Law Practice Management Asked and Answered Blog

Category: Compensation

Dec 06, 2017

Law Firm Partner Compensation – Dealing with an Overpaid Partner

Question: 

I am a founding partner of a two partner firm in Springfield, Illinois. We are finishing up our third year since we started the firm. We have six associates and our practice focuses on health law. My partner and I each have a fifty percent interest in the firm and our compensation is based on our ownership percentages. We split firm profits fifty-fifty. Ever since starting the firm I have been bringing in substantially more fees that my partner. This year I will bring in sixty-five percent of firm fees. I am getting frustrated and feel that our compensation system is not fair, not working, and needs to be changed. I would appreciate your thoughts.

Response: 

It sounds like you are referring to origination of client business and referencing fees resulting from business that you brought into the firm. Most firms do not consider fee origination as the only partner compensation variable. Working attorney fee collections as well as other contributions such as firm management, mentoring and developing associates, developing firm systems, etc. are also considered when determining partner compensation. Many firms actually give more weight (credit) to working attorney production that to origination while others may give no credit at all.

I think you need to keep in mind overall contributions of each partner – not just client origination. Pull working attorney statistics and include these in your analysis as well as firm overhead consumed. Consider other contributions that each of you have and are making and see where the data takes you. Don’t look at just one year – look at the data over the long term – say three year trends. If you still feel that the compensation arrangement is no longer fair, you and your partner need to sit down and have a heart to heart discussion.

The best approach may be to simply realign your compensation percentages after you have come to terms with the compensation factors that you consider important to the firm and the metrics you are going to use going forward.

If you and your partner can’t sit down and have such a discussion consider getting outside help.

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

Apr 25, 2017

When Should a Law Firm Partner Compensation System Be Changed?

Question: 

I am a partner in a fourteen attorney business litigation law firm in New Orleans. There are five partners in the firm. We are a first generation firm and all of the five partners are the original founders. Each of the partners have equal ownership interests and are compensated based upon ownership points. While this approach to compensation worked for many years this system is no longer working for us. Performance used to be pretty close but this is no longer the case. Your suggestions are welcomed.

Response: 

This is a common problem that new law firms eventually face. Here are a few thoughts:

• I think you need to have an open exchange about what kind of firm you want to build and the commitments each of you are willing to make to achieve that. You need to decide what you consider to be contribution and value to the firm – working attorney fees generated, fees originated, responsible attorney fees, marketing, firm management, etc. If your commitments and performance are in general alignment – then maybe you should stay on the current split for a while longer. Another option would be to stay on the same split – but create a special bonus pool – say 25% of income that could be allocated on a discretionary basic for unusual accomplishments, etc. Of course you would have to agree on who gets how much. Another option would be to have a base draw and then either a formula or discretionary bonus pool for distribution of the excess.
• The general trend in compensation systems in larger firms is toward more subjective based system rather than formula. However, many smaller firms do still use objective or formula based systems.
• 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.

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

Feb 07, 2017

Law Firm Partner Compensation – Collaborative Team Practice

Question: 

Our firm is a 25 attorney firm based in San Antonio, Texas. We have 15 equity partners. We are equal partners and have equal ownership interests. Our partners are paid based upon ownership shares. Thus, each are paid the same. The system has worked well for us for many years and has supported our team-based collaborative culture. However, we are having issues with non-productive partners and some of the productive partners feel that the compensation system is no longer fair.  Some of the partners have suggested that we more to a formulaic system. Other partners in the firm feel that such as system would destroy the collaborative culture that we have built. We would appreciate your thoughts.

Response: 

I agree that the compensation system must shift to a system that rewards performance and overall contribution to the firm and yet preserve the culture that you have built over the years. I think that a pure formulaic system would shift your culture to a “lone ranger” culture with everyone out for themselves. I believe that for your firm a subjective or a hybrid system incorporating quantitative and qualitative performance factors would be the best approach.

In order to implement such a system you will need to set up a compensation committee that will made partner compensation decisions. I suggest a three member committee elected by the partners on three-year staggered terms. The committee will determine and publish performance factors that will be considered, conduct annual face-to-face performance evaluations, approve each partner’s annual personal goal plan for the following year, and make their partner compensation recommendation to the partnership regarding the upcoming year salary and bonus for the year ending year.

The partnership agreement or other compensation policy document should specify the procedure and what happens when the partnership does not approve the recommendation of the compensation committee or when a partner requests reconsideration.

A system such as this requires more time and work but usually yields better results, especially in a team-based collaborative practice. More and more larger firms are using subjective or hybrid systems.

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

Dec 27, 2016

Law Firm Staff Compensation – Bonuses for Staff

Question:

I am the sole owner of a four attorney firm in St. Louis, Missouri. Our firm has four staff members – 2 legal assistants, a receptionist, and a office manager/bookkeeper. It is that time of year again where I anguish over year end bonuses for staff which end up being Santa Claus bonuses with no relationship to actual performance. I would like to move away from this approach and tie their bonuses to performance. How do I measure performance for bonuses?

Response:

I like to tie salary increases to performance reviews tied to skills, competencies, value of the position in the market, cost of living, etc. Bonuses on the other hand should be tied to accomplishment of specific measurable results. Since staff results usually cannot be measured in terms of billable hours or collected dollars another measure must be used. I prefer to tie bonuses to accomplishment of specific agreed to goals or objectives.

Here is a system that some of my clients are using:

1. Four goals are set at the beginning of each year.
2. Two of the goals are firm goals. One goal might be for the firm to hit a certain revenue target. Another goals might be for the firm to hit a certain profit margin target.
3. Two goals are personal/individual staff member goals that are discussed and approved by you.
4. Goals should be SMART goals
   1.     S – Specific
   2.     M – Measurable
   3.     A - Attainable
   4.     R – Realistic
   5.     T – On a specific timeline
5. Each goal (firm and personal) is worth 2.5% (maximum 10%). The percentage is taken times annual base salary of the staff member to determine bonus.
6. At the end of the year determine which goals were met and calculate bonus.

The goals should be tough.

Example of individual goals that meet the SMART test:

1. Write and publish an Employee Handbook by December 31, 2017.
2. Write and publish an Office Procedures Manual by December 31, 2017.
3. Successfully complete six hours in accounting at a local college by December 31, 2017 with a grade of B or better.

Other approaches can be taken – the key is to tie variable bonus to actual results.

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

Nov 01, 2016

Law Firm Associate Compensation – How to Deal With Overpaid Associates

Question:

I am the managing partner of a twelve attorney defense litigation firm in Santa Monica, California. We have four partners and eight associates. Associates are paid a salary. We have several associates that are being overpaid – they are being paid $150,000 – $180,000 and just barely generating $300,000 in working attorney fee receipts. I would appreciate your thoughts.

Response:

Do they have enough work? Do they put in enough hours? Are they good time managers and good timekeepers? If they have enough work – then meet with each of them – lay out the expectation of 1800 hours and consequences for non-achievement. If they have issues with time management or time keeping impress upon them the importance of improving these skills – in the meantime they may have to simply put in the extra time to get in the hours.

Suggested consequences:

1. For those not meeting expectations. Manage and coach them in real time- but be firm about your expectations. You are paying them a salary for a certain level of expectations and performance. If there is not enough work reduce their working hours and compensation. Consider production in future salary reviews and bonuses. Don't pay them an incentive bonus to perform the work you are already paying them to do. In worse case situation you may have to reduce salaries.
2. For those exceeding expectations. Reward them with a performance-based discretionary bonus. But when advising them of the bonus advise them specifically what it is for and that is it a variable bonus and award for specific performance exceeding expectation. 

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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.

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

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