Non-Equity Partnerships Are on the Rise Again

Many changes continue to occur in the traditional partner/associate structure in law firms. Permanent associates, staff or contract attorneys, temporary attorneys, of counsel (in one form or another) and non-equity partners have been added to the mix.

Until 10 years ago, only about 50 U.S. firms had a non-equity partner tier. Furthermore, as many firms dropped the category each year as adopted it, so the number remained more or less constant. Since then, however, there has been a steady increase in the number of firms creating a tier of non-equity partners. Various sources report that most of the AmLaw 200 and at least 65% of the medium-sized firms now have a two-tier structure. Even smaller firms are following the trend. There are some with as few as 20 lawyers who have created a category of non-equity partner.

Why the Increase?

Until 2008, firms were creating the category of non-equity partner (NEP) for one or more of these reasons:

1. To lengthen the track to equity partnership in order to give younger lawyers more time to develop not only their legal skills, but also their business development and marketing skills.
2. To postpone the often difficult decision of who should be made a “full” partner.
3. To attempt to retain associates who may not, or will not, be elected equity partners and therefore might otherwise leave the firm.
4. To retain young lawyers who don't want to become partners because they don't want to assume the responsibilities, work the extra hours or invest the required capital. This is usually the result of their wanting a better “quality of life.”
5. To avoid slicing the profit pie into more pieces, particularly when firm profits are flat or have declined.

Then, as they were experiencing the impact of the recession, firms began to focus on “unproductive partners” whose billable hours and/or collections had declined. In some cases they have voted these lawyers out of the firm, and in other cases they have removed the partners' equity status and made them non-equity partners. The latter step has substantially increased the number of firms that have created a multi-tier structure.

Different Categories of NEP

There are two principal categories ' temporary and permanent. There are also variations.

Temporary

In firms where NEP status is defined as “temporary” or just an additional step to full partnership, associates (or laterals) are elected non-equity partners for a designated period, usually not more than three years and in some firms only two. All lawyers in this category are then considered for equity partnership because it is assumed that NEPs will eventually become equity partners. The additional time before reaching equity
status enables these lawyers to:

• Gain more legal experience;
• Gain more client service experience;
• Develop certain specific areas of expertise; and
• Become effective business developers.

This also gives the firm more time to evaluate them.

Some firms that have a temporary non-equity tier also provide for occasional exceptions so that a “fast-track” associate may bypass the non-equity tier and be elected directly to equity partnership. Some of these firms also allow associates to request temporary non-equity status because they wish to work part-time for a while (usually to start a family) and then return to full-time practice and continue on the track to equity partnership.

Permanent

In firms where the category is defined as, or intended to be, permanent, NEPs will generally not be considered for equity partnership ' although there can be exceptions. In order to retain these lawyers, the firm designates them as “partners” to the outside world without disclosing their non-equity status

This category of NEP has increased considerably since 2008 in those firms that have de-equitized partners. In the face of their lower status ' and reduced compensation (often substantial) ' the only consolation for these lawyers is that they are still designated as “partners” to the outside world as long as they remain with the firm.

Combination

Some firms combine both temporary and permanent NEPs in their non-equity tier. This gives the firm some flexibility in the case of a “permanent” NEP who may subsequently become a desirable candidate for equity partnership. It also gives NEPs who still want to become equity partners the possibility they will be considered at some point. However, NEPs who were de-equiized are permanent and remain in that category until they leave the firm or retire.

Therefore, non-equity partnership can now take the following forms:

• A temporary, extra step en route to equity partnership;
• A temporary, extra step that can be bypassed;
• A permanent, final step in lieu of, or in place of, equity partnership; or
• A step that can be either temporary or permanent, depending on the firm's evaluation of the lawyer or the lawyer's choice of lifestyle.

What Does NEP Mean?

Regardless of whether it is temporary or permanent, non-equity partnership generally involves the following:

• No capital contribution or buy-in. If the lawyer has been de-equitized, his or her capital is returned.
• Designation as a partner on the firm's website and in all firm directories and materials.
• Receiving all financial information.
• Voting on all matters except: 1) Compensation of equity partners; 2) Admission of lawyers to equity partnership; 3) Merger; 4) Dissolution of the firm; 5) In most firms, election of the Managing Partner or Executive Committee. However, NEPs who have been de-equitized often also lose all their voting rights.
• Serving on all committees except the XCom. Some firms, however, do provide one seat on the XCom for a non-equity partner with only the NEPs voting for that seat.
• Most NEPs are salaried. The salary is usually above that of senior associates but below that of the lowest equity partners.
• Most firms pay NEPs a bonus, based on firm profitability and the lawyer's performance. These firms usually designate a certain percentage of firm profits to be distributed among the NEPs.
• Advantages of Being an NEP
• There are many advantages of being a non-equity partner, although only one or two also apply to former equity partners:
• These lawyers are considered as full partners outside the firm.
• They are given additional time to develop before facing the possibility of not being elected to full (equity) partnership.
• Lawyers who would be considered for equity status but who wish to work part-time (for a few years or permanently) can still become partners.
• Lawyers who want to be part of the firm but do not wish to assume the financial obligation (or risk) and the time commitments required of equity partners, can still become partners.
• From the firm's perspective, it maintains or even increases traditional leverage because NEPs are not classified as partners in determining the leverage ratio.

Disadvantages

But there are also disadvantages. For instance, in firms where it is a permanent status, the principal disadvantage from the non-equity partners' perspective is that they may be considered by the rest of the firm ' or consider themselves ' as “second-class citizens.” This is particularly true in the case of lawyers who still want to become equity partners. In fact, some of these NEPs eventually leave the firm anyway if offered equity status in another firm. Also, the equity partners may only be postponing the time when they inform a lawyer that he or she will not become an equity partner.

Alternatives

Non-equity partnership is not the only alternative structure for a firm. There are others including:

• Extending the equity partnership track with no promises or commitments.
• Creating a permanent category of “senior associate,” “senior attorney,” “special counsel,” etc.
• Designatiing certain five- or six-year associates as “senior associates” and providing the opportunity for them to earn substantial bonuses. This usually indicates a strong commitment by the firm that these associates will become equity partners as soon as they have completed the firm's normal partnership track.
• Maintaining the historic “up or out” approach.

Conclusion

In each firm, the decision on whether or not to create a tier of non-equity partners ' temporary, permanent or both ' should be made in the context of several factors, including the competitive situation; the firm's financial performance; the equity partners' longer-term plans for the firm; and the desires and goals of the associates. As for the lawyers involved, the decision to accept or decline non-equity status may be based on several factors, including their age, income requirements and career objectives. It can be a difficult decision.

Robert Denney, a member of this newsletter's Board of Editors, is President of Robert Denney Associates, Inc., a firm that provides strategic management and marketing counsel to law firms throughout the U.S. and part of Canada. The firm's website is www.rboertdenney.com. Mr. Denney can be reached at 710-644-7020 or [email protected].

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Many changes continue to occur in the traditional partner/associate structure in law firms. Permanent associates, staff or contract attorneys, temporary attorneys, of counsel (in one form or another) and non-equity partners have been added to the mix.

Until 10 years ago, only about 50 U.S. firms had a non-equity partner tier. Furthermore, as many firms dropped the category each year as adopted it, so the number remained more or less constant. Since then, however, there has been a steady increase in the number of firms creating a tier of non-equity partners. Various sources report that most of the AmLaw 200 and at least 65% of the medium-sized firms now have a two-tier structure. Even smaller firms are following the trend. There are some with as few as 20 lawyers who have created a category of non-equity partner.

Why the Increase?

Until 2008, firms were creating the category of non-equity partner (NEP) for one or more of these reasons:

1. To lengthen the track to equity partnership in order to give younger lawyers more time to develop not only their legal skills, but also their business development and marketing skills.
2. To postpone the often difficult decision of who should be made a “full” partner.
3. To attempt to retain associates who may not, or will not, be elected equity partners and therefore might otherwise leave the firm.
4. To retain young lawyers who don't want to become partners because they don't want to assume the responsibilities, work the extra hours or invest the required capital. This is usually the result of their wanting a better “quality of life.”
5. To avoid slicing the profit pie into more pieces, particularly when firm profits are flat or have declined.

Then, as they were experiencing the impact of the recession, firms began to focus on “unproductive partners” whose billable hours and/or collections had declined. In some cases they have voted these lawyers out of the firm, and in other cases they have removed the partners' equity status and made them non-equity partners. The latter step has substantially increased the number of firms that have created a multi-tier structure.

Different Categories of NEP

There are two principal categories ' temporary and permanent. There are also variations.

Temporary

In firms where NEP status is defined as “temporary” or just an additional step to full partnership, associates (or laterals) are elected non-equity partners for a designated period, usually not more than three years and in some firms only two. All lawyers in this category are then considered for equity partnership because it is assumed that NEPs will eventually become equity partners. The additional time before reaching equity
status enables these lawyers to:

• Gain more legal experience;
• Gain more client service experience;
• Develop certain specific areas of expertise; and
• Become effective business developers.

This also gives the firm more time to evaluate them.

Some firms that have a temporary non-equity tier also provide for occasional exceptions so that a “fast-track” associate may bypass the non-equity tier and be elected directly to equity partnership. Some of these firms also allow associates to request temporary non-equity status because they wish to work part-time for a while (usually to start a family) and then return to full-time practice and continue on the track to equity partnership.

Permanent

In firms where the category is defined as, or intended to be, permanent, NEPs will generally not be considered for equity partnership ' although there can be exceptions. In order to retain these lawyers, the firm designates them as “partners” to the outside world without disclosing their non-equity status

This category of NEP has increased considerably since 2008 in those firms that have de-equitized partners. In the face of their lower status ' and reduced compensation (often substantial) ' the only consolation for these lawyers is that they are still designated as “partners” to the outside world as long as they remain with the firm.

Combination

Some firms combine both temporary and permanent NEPs in their non-equity tier. This gives the firm some flexibility in the case of a “permanent” NEP who may subsequently become a desirable candidate for equity partnership. It also gives NEPs who still want to become equity partners the possibility they will be considered at some point. However, NEPs who were de-equiized are permanent and remain in that category until they leave the firm or retire.

Therefore, non-equity partnership can now take the following forms:

• A temporary, extra step en route to equity partnership;
• A temporary, extra step that can be bypassed;
• A permanent, final step in lieu of, or in place of, equity partnership; or
• A step that can be either temporary or permanent, depending on the firm's evaluation of the lawyer or the lawyer's choice of lifestyle.

What Does NEP Mean?

Regardless of whether it is temporary or permanent, non-equity partnership generally involves the following:

• No capital contribution or buy-in. If the lawyer has been de-equitized, his or her capital is returned.
• Designation as a partner on the firm's website and in all firm directories and materials.
• Receiving all financial information.
• Voting on all matters except: 1) Compensation of equity partners; 2) Admission of lawyers to equity partnership; 3) Merger; 4) Dissolution of the firm; 5) In most firms, election of the Managing Partner or Executive Committee. However, NEPs who have been de-equitized often also lose all their voting rights.
• Serving on all committees except the XCom. Some firms, however, do provide one seat on the XCom for a non-equity partner with only the NEPs voting for that seat.
• Most NEPs are salaried. The salary is usually above that of senior associates but below that of the lowest equity partners.
• Most firms pay NEPs a bonus, based on firm profitability and the lawyer's performance. These firms usually designate a certain percentage of firm profits to be distributed among the NEPs.
• Advantages of Being an NEP
• There are many advantages of being a non-equity partner, although only one or two also apply to former equity partners:
• These lawyers are considered as full partners outside the firm.
• They are given additional time to develop before facing the possibility of not being elected to full (equity) partnership.
• Lawyers who would be considered for equity status but who wish to work part-time (for a few years or permanently) can still become partners.
• Lawyers who want to be part of the firm but do not wish to assume the financial obligation (or risk) and the time commitments required of equity partners, can still become partners.
• From the firm's perspective, it maintains or even increases traditional leverage because NEPs are not classified as partners in determining the leverage ratio.

Disadvantages

But there are also disadvantages. For instance, in firms where it is a permanent status, the principal disadvantage from the non-equity partners' perspective is that they may be considered by the rest of the firm ' or consider themselves ' as “second-class citizens.” This is particularly true in the case of lawyers who still want to become equity partners. In fact, some of these NEPs eventually leave the firm anyway if offered equity status in another firm. Also, the equity partners may only be postponing the time when they inform a lawyer that he or she will not become an equity partner.

Alternatives

Non-equity partnership is not the only alternative structure for a firm. There are others including:

• Extending the equity partnership track with no promises or commitments.
• Creating a permanent category of “senior associate,” “senior attorney,” “special counsel,” etc.
• Designatiing certain five- or six-year associates as “senior associates” and providing the opportunity for them to earn substantial bonuses. This usually indicates a strong commitment by the firm that these associates will become equity partners as soon as they have completed the firm's normal partnership track.
• Maintaining the historic “up or out” approach.

Conclusion

In each firm, the decision on whether or not to create a tier of non-equity partners ' temporary, permanent or both ' should be made in the context of several factors, including the competitive situation; the firm's financial performance; the equity partners' longer-term plans for the firm; and the desires and goals of the associates. As for the lawyers involved, the decision to accept or decline non-equity status may be based on several factors, including their age, income requirements and career objectives. It can be a difficult decision.

Robert Denney, a member of this newsletter's Board of Editors, is President of Robert Denney Associates, Inc., a firm that provides strategic management and marketing counsel to law firms throughout the U.S. and part of Canada. The firm's website is www.rboertdenney.com. Mr. Denney can be reached at 710-644-7020 or [email protected].

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