Lateral hiring offers law firms the opportunity to bring in new clients and new revenue. However, with these potential rewards comes significant risks. Research has shown the costs to acquire a lateral candidate, along with their failure rates, to be very high.
Balancing the risks and potential rewards requires early planning, objective data and communication. Firms can improve their lateral hiring success if they consider the following factors before hiring a lateral candidate:
Title: What level is the lateral hire?
Senior laterals and solos who enjoy the Partner title in their current firm will want to keep that title unless they are trying to communicate that they are changing status. For example, Of Counsel may indicate a post partner relationship with the new firm. Often laterals will want a step up in title to move to a new firm. For example, a Senior Associate might want a Partner title.
Flexible compensation plans do not typically rely on a title to indicate compensation, but there are important marketing considerations. For example, many lawyers believe it is easier to get business when they present themselves as a partner. Additionally, it is generally negative when a title indicates a step back. For example, someone who holds themselves out as a partner before joining a new firm will likely have to explain a sudden change in title.
Sometimes title changes are unavoidable and necessary to maintain morale and fairness. It is best to deal with the title early in the process.
Compensation: How much to pay the lateral hire?
We frequently recommend a fee sharing approach when recruiting laterals with business. The fee sharing splits typically depend on a risk/reward approach and any overhead considerations.
For example, if a lateral requires an office, dedicated secretarial and/or administrative support, marketing dollars, and most other attendant benefits associated with a law firm, the level of sharing will have to consider the cost of these items.
Sometimes, it is appropriate to attribute overhead on a direct and indirect basis. The direct overhead typically includes direct secretarial/administrative support and benefits. The remainder of the overhead is typically apportioned to the lawyers on a predetermined basis. The simplest approach is to apportion the firm's total remaining expenses after direct allocations to each lawyer evenly (sometimes paralegals and other timekeepers receive overhead allocations, but we will leave them out for now).
Here is an example of an approach using direct and indirect costs.
Assume the following costs:
Legal Assistant $45,000 (assumption)
Benefits (20%) $ 9,000 (assumption)
Total Sal and Ben $ 54,000
Based on firm preference and strategic factors, marketing and other specifically identifiable costs are sometimes direct allocated.
Assume that all other non-direct expenses are $250,000 and there are 5 lawyers. Each lawyer's allocated overhead is $50,000 (250,000/5)
If this case, the total overhead allocated to the lateral is $104,000.
If your target lateral brings in $250,000 working attorney collections, the remaining amount for the lateral's compensation and contribution to firm profit is $146,000 (250,000-104,000).
Fee Share Compensation
A typical market deal is to pay a lawyer between 30 and 35% of all collections as a working attorney plus 15-20% of originated work. In this scenario, a lateral should expect to earn 45-55% of working attorney collections on files they originate. We recommend setting compensation ranges after considering overhead and target profit. Sometimes, however, it helps to pick a compensation range for the model and work backwards. Consider the following example.
- Total working attorney collections: 250,000
- Originated collections 200,000
- Collections on firm files 50,000
- Timekeeper pay range 33%
- Origination pay range 17%
Timekeeper fee share 33%
Timekeeper pay 82,500
Toni originated collections 200,000
Origination fee share 17%
Timekeeper originati 34,000
Total Pay 116,500
Assuming our lateral holds a K1 or 1099 status, there are no benefit costs. If our lateral is a W2 Employee, we would have to add 15% (=-) for benefit costs. For simplicity sake, let's assume K1 or 1099 status.
We are now in a position to determine if our proposed transaction is profitable.
Lateral working attorney collections:
Working attorney collections 250,000
Deduct Lateral's Earned Pay 116,500
Deduct Lateral's Direct OH 54,000
Deduct Lateral's Allocated OH 50,000
Firm's Profit 29,500
Percent Profit 11.8%
Most firms want to return at least a 20% profit (half of what they can earn from an associate but more than any partner leaves in) in these scenarios. Strategic factors may also influence the firm's minimum acceptable profit margin. For example, the firm and the lateral may see a mutually beneficial growth path related to their combination and forgo a level of profit or compensation. Because the recommended model fully costs compensation and overhead, it offers a level of protection to the firm.
It is not unusual for a solo practitioner to push back on sharing profit with the firm. After all, they are used to receiving 100% of their current profit. It is easier if the firm can demonstrate additional value from the association and providing the lateral with work is a popular incentive.
Bonus (sharing profit contributions)
It is important to provide incentives for hard work, origination and efficient expense management. Using a fully costed model allows a firm to calculate and share profits with We typically recommend that a firm start with this approach and when necessary or desirable, offer a bonus based on the bet profits with a lateral. We typically recommend two approaches to sharing profit. A percentage of the profit from dollar 1 and a higher percentage of the profit after a profit threshold is met. Profit sharing percentages and approach are typically different among firms and even between deals based on strategic factors.
Negotiating bonus percentages and thresholds (if applicable) is much easier if the firm has confidence in its cost model. Ensuring the model is accurate is essential to a good transaction. It is always risky when a firm tries to renegotiate a lateral deal after the fact.
The profit in our sample deal is only 29,500, which means the sharing percentages likely require adjustment.
If a lateral brings in work and gives it to one of the firm's lawyers, the origination piece (17% in our example) is applicable. For example, assume a lateral provided 50,000 in work to an associate in the firm. The lateral would receive 8,500 in additional compensation. Originated and delegated fees and related compensation are not considered in the bonus calculation.
Draw or Base Pay:
Laterals who are subject to fee sharing agreements forgo a base salary in exchange for the upside in earned compensation. Most laterals, however, need stable monthly cash flow. Law firms accommodate these needs by advancing money against anticipated future collections. These advances are also referred to as draws. It is important to set the draw at a level that works for the lateral but does not risk an overdraw.
An overdraft occurs when monthly advances exceed amounts earned under a fee sharing agreement. For example, let's assume that our sample laterals monthly draw is 7,000 and we reconcile quarterly. Assume our lateral is entitled to 19,000 for the quarter based on our fee sharing agreement. In this instance, an overdraw of 2,000 occurs (19,000 - 21,000 draw for the quarter) and no one is happy.
Alternatively, assume our lateral earned 30,000 under the fee share agreement. In this situation, the lateral is owed 9,000 (30,000-21,000 draw for the quarter) and everyone is happy.
Most firms will carry a small overdraw into a subsequent quarter and offset it against future amounts earned. Larger overdraws would require a reduction in future monthly draws until cured.
Needless to say, it is important to set the draw amount at a reasonable level because reducing future compensation is never easy and can cause tension in the relationship. We recommend setting draws at 60% of anticipated collections and making any necessary adjustments as soon as practicable.
When working with a lateral it is important to obtain enough information to adequately consider the following items:
- Fee sharing approaches include pay for working attorney collections, originations, and profit contributions. Accurate performance data are necessary.
- Set draw conservatively in the beginning and increase if warranted in future periods. Work this out with the lateral early in the process.
- Decide on an acceptable profit contribution from the lateral. It is important to consider objective and subjective factors.
- Run the profitability on any proposed deal before communicating compensation to the lateral.
- Ensure the firm prepares a cash flow model to ensure that it has enough capital to cover draws and increased overhead until the lateral bills and collects fees,
Remember not to justify any proposed deal on subjective factors only. It is not unusual for the parties in a lateral transaction to fall in love with the idea of success and disregard an objective analysis process.