Selecting New Partners

Global Trends in Law Firm Compensation Structures. The survey results reveal that while there are as many law firm structures as there are DNA sequences, U.S. firms fall into two basic partnership compensation models: the performance-based model; and lockstep, and there also exists a hybrid of the two.

Performance-Based Partnership Model. Under the performance-based compensation model, which is generally associated with U.S. firms, profit share is determined by individual performance rather than seniority. Some performance-based partnerships look solely at collections when determining profit share; others develop complex formulae, which take into account individual billings, origination, overhead costs, realization rates and the like-others attempt to factor in non-financial contributions such as recruitment, training, management and strategic planning.

The performance-based model incentives maximum individual performance and facilitates retention of star performers but can sometimes lead to conflicts about origination, and can discourage cross-marketing and client sharing.

Lockstep Model. An alternative to the performance-based compensation model is the lockstep model. It is often associated with U.K. firms and large U.S. firms with institutional clients. Under this model, seniority determines profit share. For example, a firm may have a 10-year lockstep where partners start with 20 points upon appointment, and receive two more points annually until they reach the top of the lockstep at, say 40 points. Once they reach 40 points, their share decreases annually until retirement age. The value of one point varies with firm profitability irrespective of individual performance.

Lockstep partnerships are often more cohesive than performance-based partnerships. They encourage cross-marketing and client sharing. The model seems to work best in large firms with institutional clients because partners are rewarded for servicing and retaining the business of existing clients, not just for bringing in new business. Profit distribution is simpler under a lockstep model than under a performance-based model but management is more complex. In particular, lockstep partnerships require rigid management to ensure that each partner “pulls his weight” and that underperformance is dealt with consistently. Some lockstep partnerships have “gates” at certain levels of the lockstep to encourage high performance and to avoid over-rewarding senior partners. (Some would consider a lockstep-based partnership with gates to be a hybrid or modified lockstep.) Only high performers may pass through these gates and rise to the highest levels of the lockstep and then only upon a positive vote from the partnership. The voting process can be long and time-consuming, not unlike in major political parties, where it can take months for partners to generate enough support to reach the next level.

Hybrid Model or Modified Lockstep Model. Some firms deliberately adopted a hybrid of the performance-based and lockstep models upon formation. Other firms have blended the performance-based and lockstep compensation models as a result of a merger. Many believe that this hybrid or “modified lockstep” model is the ideal partner compensation model because it applies the best aspects of performance-based and lockstep models. Partners receive part of their income in accordance with seniority and the rest through performance-based distributions or bonus. For example, one firm distributes 80% of its profits in accordance with lockstep and holds 20% back in a “bonus pool,” which it distributes in accordance with each partner's performance. Some partners may receive no bonus at all while others may receive a bonus that is two or three times as much as their lockstep distribution. Some law firms calculate only junior partners' compensation on a lockstep basis, shifting to a partial or entirely performance-based calculation after partners have had a few years to develop their practices.

Trends Specific to Survey Questions

Partner Compensation

• Large firms with institutional client bases are more likely to be lockstep than other U.S. firms.
• Where law firms apply a performance-based compensation approach, compensation is generally decided by a compensation committee, taking into account each partner's originations, personal and team or practice group billings and, to a lesser extent, non-financial contributions such as training or mentoring, marketing (even if not reflected in originations, administration or management).
• Bonus pools are most prevalent in law firms with modified lockstep compensation structures.

Tiers of Partnership

Most firms have two tiers of partnership, equity and non-equity. Further research outside the survey showed the following:

• Approximately 70% of the 2002 AmLaw 100 (America's highest grossing law firms in 2002) had two partnership tiers, and 60% of the 200 highest grossing firms. (The American Lawyer, AmLaw 100, July 2003 issue.)
• Eight of the 10 most profitable U.S. law firms in 2002 had only one partnership tier. Ibid.
• U.S. firms began to introduce a non-equity partner tier in the early to mid-1980s. (Giuliani, P., “Amending Traditional Partnerships: Two-Tiered System Offers Associates Alternative Path”, The American Lawyer, May 1990.)
• A late 1980s survey found that approximately 50% of all U.S. firms with more than 75 lawyers had two partnership tiers. Ibid.
• In 1990, two-tiered partnerships were more common in Chicago and Boston than in New York and California. (From a poll cited in Robert I. Weil, Ward A. Bower and Paul Roy, “Paying Partners and Stockholders: A Multi-Faceted Decision”, Legal Economics (ABA), March 1987.)
• The titles “Of Counsel,” “Special Counsel” or “Senior Counsel” are used as a catch-all category for: a holding place for senior associates expected to make partner when economics are right; someone who has either not been selected for partnership or has chosen not to be on the partnership track where the firm and the individual mutually agree that the associate may remain; and retired partners.

Length of Partnership Track

• Partnership tracks are generally longer at international firms, from eight to 10 years, than at national, regional, local and boutique firms.
• Non-equity partner tracks have decreased by one or two years at international and regional firms in the U.S. in the last five years.
• Equity partner tracks have increased by 2 or 3 years at international and regional firms in the U.S. over the last 5 years. While some firms were willing to promote superstars earlier than specified by the partner track in the 1990s, such instances have all but vanished today.

Factors in Deciding Partnership Appointments

The four most important factors taken into account when selecting partners are:

• overall performance/legal skills;
• assessment of attorney's capacity or potential to generate business;
• cultural fit/leadership; and
• practice area.

These results are not affected by partnership type (international, national, etc.) or by the partnership model (lockstep, performance-based or hybrid). The importance of practice area is easy to identify by looking at the reduction in corporate partner appointments in 2001, 2002 and 2003.

• Contrary to expectations, partnerships with performance-based compensation systems are no more likely to consider book of business or an associate's ability to develop business when selecting partners than law firms with lockstep compensation systems. The issue here is not compensation model but law firm size and whether or not the firm's client base is institutional. Where the client base is institutional, firms look at whether or not clients seek out and rely regularly on a particular associate as a way of assessing that associate's ability to attract business. There was one instance where the partners of a large Wall Street firm took executives from their major institutional client out to lunch and asked for their recommendation on which corporate finance associate to appoint out of the three who are currently up for partnership.
• The least important factor in selecting partners is longevity. Like quality of work and quantity of work (high billable hours), longevity is a threshold factor; attorneys are not considered for partnership unless they are senior enough.

Comparison of Internal and Lateral Partner Selection Policies

As recruiters, we found some glaring differences between internal and lateral partner selection that are worthy of discussion:

• P-P-P. The three Ps of lateral partner selection are: profits, profits and profits. Most firms achieve significant growth by acquiring revenues in the form of a partner's or group's practice. Accordingly, the acquiring firm's initial focus in most instances is on assessing the book of business, the portability of the book (clients' willingness to follow) and the quality of the partner's relationships. Conversely, all firms that responded to our survey cited overall performance, interpersonal skills and cultural fit as the critical factors in determining whether a partner is eligible for partnership.
• Client Skills v. Clients: A U.S. law firm will rarely consider hiring a lateral partner without a significant book of business. Those same firms, however, regard their associates' ability to maintain and grow the firm's institutional clients' business as one of the most important factors in determining whether the associate is partnership-worthy.

Preparing Associates for Partnership

• The top Wall Street firms generally address partnership with seventh year associates in preparation for appointment at eighth to 10th year whereas the leading Californian firms discuss partnership with associates in their fifth or sixth year.
• Business development is a component of general training at the associate level at most firms with the clear exception of most first tier Wall Street firms.
• Some large firms indicated that they preferred that their associates not generate business, as associate-generated business is typically low-margin, low billable rate work and takes the associate away from the work for the institutional clients.

The Selection Process

• No firm surveyed indicated an entirely “up-or-out” approach to partnership selection. However, some firms that claimed not to apply an “up-or-out” approach commented that they do sometimes ask associates to leave within a certain time period (usually 6-12 months) if they are not nominated for partnership. We regard this as “up-or-out.”
• In the vast majority of cases, nominations result in a positive partnership vote.
• Nomination is mostly by practice group head. In small firms, such nominations generally go straight to a vote, and partners are encouraged to review each candidate prior to consideration and vote.
• In large, international firms, initial nomination is generally by practice group head in each office. These nominations are then reviewed and refined by a special partnership committee or by the executive committee, and then go to a vote of the full partnership, which usually results in a positive vote.
• Partnership selection is one of the major reasons underlying law firms' decisions to introduce a non-equity partner tier. The introduction of that tier has allowed law firms more time to evaluate associates, particularly those who are not ready to go straight from associate to equity partner.

Conclusion

The survey results reveal the tough partnership policies and procedures of major U.S. law firms in 2002, and show how these firms have made it more difficult for associates to reach equity partner in the last couple of years. The picture may well be different in a few years time, since law firms evolve cyclically with the market.

From the establishment of the very first law firm, there has existed a tension between profitability, in particular profit distribution, and retention. The survey shows how today's law firms manage that tension, by developing policies to admit only those lawyers who will enhance profits without losing other lawyers in whom they have invested years of training and who have developed close relationships with key clients, but who are not partnership material. It also shows how globalization has increased that tension, necessitating growth through merger and lateral hiring in order for law firms to survive. As the market improves, law firms will probably relax their admission policies again and generally loosen their grip around the brass ring. It will be interesting to test that prediction when we repeat this process in a few years' time.

Over the past year and a half, the recession has sparked a dramatic rise in lateral partner moves as law firms have tried to expand active practice areas and partners have sought safety in ever-larger firms.

Major, Hagen & Africa conducted a proprietary survey of nearly 200 law firms worldwide with a particular focus on the United States. The survey sought to assess what factors are taken into account by law firms when selecting new partners and how partner selection is affected by size and structure. It focuses on:

• factors taken into account by law firms when deciding to appoint new partners
• different law firm models, including partnership tiers
• length of partnership track
• how and when law firms prepare associates for partnership
• the selection process

We surveyed international, national, regional, local and boutique law firms in several regions of the country, to examine differences among law firms.

Survey Results

Global Trends in Law Firm Compensation Structures. The survey results reveal that while there are as many law firm structures as there are DNA sequences, U.S. firms fall into two basic partnership compensation models: the performance-based model; and lockstep, and there also exists a hybrid of the two.

Performance-Based Partnership Model. Under the performance-based compensation model, which is generally associated with U.S. firms, profit share is determined by individual performance rather than seniority. Some performance-based partnerships look solely at collections when determining profit share; others develop complex formulae, which take into account individual billings, origination, overhead costs, realization rates and the like-others attempt to factor in non-financial contributions such as recruitment, training, management and strategic planning.

The performance-based model incentives maximum individual performance and facilitates retention of star performers but can sometimes lead to conflicts about origination, and can discourage cross-marketing and client sharing.

Lockstep Model. An alternative to the performance-based compensation model is the lockstep model. It is often associated with U.K. firms and large U.S. firms with institutional clients. Under this model, seniority determines profit share. For example, a firm may have a 10-year lockstep where partners start with 20 points upon appointment, and receive two more points annually until they reach the top of the lockstep at, say 40 points. Once they reach 40 points, their share decreases annually until retirement age. The value of one point varies with firm profitability irrespective of individual performance.

Lockstep partnerships are often more cohesive than performance-based partnerships. They encourage cross-marketing and client sharing. The model seems to work best in large firms with institutional clients because partners are rewarded for servicing and retaining the business of existing clients, not just for bringing in new business. Profit distribution is simpler under a lockstep model than under a performance-based model but management is more complex. In particular, lockstep partnerships require rigid management to ensure that each partner “pulls his weight” and that underperformance is dealt with consistently. Some lockstep partnerships have “gates” at certain levels of the lockstep to encourage high performance and to avoid over-rewarding senior partners. (Some would consider a lockstep-based partnership with gates to be a hybrid or modified lockstep.) Only high performers may pass through these gates and rise to the highest levels of the lockstep and then only upon a positive vote from the partnership. The voting process can be long and time-consuming, not unlike in major political parties, where it can take months for partners to generate enough support to reach the next level.

Hybrid Model or Modified Lockstep Model. Some firms deliberately adopted a hybrid of the performance-based and lockstep models upon formation. Other firms have blended the performance-based and lockstep compensation models as a result of a merger. Many believe that this hybrid or “modified lockstep” model is the ideal partner compensation model because it applies the best aspects of performance-based and lockstep models. Partners receive part of their income in accordance with seniority and the rest through performance-based distributions or bonus. For example, one firm distributes 80% of its profits in accordance with lockstep and holds 20% back in a “bonus pool,” which it distributes in accordance with each partner's performance. Some partners may receive no bonus at all while others may receive a bonus that is two or three times as much as their lockstep distribution. Some law firms calculate only junior partners' compensation on a lockstep basis, shifting to a partial or entirely performance-based calculation after partners have had a few years to develop their practices.

Trends Specific to Survey Questions

Partner Compensation

• Large firms with institutional client bases are more likely to be lockstep than other U.S. firms.
• Where law firms apply a performance-based compensation approach, compensation is generally decided by a compensation committee, taking into account each partner's originations, personal and team or practice group billings and, to a lesser extent, non-financial contributions such as training or mentoring, marketing (even if not reflected in originations, administration or management).
• Bonus pools are most prevalent in law firms with modified lockstep compensation structures.

Tiers of Partnership

Most firms have two tiers of partnership, equity and non-equity. Further research outside the survey showed the following:

• Approximately 70% of the 2002 AmLaw 100 (America's highest grossing law firms in 2002) had two partnership tiers, and 60% of the 200 highest grossing firms. (The American Lawyer, AmLaw 100, July 2003 issue.)
• Eight of the 10 most profitable U.S. law firms in 2002 had only one partnership tier. Ibid.
• U.S. firms began to introduce a non-equity partner tier in the early to mid-1980s. (Giuliani, P., “Amending Traditional Partnerships: Two-Tiered System Offers Associates Alternative Path”, The American Lawyer, May 1990.)
• A late 1980s survey found that approximately 50% of all U.S. firms with more than 75 lawyers had two partnership tiers. Ibid.
• In 1990, two-tiered partnerships were more common in Chicago and Boston than in New York and California. (From a poll cited in Robert I. Weil, Ward A. Bower and Paul Roy, “Paying Partners and Stockholders: A Multi-Faceted Decision”, Legal Economics (ABA), March 1987.)
• The titles “Of Counsel,” “Special Counsel” or “Senior Counsel” are used as a catch-all category for: a holding place for senior associates expected to make partner when economics are right; someone who has either not been selected for partnership or has chosen not to be on the partnership track where the firm and the individual mutually agree that the associate may remain; and retired partners.

Length of Partnership Track

• Partnership tracks are generally longer at international firms, from eight to 10 years, than at national, regional, local and boutique firms.
• Non-equity partner tracks have decreased by one or two years at international and regional firms in the U.S. in the last five years.
• Equity partner tracks have increased by 2 or 3 years at international and regional firms in the U.S. over the last 5 years. While some firms were willing to promote superstars earlier than specified by the partner track in the 1990s, such instances have all but vanished today.

Factors in Deciding Partnership Appointments

The four most important factors taken into account when selecting partners are:

• overall performance/legal skills;
• assessment of attorney's capacity or potential to generate business;
• cultural fit/leadership; and
• practice area.

These results are not affected by partnership type (international, national, etc.) or by the partnership model (lockstep, performance-based or hybrid). The importance of practice area is easy to identify by looking at the reduction in corporate partner appointments in 2001, 2002 and 2003.

• Contrary to expectations, partnerships with performance-based compensation systems are no more likely to consider book of business or an associate's ability to develop business when selecting partners than law firms with lockstep compensation systems. The issue here is not compensation model but law firm size and whether or not the firm's client base is institutional. Where the client base is institutional, firms look at whether or not clients seek out and rely regularly on a particular associate as a way of assessing that associate's ability to attract business. There was one instance where the partners of a large Wall Street firm took executives from their major institutional client out to lunch and asked for their recommendation on which corporate finance associate to appoint out of the three who are currently up for partnership.
• The least important factor in selecting partners is longevity. Like quality of work and quantity of work (high billable hours), longevity is a threshold factor; attorneys are not considered for partnership unless they are senior enough.

Comparison of Internal and Lateral Partner Selection Policies

As recruiters, we found some glaring differences between internal and lateral partner selection that are worthy of discussion:

• P-P-P. The three Ps of lateral partner selection are: profits, profits and profits. Most firms achieve significant growth by acquiring revenues in the form of a partner's or group's practice. Accordingly, the acquiring firm's initial focus in most instances is on assessing the book of business, the portability of the book (clients' willingness to follow) and the quality of the partner's relationships. Conversely, all firms that responded to our survey cited overall performance, interpersonal skills and cultural fit as the critical factors in determining whether a partner is eligible for partnership.
• Client Skills v. Clients: A U.S. law firm will rarely consider hiring a lateral partner without a significant book of business. Those same firms, however, regard their associates' ability to maintain and grow the firm's institutional clients' business as one of the most important factors in determining whether the associate is partnership-worthy.

Preparing Associates for Partnership

• The top Wall Street firms generally address partnership with seventh year associates in preparation for appointment at eighth to 10th year whereas the leading Californian firms discuss partnership with associates in their fifth or sixth year.
• Business development is a component of general training at the associate level at most firms with the clear exception of most first tier Wall Street firms.
• Some large firms indicated that they preferred that their associates not generate business, as associate-generated business is typically low-margin, low billable rate work and takes the associate away from the work for the institutional clients.

The Selection Process

• No firm surveyed indicated an entirely “up-or-out” approach to partnership selection. However, some firms that claimed not to apply an “up-or-out” approach commented that they do sometimes ask associates to leave within a certain time period (usually 6-12 months) if they are not nominated for partnership. We regard this as “up-or-out.”
• In the vast majority of cases, nominations result in a positive partnership vote.
• Nomination is mostly by practice group head. In small firms, such nominations generally go straight to a vote, and partners are encouraged to review each candidate prior to consideration and vote.
• In large, international firms, initial nomination is generally by practice group head in each office. These nominations are then reviewed and refined by a special partnership committee or by the executive committee, and then go to a vote of the full partnership, which usually results in a positive vote.
• Partnership selection is one of the major reasons underlying law firms' decisions to introduce a non-equity partner tier. The introduction of that tier has allowed law firms more time to evaluate associates, particularly those who are not ready to go straight from associate to equity partner.

Conclusion

The survey results reveal the tough partnership policies and procedures of major U.S. law firms in 2002, and show how these firms have made it more difficult for associates to reach equity partner in the last couple of years. The picture may well be different in a few years time, since law firms evolve cyclically with the market.

From the establishment of the very first law firm, there has existed a tension between profitability, in particular profit distribution, and retention. The survey shows how today's law firms manage that tension, by developing policies to admit only those lawyers who will enhance profits without losing other lawyers in whom they have invested years of training and who have developed close relationships with key clients, but who are not partnership material. It also shows how globalization has increased that tension, necessitating growth through merger and lateral hiring in order for law firms to survive. As the market improves, law firms will probably relax their admission policies again and generally loosen their grip around the brass ring. It will be interesting to test that prediction when we repeat this process in a few years' time.