Law Practice Management Asked and Answered Blog

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May 14, 2013

Law Firm Compensation – Associate Bonus – Fee Split

Question:

Our firm is a 12 attorney firm located in downtown Chicago. We have 8 partners and 4 associates. We are considering making a change to our associate compensation system. Currently associates are paid a salary plus a discretionary bonus at the end of the year. We are considering continuing to pay them a salary plus 60% of any business they bring in (origination). Does this plan make sense?

Response:

I would need to know more about your financial situation, your overhead, and profit ratio. You and your partners should expect to make a profit from your associates. I believe you should expect to realize a profit margin of 25% – 30%.  After factoring in firm overhead and associate compensation I don't believe you will be able to give away 60% and realize this goal. 20%-30% may be all that you should incorporate into a bonus system. Be careful that a bonus system such as this accomplishes what you are seeking to accomplish and that you don't create a lone ranger culture. 

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

 

 

 

May 07, 2013

Law Firm Growth and Reduction in Profits

Question:

Our firm is a personal injury plaintiff firm in Topeka, KS. Until two years ago we had two attorneys (both partners) and two support staff members. In early 2012 we added an associate attorney, increased our marketing investment, moved our offices and took on additional space, added five additional support staff members, and implemented a case management system. We currently have 500 open cases – up from 200 cases 2+ years ago. Revenues are up – but the two partners are each taking home $40,000 less than they were before the expansion. Our home grown office manager manages and runs the office. What should we be doing differently?

Response:

My first thought is that your revenues have not caught up with the overhead and the growth investments that you have made. (You should review your reports and verify this) Personal injury cases have a much longer revenue lag than does work that gets "time-billed" monthly. Some cases may be in progress for two years or so. So be patient but don't be complacent.

You do need to be proactive in managing your case pipeline and your team. Someone needs to mind and manage the store. You are a larger firm now and you can't assume that your team is working to maximum effectiveness and efficiency. Insure that you actually need all of these people and that people are working smart. Roles for each member of the team should be created and performance standards and expectations established. Goals (cases) should be created for each team member, metrics and measurements established, standard reports created – generated – and used, and team members held accountable for results. Use the reports that the new case management system provides to measure goal accomplishment and performance.

Evaluate whether your office manager has the leadership skills that the firm now requires.

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

 

 

May 01, 2013

Law Firm Capital – How Much Do We Need

Question:

Our firm is a relatively new firm. Several of us left a large firm in Dallas and started the firm last year. We have 17 attorneys – 10 of us are partners. When we started the firm we each put in a little cash and obtained a line of credit which we have used extensively and we are at our limit. Is this a good practice? Should the partners contribute more capital? How much? I would appreciate your ideas.

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

 

Apr 23, 2013

Law Firm Succession – Client Transition

Question:

Our firm is a 24 attorney firm in Chicago West Suburbs. We have 10 partners – five of which are in their early 60s. We represent small to mid-size business clients. Recently we have been discussing the eventual retirement of the senior partners and approaches to client transition. We would appreciate your thoughts.

Response:

Client transition involves different challenges that have to be overcome in order to successfully transition client relationships. Consider the following challenges and hurdles:

  1. Relationships take an investment of time and must be nurtured on behalf of the parties making the introductions and connections as well as the parties trying to form the  new relationship. Attorneys often want immediate gratification and the "quick fix" and are unwilling to invest time needed for longer term results. More than a "one-shot" simple introduction is required.
  2. Clients hire lawyers not law firms.
  3. Client transition requires trust on the part of all parties (introducers and new players). A high level of trust must exist within the law firm organization between the attorneys involved and within the client organization between the parties there as well.
  4. There is potential risk of embarrassment for all concerned. The transitioning attorney in the law firm could risk losing the client if the other attorney does poor work for the client. Another issue is the loss of control over the client. The individuals in the client organization could also risk criticism (or even their jobs) if the new relationship does not pan out.
  5. Many law firms are "lone ranger" rather than "firm first" or "team based" firms. As a result there is no inclination or incentive to invest the time and effort nor take the risk to refer work to others in the firm.
  6. Lack of knowledge regarding other partners' practices.
  7. Fear of losing clients.
  8. Fear of losing client control.
  9. Compensation systems in many law firms encourage hoarding of work and discourage the referring of work to others.
  10. Communication systems in  some law firms do not facilitate relationship building among attorneys. Effective client transition is simply not possible without strong relationships and high levels of trust among attorneys in the law firm.

Effective client transition is not a one-time lunch or introduction event – it most go deeper to bind the new relationship. This takes time. Start early and allow ample time for an effective partner winddown.

I generally suggest five year client transition programs.

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

 

Apr 16, 2013

Managing Partner Non-Billable Time in a Law Firm – How Much?

Question:

I am a partner in a 17 attorney firm in Madison, Wisconsin. We are a business law firm and we have ten partners and seven associates. We are managed by a managing partner, one of my partners, and he also practices law. We pay him his standard client bill rate for his non-billable time spend on law firm management. For the last couple of years his non-billable hours spent managing the firm have been increasing to the point where he is now spending 50% of his total time – 1000 hours a year managing the firm. This has caused tension in the firm and my partners and I are concerned. I would appreciate your thoughts.

Response:

I would concur that this amount of time is excessive for a firm your size. Even if you stay with the managing partner model of governing your firm – most managing partners in firms your size are able to get the job done for around 500 non-billable hours a year – 25% or less of their total time. You may want to consider the following:

  1. Put in place a budget for the total non-billable hours that the firm will pay the managing partner.
  2. Clarify the duties, role, responsibilities, and projects that the managing partner should be spending his time.
  3. Review the overall governance/management structure that the firm has in place.
  4. Consider supplementing the Managing Partner with an Office Manager or Firm Administrator.
  5. Consider whether the managing partner role is still the most appropriate approach for your firm.

I suspect that your managing partner is either not delegating to staff some of the day to day management tasks or he does not have sufficient billable work to stay busy.  At $275 bill rate – 1000 hours per year costing the firm $275,000 a year. I believe that a firm your size can handle this function more economically.

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

 

Apr 09, 2013

Law Firm Margin/Profitability Ratio – Net Income to Gross Revenue

Question:

I am the owner of an elder law firm in Boston. I recently closed out the 2012 books for tax preparation, I'm reviewing my annual numbers from what was my 4th year in solo practice and wondering how I'm doing.  Is there some kind of benchmark/goal or can you share any advice about an ideal ratio between gross income and overhead costs?

Response:

I usually say 35-45% margin (net income divided by total fee revenue) which is supported by most of the survey data. (Expenses used in the determination of net income defined as total expenses less owner/partner compensation). However, I have some law firm clients that have 20% margins were the partners/owner are taking home $1,000,000 per year. So margin is sometimes tells only part of the story. Depends upon the area of practice and practice/leverage structure. Solos operating virtually with no staff may have a margin of 80% but only taking home $40,000. ($40,000 net income divided by $50,000 fee revenue – only $10,000 in expenses.)

Be careful of using the term overhead as this often refers to expenses less all producer compensation. (partners, owners, associates, and paralegals) I assume that by the term overhead you are referring to total expenses less your compensation or draw.

Click here for our blog on financial management

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

 

Apr 02, 2013

Law Firm Merger – Where to Start When Merging/Acquiring a Smaller Firm

Question:

Our firm is a 26 attorney firm in Louisville, Kentucky. We are considering merging/acquiring a 12 attorney firm in the local area. This is virgin territory for us as we have not done this before. We would be interested in your thoughts as to where we should start and the process we should use to minimize the risk of making a mistake.

Response:

While mergers can be a valid option making them work is often another matter. Research indicates that one third to one half of all mergers fail to meet expectations due to cultural misalignment and personnel problems. Don’t try to use a merger or acquisition as a life raft, for the wrong reasons and as your sole strategy. Successful mergers are based upon a sound integrated business strategy that creates synergy and a combined firm that produces greater client value than either firm can produced alone.

There can be a whole list of reasons for failure including poor financial performance, attorney defections, loss of key clients, and leadership and management issues. However, it has been our experience that most failures have been the result of poor cultural fit. The merging firms – after they have moved past conflict checks and excitement about new client potential – jump immediately to an examination of practice economics and the financials. They fail to perform proper due diligence on the people. It is critical that firms insure that cultural due diligence is a key component of the merger assessment process. Philosophies, personalities, and life styles should be generally compatible. The partners should like each other and the deal should make sense.

The question is not the what (merge) but the who (people)

You should do all the due diligence that you can – start with the people – then move through the rest of the process.

Click here for our blog on mergers

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

Mar 26, 2013

Sale of Law Practice – Proper Timing

Question:

I am a sole owner of a 4 attorney law firm located in Washington, D.C. Our practice concentrates on estate planning and administration. We have 6 support staff members. I just turned 60 the first of the month and am beginning to think about what I will eventually do with the practice. None of the associate attorneys are interested in partnership or in purchasing the practice – they just want jobs – they are not interested in owning a law practice. When is the best time for me to sell my practice?

Response:

You really have to give some thought to your timeline – how long do you want to work? Do you plan on pursuing another career? Have you put enough money away so you can simply retire without concern about the need to generate additional income?

If you need revenue for an additional ten years – a way to earn it – and if you enjoy what you are doing – then it will not be in your interest to sell the practice too early. Let's say you could sell your practice for one million dollars – this might equate to two years of earnings. If you worked another ten years – you could have earned five million dollars.

To a large extent owning a law firm is in essence a job where you work for a living where you have provided employment for yourself. It might be hard to find a job that pays as well as your firm. So if you need revenue for another ten years and your enjoy your work – you should probably plan on working another ten years. Build you timetable to sell your practice around your future work timeline. Things change – you may find that your associates change their mind or down the road you may end up with new hires that will have an interest in partnership.

Start with planning out how long you want or need to work and go from there.

Click here for our blog on succession/exit strategies

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

 

Mar 19, 2013

Law Firm Lateral Partner: Size of Book of Business

Question:

I am a partner in a mid-size firm in Memphis. We have 250 attorneys in the firm and I am considering making a move to a smaller firm. While I have a client base I am not sure how much business would go with me. I am currently making $600k in compensation. With my experience – 25 years plus – how important is a book of business initially? How big of a book will firms be looking for?

Response:

A portable book of business is critical – especially if you are looking to earn what you have been earning. A rule of thumb for many of the lateral moves that we have seen for compensation is 1/3 of book. You will need a book of $1.5 to $2.0 million to generate interest from major players.

Click here for our blog on laterals and mergers

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

Mar 12, 2013

Partner Compensation – Two Attorney Start-up Firm

Question:

I am a solo practitioner in Chicago. I've been offered by another solo to join him as a partner, and was wondering if you could suggest any articles or books I could look at to think about how to structure the partnership.  We bill about the same number of hours, but his rate is 50% higher than mine (300 v 200) and he has 20 years on me in age and experience.

Response:

I am a believer in true partnerships as they seem to work best and the compensation system that seems to work the best is where the partners share and share alike the profits based upon their ownership percentage. Initially a percentage is agreed upon based upon the revenue/profit
history and experience that each brings to the firm. If the level of contribution changes over time you talk about it and the percentages are adjusted. You may want to start by looking at your fees and profits over the last five years and compare them to his and use this as a starting point. Consideration should also be given to his experience. Hours don t matter as much as dollars. Then determine that ratio. Often in an arrangement such as this, depending on the ratio, it might be a 60%/40% split. If this is what you agree to then establish your capital accounts in accordance with that ratio (initial firm investment in the form of cash or other assets) and then split profits according to this split. Over the years adjust as needed. If you have a healthy partnership you will be comfortable discussing this subject.

Other approach if you want to be lone rangers would be a formula eat-what-you kill approach.

Here are my blogs on this topics generally:

https://www.olmsteadassoc.com/blog/category/compensation/ 

Here are a couple specific blogs:

 https://www.olmsteadassoc.com/blog/2009/05/  

https://www.olmsteadassoc.com/blog/law-firm-eat-what-you-kill-partner-compensation-systems

Click here for articles on other topics

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

 

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