Tag Archives: equality

Sharing Profit and Millennial Partners

The millennial generation, born from 1981 to 1996 (or thereabouts), now 23 to 38 years of age (or thereabouts), are THE succession plan for most law firm partnerships. I wonder if our sharing methodologies are ready.

Methodologies for sharing profit among equity partners have been an interest of mine for many years. A decade or so ago I wrote a doctoral thesis on the behavioural consequences of alternative models, in particular the impact of various models on equity-partner diversity. The millennial generation are the most diverse generation of lawyers the Australasian profession has experienced, ever.

When I started monitoring and consulting law firms in the late 1980s, equal sharing was the norm in Australasia; it’s still common among many larger, mid-sized and smaller firms in Australia and New Zealand. Some of our larger firms, having been performance sharers for years, are drifting back towards equality. When equal sharing (typically after a 5-year lock-step) was the dominant model, law firm partnerships were relatively homogeneous, typically male, typically Anglo and typically full time.

Changing Demographics

This morning the Australian Financial Review reports that a survey of 5000 staff from major Australian law firms has found that ‘25% of graduates and 20% of non partner lawyers are of Asian background’. The survey found that only ‘8% of partners are of Asian background’. Although not reported, I wonder what percentage of equity partners (as distinct from ‘non-equity’ or ‘fixed draw partners’) are of Asian decent?

Of course, we don’t need a survey to reveal the long-observed disparity between women graduates, employed lawyers and equity partner numbers relative to their male contemporaries. This has existed for over a decade.

No immediate solutions to see here, just some questions to ask around sharing models and their readiness for the next, diverse generation of partners.

In the past homogeneity among partners, for better or worse, made equal sharing work. I might be wrong, but I don’t think that equal sharing for perceived equal contribution is going to cut it among the next generation of partners.

While the number of performance-based sharers, seeking to reward on the basis of personal effort and results, has significantly increased, many of these firms apply performance measures ‘at the margins,’ with 80% of partners clustering around a new ‘equality’. The top 10% are topped up and the bottom 10% bashed up. Origination credits have not been institutionalised in Australasia to the same extent they have been in North America, although that is beginning to change. ‘Performance’ often includes an assessment of subjective contribution but, by and large, usually comes down to ‘fees controlled’; an individual partner’s billings, their team’s (direct reports) billings and work introduced to other partners.

Law firms see themselves as meritocracies. We promote people to equity partnership and compensate them accordingly. I suspect that’s why law firm partnerships seldom resemble the diverse nature of the annual graduating class of lawyers. We’ve assumed ‘merit’ as a virtue axiomatically but what does it really mean? Judging by the overwhelming majority of equity partners, it means doing what all of the existing equity partners did, ‘performing’ and ‘contributing’ in the same (typically) full time manner. The individual sinks or swims on his or her own merits.

There is a growing scholarly literature around merit and diversity. I’ll develop this discussion in a future article. I would like here to concentrate on one of the root causes of partner homogeneity, traditional equal profit sharing.

Equal Profit Sharing

The underpinnings of equal or near-equal sharing are pretty obvious – portfolio theory (I’ll be up when you’re down and visa versa, hence risk-minimisation if we share equally over time), equal effort for equal return, and the greatest incentive to share clients and cross-refer. For these elements to coalesce in favour of success, partners need to contribute equally, for a long time and in similar ways. Merit becomes a convenient verb for describing what all of our full parity or equal sharing partners do, and the way that they do it. In other words, role-modelling the successful (white, middle-aged male) partners, building and serving a client base as they built and serviced ‘theirs,’ leads to career progression and ultimately partnership.

I regularly present in new partner programmes in Australia and New Zealand and I often hear aspiring associates and new non-equity partners talk of their frustration with attaining perceived equal or near-equal contribution. They speak of the covert guilt that accompanies part-time or flexible partnership, and the overt assumption among their fellow partners that any part-time arrangement is a temporary privilege. They speak of inequity in opportunity. Who gets mentored by and wins the favour and friendship of influential senior partners? Well, not surprisingly, people like them (the next batch of pretty similar men from a pretty similar background). It’s as though many female lawyers and those from minorities perceive themselves as working in a different and separate workplace under the same roof with those who more closely conform to the traditional ‘norm’.

Contributed Profit

Achieving a greater level of minority group representation at equity-partner level is a big and complex task, a task way beyond the scope of this brief article. There is however one thought balloon I’d like to float in the interest of greater gender equity among equity partners, and a better way of achieving inclusivity with a more diverse generation: share profits on the basis of contributed profit.

In a ‘contributed profit’ system, the profit of a partner includes that person’s billings, their team’s billings and fees referred to other partners, less the direct attributable cost. The partner with the highest profit contribution gets 100 points; others share proportionately. (Most firms can measure this accurately, smaller firms probably less so but it’s straightforward.) This would enable partners to enter much earlier. It would cater for part-time partners (if I can contribute more profit working three days a week than one of my full-time contemporaries, why should I earn less? Similarly, if I choose to work six days a week, why should I subsidise those on flexible arrangements?)

Profit-derived profit-sharing is educational. It encourages and rewards partners who structure their teams in the most profitable way. It also future-proofs the partnership. When the Millennial partners arrive in greater numbers they will want greater diversity and flexibility (and their Millennial clients will demand it through ‘socially responsible’ procurement processes). They will want (in some cases, perhaps expect) the prize sooner. In five years’ time, compensating partners on the basis of fees controlled and time spent in the office will seem so ‘yesterday’.

Sharing entirely on profit contributed would be pretty extreme and probably a little short-sighted. Firms need to invest in practice areas from time to time, new partners need to be encouraged and supported, there are pro bono considerations, and the list goes on. I am just suggesting that measuring profit contribution in the mix (instead of fees controlled) removes a significant block to greater gender and diversity diversity at partnership, and offers greater flexibility for all who want it.

A director of FMRC for 20 years, Edge Principal Neil Oakes, PhD assists law firms with strategy and profit growth, partner/director management and profit sharing, key talent management, management structures, and succession management consulting. He regularly conducts law firm planning retreats and helps large and small, private, corporate and government legal organizations to function optimally.

Equity: From Goodwill to No Goodwill

In recent years I have been engaged by a number of firms to change their equity arrangements and transition from a ‘goodwill firm’ to a ‘no goodwill firm.’

The push to make these changes usually arises from one of two managerial requirements, both of which are due to the success of the firm. The first reason is a desire to move to a differential profit share and the second is to make an equity stake in the firm more affordable for new partners.

Differential Profit Shares

I have long maintained that one of the strengths of smaller firms in Australia and New Zealand is that in most firms, all equity principals (new and existing) have an equal number of points, or are on a pathway to equality over a defined period of time. The rationale should probably be the subject of a separate article, but one benefit of equality in a smaller firm is that ‘performance’ can be measured on effort as opposed to revenue or profit, because not everyone can do the work that is profitable given the general nature of most of these practices.

I have worked with a number firms recently that have wanted to move away from equality to a differential profit share. (I should note that not all partners are keen on this idea for obvious reasons.)  The snag has been that these firms sold goodwill to incoming partners on the basis that it was an equal profit-share arrangement, and in many cases the most recent entrant paid the most and is now being subject to questions over contribution.

Moving toward a differential profit share without changing the equity admission and exit mechanics of the firm will result in years of unhappy partnership before the whole thing implodes.

Admitting New Partners

There are an increasing number of first-generation firms that have become so profitable or carry so much work-in-progress that it is not affordable for an employee to buy equity at fair market value. The equity partners in these firms are faced with a decision to either significantly discount a sale / purchase price, not sell any equity and drive the firm as hard as possible until the end then walk away, or change the equity structure to make it more affordable.

A Workable Solution

From an accounting perspective, removing goodwill from a firm can be relatively simple. Resistance to making a simple accounting change understandably comes from those who have paid goodwill either directly when buying in or via ‘sweat equity’ to establish the firm.

When advising firms that need to make the change, almost all can see the rationale and benefits that arise from bringing new partners into equity via a lockstep, as opposed to the sale and purchase of goodwill, but most struggle with working out how to extract their embedded value in the process.

Doing away with goodwill and transitioning to a lockstep firm will provide firms with the flexibility required to overcome many of their equity challenges. Broadly this will require:

  • The firm agreeing on the value of goodwill;
  • Borrowing a portion of that value and distributing to each partner according to their equity holding;
  • The balance of the goodwill being paid via a ‘superannuation’ fund or similar at an appropriate time.

The benefit of doing this is:

  • Compensation is no longer linked to Return on Investment;
  • You have flexibility to provide additional points to the absolute standout star performers (plus the capacity to take points away from the under-performers);
  • No one will be bound to stay in a poisoned relationship due to the financial handcuffs of their buy-in price and/or an onerous partnership agreement;
  • Partners are not obliged to keep someone they would rather not work with;
  • It is easier to admit new partners

The mindset of the incumbent equity partners is key to the success of such implementation. The above will involve some pain, and in the short term there will be some winners and losers. If you start the journey early enough, any short-term loss will be washed away by the longer-term gain. This will not work if the primary focus of any of partner is to win in the short term (or to ensure that someone else does not win).

I get a sense that we will be seeing more of these transitions occurring in the near future as the pace of succession in the law increases.

Edge Principal Sam Coupland is considered the foremost authority on law firm valuations in Australia, helping firms calculate accurate capitalization rates and assess their risk profile, cash flow and profitability. He is a frequent presenter on practice-management-related topics, delivering dynamic presentations to hundreds of lawyers every year in the areas of financial management, business development, succession planning, strategy, and people management.