We have seen countless examples of firms who believe they can operate independently of the market. Maybe some can, but mostly, once a firm loses its edge, it is nearly impossible to get it back. Firm’s who lose their ability to compete often struggle to recognize they are failing. Without an objective process for measuring performance, a firm can fall into a cycle of poor decision making on emotion and insufficient information.
A market sensitive compensation plan (paying for contributed profits) is an essential part of maintaining a competitive firm. Any firm can enter a decline phase. Keeping and attracting top-performing lawyers and staff is the best way to ensure your firm does not suffer this fate. Objective performance measurement and reasoned judgment are the two most important tools.
A data-driven compensation plan that pays at market levels can reconcile the perceived and actual value of a lawyer's economic contributions. There is no better gauge of value than what a competent competitor will pay. Competent competitors include firms that have strong financial results, a successful track record, and a well-defined strategy.
Accomplishing this level of acceptance will remove a large obstacle inherent in the practice transition process. The primary tool for compensating at the market is a contributed profit analysis by originator with client and file level detail. The typical elements, policies and best practices of this system include:
- Origination sharing policies;
- Profitability by originator with client, file, and timekeeper detail;
- Overhead allocation policies;
- Maximum empowerment over directly allocated costs;
- Maximum empowerment over case staffing;
- Maximum empowerment over directly assigned marketing costs;
- Objective income pools of 80% + total firm income allocated using contributed profit;
- Compensation policies for administrative contributions: and
- Two-year rolling average contributed profit for income allocation.
Admittedly, these systems take time and effort to build, but experienced professional help and software are available. The resulting impact on profitability, firm competitiveness and attractiveness in the market can transform a struggling firm and elevate the success of high performing firms. Combining a market- based compensation system with a transition compensation feature and a process for the orderly transition of ownership interests will significantly increase a firm’s ability to pass from one generation to the next.
Other essential factors
Preserving the competitiveness of a law practice over an extended period also requires a consistent focus on several fundamentals including:
- Marketing effectiveness;
- Rates and realization;
- Billing and collection habits;
- Legal staffing and capacity;
- Training and leveraging contributions;
- Recruiting contributions;
- Attorney development;
- Client service metrics; and
- Client relationship fundamentals.
It is tough for busy lawyers to pay attention to all these factors and to manage client legal work. A good support system that includes planning tools, advice, and advanced reporting can help order priorities make staying competitive much easier.
Many partners report the work it takes to keep their practices fundamentally sound grows harder with time and success. At some point, partners must choose between continuing to invest time (something many feel they are running short of) into the long-term health of their practice and short-term profit maximization.
It is equally important to recognize that ceding client control, often necessary for keeping a practice healthy, happens on an individual lawyer basis and can often lead to adverse pay implications. Further, many lawyers also believe they have not received full compensation for their years of hard work and personal sacrifice. Together these factors can make the transition process exceedingly difficult for unprepared firms.
A transition plan can address the adverse short-term pay implications, but it is more difficult to value prior contributions and service. Firms who have employed a profit-based compensation system coupled with pay for administrative contributions typically have fully rewarded for prior contributions.
Firms who have heavily leaned on the profits of a few successful partners to survive have a much tougher time dealing with prior contributions and the transition process in general. In some instances, retiring partners are willing to forgo payments for prior service in the interest of perpetuating the firm, but many are not, which typically requires a negotiated solution facilitated by an objective party.
Firm valuation is a related topic that we will address in a later post.
Beyond transition issues
Often factors not directly related to the transitioning partners or their staffs can affect a firm's ability to focus on the necessary longer-term success of the firm. For example, savvy younger partners may come to realize their firm has no transition plans and leave for a better opportunity. Often the primary motivation for leaving is the reality that their earnings will erode due to an inevitable loss of business from aging senior partners.
Partners may also believe their current good fortune will not last forever and want to maximize their income during success periods. Compensation plans that are not responsive to profitability make the firm vulnerable to either losing successful partners or contributing to an atmosphere of declension.
Alternatively, partners incented to grow their practices can offset losses at the senior partner level. Market sensitive compensation can also make it easier to attract good fit laterals who can also offset losses in other areas.
Firms that focus on these key success factors, pay market rates, and pay attention to their fundamentals can significantly increase their chances of long-term success and avoiding a decline phase.