Recognizing the Essence of Small and Mid-sized Law Firm Compensation

There are a lot of small and mid-sized law firms that rely on relatively few clients.  These client relationships are typically consolidated among an even smaller subset of top performing lawyers. It is not unusual for us to  encounter a firm of twenty lawyers serving less than 20 or 30 clients that are managed by three or four partners. We have also worked with firms of more than 50 lawyers working for 6 or 7 groups of clients controlled by as many partners. In these instances, the loss of a client or a partner is potentially a destabilizing event.

Compensation Challenges

Compensation in these environments can present real challenges. Many of these firms, despite their longevity and history, are one or two client losses away from instability. This insecurity can permeate the thinking of law firm partners, causing them to have a short-term approach to organizational development and compensation.

Dominant Instincts

The dominant instincts present in many of the top performers in these firms include the following:

• Business development is a priority;
• Business development carries the highest reward;
• Personal billable contributions are important but secondary to attracting new work;
• Attorneys must maximize compensation while they have the clients;
• Disruptions in client relationships can cause more stress than the legal work;
• Others don’t appreciate the effort it takes to develop, keep and grow a client base;
• As attorneys, we feel threatened all the time; and
• With so many incomes reliant on relatively few books of business, it is difficult to relax.

Top Performer Power

As a means of survival, a firm’s culture often bends around the immediate needs of a small but powerful group. As a result, unintended consequences can occur. For example, top performers may appreciate that another partner is succeeding, and even might take less short-term compensation to support their growth, but also might not like the potential shift in the future balance of power.

Small entrepreneurial firms that were created by a few high energy producers can pay better than market compensation for many years. By staying lean and making only long-term investments that support the practices of the top performers, these firms can generate high profits. Managed properly, the partners in these firms can amass a nice retirement, and some even become wealthy. In many ways, partners in these firms accomplished what they set out to do when they took the risk of starting the firm.

Law Firm Transition Process

At some point, however, small firm partners reach retirement age or their practice starts to diminish and many begin to focus on transitioning the firm or creating a more viable institution. Because of their immediate profit generation focus, these firms generally do not have the infrastructure or the necessary junior partners who are capable of perpetuating the firm.  And when there is a transition path, splitting the origination portion of the compensation pool becomes a challenge. If the compensations issues are not addressed, any attempt to transition or transform a firm may be derailed. 

Forward-thinking partners start the transition or transformation processes well in advance of retirement or foreseeable client losses. A transformation process starts when the current partners who make up the power structure of the firm desire to change or transform the firm’s strategic vision and operating model. Since most clients buy first from lawyers and then from firms, it is easy to understand why most  firms find it difficult to transform from a collection of individuals to a branded offering . Most successful small and mid-sized firms focus compensation on keeping originators happy first, followed by high producing lawyers and those with unique skills sets, with everyone else falling to the third tier.

Stability Factors

Organizational development that includes advanced compensation concepts comes from stability.  This requires time and means that high producers must embrace the transformation. A firm can find itself in between what is good for current profits and what is best for the long term. Highly productive partners (enabling partners) are called on to invest more income into a strategic initiative than under-performing or new partners. As the new partners or previously under-performing partners become more successful and demand more in the compensation formula, the enabling partners’ incomes can decline, and their prior strategic investments of current income are potentially lost forever.

Analysis and Tools

One way to deal with this is to use a rolling average of results in the compensation formula. For example, a firm that uses a 3-year rolling average of results can allow productive partners to participate in the future uptick in earnings resulting from a successful strategic plan implementation. Some of our clients refer to this as a “slow up/slow down” approach. Theslow up/slow down approach is not without issues. Declining partners can “hide” in the formula for a couple of years. While these declining partners deferred income in previous years, it often creates tension when nonperforming partners draw a disproportionate share of current year earnings.

Recognition of where a firm is in their life cycle is also essential. A compensation plan for a young firm that has not fully passed through their start-up phase is likely to differ from a firm that is approaching the transition stage. In our experience, there are several best practices that support stability at all stages, but variations of the application of these best practices is often required. For example, moving from a one-year results approach to a rolling two or three-year results approach.  Another example includes the level of profits apportioned to objective, equity, and subjective pools.

Putting It All Together

Properly designing and administering small and mid-sized law firm compensation systems requires a process-oriented approach, experience, analysis and tools, and an understanding of the factors that contribute to stability. A sense of the firm’s economic, political, and market factors contributes to the development of an effective compensation plan. The capability, capacity and commitment of the firm’s revenue-generating staff to achieve strategic goals and produce a market competitive profit are equally important.