. We would appreciate your thoughts.

Response:

First I would identify the duties and hours involved and make sure the duties are managing partner level duties and not office manager level duties that should be handled by staff. Delegate or consider hiring an office manager for duties than can be delegated. For duties that can't be delegated I would suggest you that a look at the hours that will be required and determine a  fixed additional compensation amount based on expected hours and the partner's standard billing rate. The partner's compensation would be his/her fixed additional compensation amount plus his/her allocation based upon ownership interest.

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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.

Aug 25, 2015

Law Firm Associate Compensation – Incentives

Question:  

I am the owner of a seven attorney litigation boutique firm in New York City. I am the only equity owner and the other six attorneys are associates. Currently all of the associates are paid a straight salary with raises given every year. I am considering freezing their salaries at current levels and putting in place an incentive bonus for individual revenue generation above a certain number. I am concerned that this approach might create an eat-what-you-kill mentality and destroy teamwork in the firm. Do you have any thoughts?

Response: 

I concur with an approach that ties compensation to individual performance such as working attorney collected fee generation up to a point. You are right that this could create more of an individualistic attitude and may spur internal competition which may not be all bad. However, since there are other aspects of firm contribution other than working attorney collections you might want to add a goal bonus component that outlines specific goals that are important to the firm and specifies specific dollars or percentage of salary for each goal with a maximum attainable per year. These goals must be specific, measurable, attainable, realistic, and on an agreed timeline. 

A goal bonus component will reward other non-financial contributions and serve as the glue that will minimize the potential for creating an eat-what-you-kill environment.  

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

Jul 28, 2015

Law Firm Compensation – Client Origination Guidelines

Question: 

I am the managing partner of a 25 attorney firm in Charleston, South Carolina. Our practice is limited to insurance defense. We have eight equity partners and four income partners, and five associates. Our firm is in second generation and virtually all of our clients were originated by first generation partners that are no longer here – they have since retired. Our compensation system focuses totally on working attorney dollars. I believe that we must begin to stress the importance of origination of new clients and factor that into the equation. I would appreciate your thoughts.

Response: 

Origination of new client business is important in any firm. Many insurance defense firm are too dependent on four or five insurance companies and need to diversity their client portfolio. Origination should be at least a factor in compensation systems – whether treated objectively or subjectively. There are pitfalls and you will need to establish specific rules, guidelines, and a policing committee. 

Here is an example of origination guidelines that some law firms have implemented:

1. Firm Employee or Employee Referral. Whenever the firm is employed by one of its non-lawyer employees or by a client referred by such employee, the client should be considered a firm client and no origination attribution aware should be made.
2. Employee of Existing Client. When an employee of an existing client (other than a principal) becomes a client of the firm, the presumption will be made that the employee is a client of the attorney to whom the employer is attributed. There may be extenuating circumstances calling for a different result, and these circumstances should be brought to the attention of the Attribution/Compensation Committee.
3. Martindale and Similar Lawyer Lists. Referrals generated by Martindale and other such lawyer lists should always be considered clients of the firm.
4. Clients Resulting from Prior Clients. In the case of a client attracted to the firm by reason of a lawyer's prior representation of another client, the new client shall be presumed to be the client of the lawyer to whom the existing client is attributed unless the new client was demonstrably attracted by the lawyer representing the existing client.
5. Direct Referral by Existing Client. In the case of a referral by an existing client of Lawyer A to Lawyer C (by reason of Lawyer C's particular expertise), the client shall nevertheless, in most instances, be deemed to be the attributed client of Lawyer A.
6. In-Town Referrals. Referrals by lawyers in (name of city) resulting from conflicts of interests should be considered firm clients. However, some referrals to our firm are made by other lawyers who have recognized the particular expertise of one of the lawyers in the firm. All in-town referrals should be first referred to the Attribution/Compensation Committee prior to any attribution being made.
7. Out-of-Town Referrals. In Most instances, out-of-town referrals (other than from lawyer lists) are the result of friendships and professional associations between lawyers. The attribution should properly be awarded to the lawyer to whom the referral is made.
8. Paralegals. All dollar amounts resulting from the work performed by paralegals shall be attributed entirely to the attorney to whom the client is attributed.
9. Contingent Fee Cases. Upon receipt of the firm's share of amounts payable under a contingent fee contract, the originating attorney should be attributed ___% of the fee and the remaining ___% should be spread among the lawyers in proportion to their hours of service on the case, taking into consideration their respective hourly rates.
10. Joint Referrals. The affected lawyers should meet in an attempt to resolve their respective sharing. If, however, the matter is not resolved, it should be referred to the Attribution/Compensation Committee for a binding decision.
11. Retiring Partners. The clients of retiring partners are presumed to be firm clients.
12. Attribution/Compensation Committee. All origination attributions should be reviewed by the Attribution/Compensation Committee in the same fashion that it reviews new clients. Independent inquiry should be made of new clients where there may be some question as of the appropriateness of attribution.

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

Jul 01, 2015

Law Firm Ownership – Acquiring a Founding Partner’s Interest

Question:

I am a senior associate in a eight attorney elder law firm in Miami. There is one owner (founder) and seven associates including myself. The owner has approached me with a proposal to over time buy out his interests. I am the only senior associate in the firm and the only associate that he has approached concerning selling his interests. Specifically his proposal is as follows:

1. Pay him $825.00 for the practice over five years.
2. After five years I will own 100% of the shares.
3. My compensation arrangement will remain the same (salary plus formula percentage incentive bonus based upon my responsible attorney collections) until I have acquired 100 percent interest of the firm.
4. The owner wants to work in the firm indefinitely after his interest are acquired as an employee or Of Counsel.

I don't know how to respond to this proposal and would appreciate your thoughts? Is it fair? Does it make sense?

Response:

It makes sense for him. Seriously, you are going to need much more information that this proposal. To get started you need to ask for and review the following:

1. Profit and Loss statements and Balance Sheets for the past five years.
2. Tax returns or Schedule C for the past five years.
3. A report showing the current accrual based assets – mainly unbilled work in process and accounts receivable. There are often the largest assets that a firm has and it is not on a typical cash-based profit and loss statement.
4. A list showing any off-balance sheet liabilities.
5. Copies of the office lease and other leases to determine lease liabilities.

From these documents you can get a feel for the cash-based net equity, the accrual-based net equity after considering work in process and accounts receivable and unrecorded liabilities.

Two numbers that may be even more important is the average fee revenue generated over the past five years and the average compensation (net profit plus compensation – W2 and K1 earnings) that the owner has been earning over the past five years.

Here are a few thoughts:

1. One to one and a half times the owner's average earnings for the past five years is typical. So from this guideline you can evaluate the appropriateness of the $825,000.
2. What assets are included? Will he exclude any assets?
3. Will you be able to acquire minority interests over the five years as you pay towards the payout? I will insist on such.
4. If you do acquire minority interests as you go will there be a profit pie for you to share in or will the owner increase his compensation, personal perks he passes through the firm, cut down on his working time, etc.? You should get a handle on compensation as well.
5. I would not have the owner's employment open ended after you acquire 100% interest. Have some protection in case he fails to produce or has physical or mental problems that affects his performance. Suggest an Of Counsel agreement that gets reviewed and renewed annually.
6. Consider whether there is a transition that insures that the clients and referral sources stay with you after he retires. If he has not groomed you, involved you in relationships with clients and referral sources, had you giving seminars, and plugged you into referral sources future business could drop off dramatically. This should be factored into the value.
7. Weigh the cost-benefit of starting your practice v.s. purchasing his practice. 

Good luck!

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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

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