Law Practice Management Asked and Answered Blog

Aug 17, 2010

Law Firm Partner Compensation – Should We Change Our System

Question:

We are a three attorney law partnership that does primarily business transactional work. My partner and I have been in practice together for four years. We are equal partners (50% each) as far as our partnership interests and we use these same interests for determining partner compensation. In other words we receive the same compensation. We recently have been discussing whether we should look into a different method for determining partner compensation. Currently we produce about the same level of fee revenue. What are your thoughts?

Response:

I could write a whole book on compensation systems – but here are a few thoughts:

Over the past 30+ years I have seen just about every form of compensation system that there is – from "even steven" systems such as yours to "eat-what-you-kill", other formula systems, profit center systems, objective systems, etc. No particular system is better than another system. It depends upon the firm – the culture – strategic goals – and the environment.
If the system is working – sometimes it is better to leave it alone. There is nothing wrong with an "even steven" system as long as the contributions (fee generation, fee origination, firm management, and otherwise) made by both of you to the firm are perceived as equal. Frequently, partners start out making even contributions and down the road contributions change (often due to life or family changes) and are no longer in alignment.
When perceived contributions get out of alignment partners are reluctant to have the candid discussions that need to occur as well as changes in the arrangement or compensation system. It could be the system – percentage interest is fine – but as contributions have changed the percentages need to change.
Resist the temptation to look at financial contributions in a single year. Look longer term – say the past three years.
Consider not just the compensation as to whether people are happy with what they are getting – but consider whether the system in encouraging the behaviors that you need to achieve firm goals? For example – management of the firm, marketing activities, mentoring and training associates and others in the firm, etc. Often we discover that firms that are not realizing their strategic goals (those firms that have such goals) – for example growth – are victims of their compensation systems. The systems are motivating "lone range behaviors" rather than firm strategic goals. Often this is the primary reason that firms decide to change their system – to transition from "long ranger" to "firm-first" team-based firms.
Consider bonus pools and other methods of supplementing the base system.
Start slow.

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

Aug 10, 2010

Personal Injury Law Firm Profitability

Question:

We are a 5 attorney (all partners) personal injury plaintiff law firm in Central Illinois. We are all working hard, are extremely busy, but we don't seem to be seeing the results of our hard work in our earnings and compensation. We are making hefty marketing investments – in fact we are spending around 6% of revenue on marketing. What are your recommendations on how we can improve our profitability?

Response:

It is hard for me to comment specifically with the limited information that you have provided. There are numerous variables that need to be examined. However, in general terms:

How long have your lawyers been in practice? If over 10 years – you ought to be taking home $200,000+. Many lawyers aren't – but if they have tuned and focused their practices they should/could be.

Each lawyer should be collecting $300,000+ per year in fees. If not examine case production hours, quality of cases being accepted, effective rate per hour as well as realization. (Assumes time is being kept on contingency fee cases)

Firm's margin should be in the range of 35 – 45%. (Net Income – excluding owner salaries divided by Gross Fee Revenue)

Is the firm (a high volume low dollar PI firm) investing 8-10% of fee revenue on marketing? Many high volume PI practices are spending much more.

Are you measuring the ROMI (return on marketing investment)? This is critical. Not all marketing investments produce fruit – some fail. You must actively measure, manage, and fine tune marketing programs. Identify those that don't work and kill them. Dashboard reports are crucial. Measure everything – from calls and inquires and where they came from to cases signed up, dumped, etc. When cases are concluded tie the final result back to the original marketing source.

Are you leveraging paralegals, case managers, and technology – especially if you are a high volume plaintiff practice?

My guess is that overhead and expense is not your primary problem – it usually isn't. But examine your overhead and insure that you are using your resources wisely.

In essence in a high volume practice – you need effective marketing to get enough cases (quantity and quantity) and you need the infrastructure to properly handle the work.

Consider referral fees a marketing cost in addition to other marketing investments – because it is.

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

Jul 16, 2010

Law Firm Eat What You Kill Partner Compensation Systems

Question:

We are current using an “eat what you kill” compensation system in our firm. Is this appropriate method for our firm to use?

Response:

It depends. You must ask yourself what kind of firm you want to be – team-based firm or group of space sharers or partnership of individual firms. Such systems are not appropriate for law firms that want to build a firm and create a team-based practice since such compensation systems typically reinforce “lone ranger” behavior resulting in a “me first vs firm first” orientation. It is hard to build a team-based firm with such an orientation. However, some firms do not want to practice as team-based firms – they want to practice as groups of individuals. For these firms such a system may be appropriate. The challenge will be to nail down a method of allocation revenue and overhead that is fair and equitable to all members concerned. Compensation systems should do more than simply allocate the pie – they should reinforce the behaviors and efforts that the firm seeks from its attorneys. Many firms are discovering that desired behaviors and results must go beyond short term fee production and must include contributions in areas such as marketing, mentoring, firm management, etc. to ensure the long term viability of the firm. Eat-what-you-kill systems discourage these behaviors.

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

Jul 15, 2010

Getting Control of the Financial Side of Your Law Practice

Question:

I am a partner in a 14 attorney firm. Our bookkeeper has been with us for 20 years. We have a time and billing system, a separate bookkeeping system, and a separate database for clients, and something else for trust accounting. The other partners and myself do not know the name of the software that we are using, don't know how to access the software, and we have to ask the bookkeeper for any financial information that we require. We feel like "hostages". She gets offended when we ask questions. When we do receive information we don't know how to read or interpret much of the information. How can we get control of our firm back?

Response:

It is imperative that owners and partners in a law firm have access to financial information on a timely basis, understand the information, and use the information in a proactive way to manage the practice. We suggest:

The owner (or an appointed partner(s) in larger firms) obtain detailed training on the accounting software system(s) along side the bookkeeper when the system is implemented. In addition to general operation of the software, special training should also be obtained on intepretation and use of the management reports.

In your current situation – this may be a good time to consider upgrading your system and at that time obtain training on the new system, review the roles of all parties, and current procedures.

Insure that you have accounting controls in place and appropriate segregation of accounting duties.

Outline your expectations and requirements of the bookkeeper, meet with her/him, and communicate appropriately.

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

Jul 15, 2010

Valuation of My Law Practice For Merger or Acquisition

Question:

I have been thinking merging or selling my practice. How do I determine what my practice is worth?

Response:

You might want to consider retaining the services of outside advisors to help you with this process. There are a variety of methods used to value law practices including:

Fair Market Value Methods
Rule of Thumb Methods
Price Earnings Ratio
Discounted Cash Flow Models, etc.

CPA practices are often valued using a rule of thumb method employing a multiplier of 1.0 to 1.5 times average gross revenues for the past five years. Thus, a practice with average billings of $400,000.00 per year might sell for $600,000 with 50% of the purchase price paid upon closing and the balance (50%) paid over a five year period based upon subsequent collections.

Law practices are more difficult to value. CPA firms often have more repetitive work from ongoing clients and less risk in the practice – say compared to a personal injury law practice. CPA firms often have enforceable non-compete agreements which are non enforceable and therefore non existent in law firms. Law firms have much more fluctuation in practice valuation and no valuation model dominates. The rule of thumb model – when used – ranges from .5 to 3.0% – and will dependent upon the amount of repeat business, extent of institutional vs indivdiual clients, and the ability to sucessfully transfer clients to the acquiring practice.

Look for ways to institutionalize your practice in a way that your practice is not "uniquely you."

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

Jul 14, 2010

Succession/Exit Planning Questions

Question:

I am sole owner of a 8 attorney firm in the Northwest. Two other attorneys are income partners – no equity – and the other five attorneys are associates. I am just turning 50 and am beginning to think about future retirement. What questions/issues should I be thinking about?

Response:

Fifty seems to be the point at which attorneys being thinking about their retirement and their future. Some even consider and in fact make complete career changes at this point in their lives. Here are a few questions to begin thinking about:

Have you decided when you want to retire and leave your firm? Or do you want to work forever?
What amount of cash or annual cash flow do you need when you exit?
Do you presently have a retirement plan and how much income to you project that it will provide at different exit times?
To whom do you want to transfer your interest? Family members in law school, other attorneys in the firm, another firm, etc?
Based on future cash flow, do you know how much the firm is worth today?
Do you know how to best maximize the income stream generated by the firm – in the years ahead while you are still with the firm and after you leave the firm?
Have you been able to institutionalize the firm – or is it uniquely you?
Is the firm even marketable?
Do you have a succession/exit plan?
Do you have a plan for your business if the unexpected happens to you?
Have you taken steps to protect your family's wealth?

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

Jun 23, 2010

Law Firm Cost Cutting Strategies

Question:

Our firm is a 20 attorney defense firm in the Southwest. We are having a hard year and are looking for cost cutting ideas and strategies.

Response:

I am often asked to help law firms design and implement profitability improvement programs. In most of my engagements the real problem is insufficient gross income and lack of sufficient investment (spending and time) on marketing and initiatives designed to stimulate client and revenue growth. For most firms increasing revenues is the most effective way of impacting the bottom line. However, we do find that there is waste and unnecessary overhead that eats away at profits and a cost control program is also recommended and implemented. During recessionary times such as we are currently facing – drastic cost control are often the only option. Reducing overhead can immediately and effectively improve a firm’s bottom line.

The first step in an expense control program is to identify those areas where potential savings exist. Review your profit and loss statement. Resist the temptation to arbitrarily cutting costs which could cut the muscle with the fat and result in revenue loss as well. You have to spend money to make money – so if cost cutting is the appropriate strategy – cut the right costs. Think strategically about cost reduction.

After you have identified areas where savings can be made prioritize and develop specific strategies and implement action plans to achieve the savings.

Here are a few ideas:

STRATEGY #1: Reduce Headcount

This is the largest area for potential savings. Downsizing is a strategy that has been used by many firms this past year. However, it can have long term negative consequences for revenue and talent management. Consider all levels – non-productive partners, associates, paralegals, and staff. Be prudent and sensitive in implementation.

STRATEGY #2: Reduce Compensation

Obviously one way is to cut salaries – a strategy to be used as a last resort. A better approach is to reduce fixed salary (paying people for showing up) and add a variable pay component which will allow employees to earn additional compensation in the form of bonus for results achieved. Another approach is to freeze salary increases.

STRATEGY #3: Benefits

A major area for cost savings – especially health insurance. Determine which programs are most important to employees. Do your best to protect those and reduce or eliminate programs that are less important. Consider offering more than one health insurance plan. Pay the premium for the lowest cost plan and provide options for employees to “opt up” to the better plans by paying the additional premiums. Consider increasing deductibles and requiring employees to pay a portion of the base premiums.

STRATEGY #4: Outsource

Examine potential for outsourcing – from copy services – IT management – to your legal team.

STRATEGY #5: Occupancy

Review your lease invoices and question increases and escalators for which you have been charged. Consider renegotiating your lease and ask for a lower rate. Reduce excess space either through a renegotiated lease or through sub-leasing.

STRATEGY #6: Telephone Service

Scrutinize your bills and examine rate tariffs as well as items that have been tagged to your bill by third parties. Negotiate and ask refunds for any discrepancies or abuse found. We have seen firms receive thousands of dollars in refunds.

STRATEGY #7: Virtual Office

Do you need an office at all. Many solos are working out of virtual and home offices or a combination of same. Some larger firms are reducing the size of their primary expensive downtown offices by having some attorneys work from home offices or other locations.

STRATEGY #8: Marketing

Many firms actually need to spend more money on marketing. However, this does not mean that it should be wasted on sacred cows. Review marketing investments, eliminate feel good items, and insure that they are producing results. Reallocate funds.

STRATEGY #9: Supplies and Other Purchases

Eliminate waste and unnecessary expenses. Consolidate with fewer vendors and solicit discounts for exclusive relationships.

STRATEGY #10: Develop a Budget and Financial Plan

If you don’t have one – develop a budget and financial plan and work the plan.

Good luck!

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

Apr 08, 2010

Why Do Law Firm Mergers Often Fail

Question:

Our firm has been discussing the possibility of merging with another law firm of similar size. We are are 25 attorney firm. We have heard horror stories of firms that have merged and been unhappy with the experience. Why do mergers fail and what should we look out for?

Response:

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 excitment about new client potential – jump immediately to an examination of practice economics and the financials. They fail to perform proper due dilligence on the people. It is critical that firms insure that cultural due dilligence 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.

Do all the due dilligence that you can – start with the people – then move through the rest of the process.

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

Dec 26, 2009

Dialing For Dollars: Tips For Collecting From Your Clients

Q. These economic times have been challenging for our firm at best. A major problem for us is collecting our client receivables. Do you have any suggestions?

A. Regardless of whether economic times are good or bad cash flow is always a matter of prime concern for law firms. With it taking in general 3-4 months to convert client work to cash anything the firm can do to speed up the collection cycle is always desirable. Here are a few ideas:

Do everything you can to keep receivables from going out to 90 days. Receivables aged one month are 93.2% collectable; three or more months are 72.3% collectable, and one year or more are 28.4% collectable.
Call – don't waste time with mailing follow-up letters.
Treat collection calls as an extension of client service. Calls should be treated as client service calls – not collection calls.
Caller should be someone other than the attorney who did the work for the client, qualified staff member or outsourced Accounts Receivable Account Manager.
Calls should be made by a trained Accounts Receivable Account Manager with client-friendly people skills.
Calls should be made on each account as soon as it reaches the due date.
Accept credit cards and offer it as a payment option.
Discount bills when necessary if it will expedite payment and engineer payment plans.
Diary, calendar, and follow-up.
Consider outsourcing to an Accounts Receivable Account Manager – not a collection firm.
Consider our firm for outsourcing this effort.

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

Dec 22, 2009

Is Your Firm Ready For the New Competitive Landscape

Question:

At a recent partner meeting we discussed the current economy and what changes we need to be thinking about both now and when we come out of the recession. What are your thoughts?

Response:

As law firms emerge from the current recession many will face many new business realities and be forced to consider whether existing business models are still appropriate for the future. Legal process outsourcing (LPO), off-shoring, virtual offices, alternative billing, etc. We believe that the recession may accelerate the pace by which firms reevaluate existing processes and consider new business models.

Ten years ago (1999) the ABA hosted the "Seize the Future" conference in Phoenix, Arizona.

The conference predicted massive change fueled by the internet. Many of these changes we have already witnessed and experienced – others are yet to come – possibly in the near future. Richard Susskind's popular book "The End of Lawyers: Rethinking the Nature of Legal Services paints an interesting future. As we emerge from the recession pressures will exist that may excelerate some of the other changes that have been predicted.

Here are some changes that some firms are already implementing:

Outsourcing back-office support functions such as accounts receivable management and collections, leased employees (PEO), billing and accounting, IT support, payroll, facilities management, copying and duplicating, etc.
Outsourcing legal services to contract attorneys and paralegals and on-shore and off-shore legal process outsourcing (LPO) providers.
Unbundled legal services by clients with segments of work assigned to in-house counsel, outside counsel, and on-shore and off-shore legal process vendors.
Partnering by U.S. law firms with on-shore and off-shore legal process vendors.
Internet service delivery models.
Flat fee billing arrangements by large law firms with large major corporate clients.
Success fees and risk sharing with clients.
Virtual law firms.
Virtual employees.

Here are a few examples:

The key ingredent is to not get stuck in the past. Incumbancy and pass success has never been worth less. Ask General Motors.

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