12 Tips to Enhance Your Firm's Partner Compensation System

When making any changes to your firm's compensation system, it will be important to consider the entire package. Since the vast majority of changes that may be made to any compensation system will be interrelated. It is vitally important that partners understand the likely impact and potential ramifications of these changes when viewed as an integrated package. Unintended consequences affecting partner compensation may have devastating repercussions for a law firm.

Below are 12 tips I have recommended to many of our law firm clients to enhance their partner compensation systems. These include:

1. Generally, changes to any compensation system should be viewed more as evolutionary than revolutionary. The focus of every new compensation plan should be on business production, business origination, business retention, management, delegation and profitability. These are the major determining factors for ownership in many successful law firms.
2. Remember, you get what you pay for. Lawyer managers cannot move the firm in a different direction unless the compensation system goes in that direction too. So, a compensation system must have as its foundation the basic premise of what the firm is hoping to achieve. The factors that the compensation system emphasizes will become the emphasis of the firm, i.e. , business production, new business, hours, management, delegation, transition of clients, etc.
3. Reward partner contributions over a period of time rather than in a single year. Bonuses may be allocated to reward significant performance contributions for the current year. I generally recommend a three-year “look-back” when setting partners' draws. This will avoid making dramatic changes in partner compensation from year-to-year. Some firms that have implemented a three-year “look-back” have found that certain attorneys who have had exceptionally profitable years may work at a more leisurely pace for one or two years, depending upon the more profitable year to carry them. To keep all partners working hard, especially if certain individuals have had exceptionally profitable years, I recommend that the firm weigh the most current year more heavily than the prior two years. The benefit for such an approach would be to reduce any wide swings in partner compensation.
4. Allocating percentages prospectively rather than retrospectively. The advantages of this approach is the ability to establish compensation percentages at the beginning of the year so that increasing firm revenue and profit become the focus rather than working to garner a greater share by individual. Also, it often takes the focus off of one particular year and shifts the focus to trends in contribution over time.
5. Base salary usually serves as the backbone of a firm's compensation system. To manage the firm's available cash prudently, many firms have a salary/draw structure that includes the “hold-back” of a percentage of compensation (that will be distributed to the partners as cash flow permits.) This hold-back may be a set percentage for all partners, i.e. , all partners may receive 75% of their anticipated monthly draws. Or, partners earning higher draws may receive 70% of their anticipated monthly draws up to $150,000 and 65% of all amounts above.
6. Quarterly draws. It is the practice of many firms to distribute monies to partners quarterly, or as cash flow permits. Also, it is the practice of many firms to match their quarterly tax payment. I suggest tying the amount of quarterly tax distributions to base salary, since that forms the basis for the tax requirement. In large part, this is also a cash flow issue.
7. Tax draws should be relatively small. The expectation should be that there is sufficient cash flow generated by the firm's operations to meet the quarterly tax draw schedule. The firm should not be placed in a position where short-term bank borrowing will be required to meet salaries and quarterly tax draws. It is recommended that your firm should err on the side of conservatism when committing firm funds to be distributed to the partners.
8. Focusing on the importance of profitability as a key component of the compensation systems. Consider whether attorney profitability and client-matter profitability are important to the ongoing success of the firm. If so, they need to be a component of compensation. A key factor when assessing attorney profitability is to know how much it costs the firm to retain each attorney. Once this cost is known, the next challenge is to assess the objective and subjective contributions of each attorney to determine whether that attorney is covering his or her total maintenance expense. If the attorney is contributing marginally or not at all, lawyer management has to determine how to deal with that attorney.
9. Hand-in-hand with profitability is the generation of additional business. Again, how critical is the generation of additional business to the ongoing success of the firm? Many compensation plans over-emphasize revenue from personal production, not generation of new business or maintenance of existing business. The latter are two key components in compensation plans in virtually every successful firm.
10. Effective management is a key element in the success of every business. Somehow, that has to be rewarded. Yet, most firms struggle with how to reward partners for their role in management. Resist the urge to base the reward on the amount of time spent by each partner. Many firms attach a stipend to each management position. My recommendation is to reward effective management; it is key to the future success of every business.
11. Many firms adopt a compensation plan that rewards partners for their extraordinary performance during a particular year. They set aside a percentage of distributable dollars that will be allocated to those partners who have made extraordinary contributions to the firm.
12. Allocate overhead cost allocation to attorneys (and paralegals) proportionately. Determining the allocation of overhead is often a tricky proposition for many law firms. We suggest that the calculation be kept simple. Consider following these steps to determine a fair allocation of overhead: Determine the number of full-time equivalent lawyers and paralegals. This is a standard industry calculation. A full-time equivalent is determined based upon the number of months a “timekeeper” (attorney and paralegal) is employed by the firm. A timekeeper employed for four months counts as one-third full-time equivalent; a timekeeper employed for six months counts as one-half. Allocate salary, including quarterly bonus, plus a 20% benefits factor to every timekeeper. Many firms also add a “profit” factor to this equation for non-equity partners and associates. Take the remaining expenses and allocate those amounts to every timekeeper on the basis of their timekeeper classification and full-year equivalent. For allocation of general overhead, we will assume a factor of 1.40 for every partner, 1.00 for every associate and .40 for every paralegal. Based upon my experience, this approach will result in a fair allocation of overhead to every timekeeper.

The results of considering and incorporating these recommendations to enhance your firm's compensation system should result in fair compensation to the partners, when viewed over time. In any one year, there could be some anomalies; however a longer-term view is more appropriate.

Joel A. Rose, a member of this newsletter's Board of Editors, is a certified management consultant and president of Joel A. Rose & Associates, Inc., Management Consultants to Law Offices (www.joelarose.com), in Cherry Hill, NJ. He has extensive experience consulting with private law firms, and performs and directs consulting assignments in law firm management and organization, strategic and financial planning, lawyer compensation, mergers and acquisitions, and legal services marketing. He also plans and conducts retreats, and has special expertise resolving problems within firms. Rose may be contacted at 856-427-0050 and [email protected].

There are numerous characteristics that account for compensation systems that are perceived by partners as being fair and equitable. These include the system itself and how the system is administered. Below is a list of compensation criteria that are considered by most firms when setting partner compensation.

1. Production. The commitment of time to client matters as well as the valuable commitment of non-chargeable time in areas such a business development and marketing, management, training, etc.
2. Billings and Collections.
3. Business generation from new and existing clients.
4. Business development and marketing. This includes being active outside the firm in pursuing opportunities to attract business and enhance the firm's reputation.
5. Leverage. This includes delegating work to others and supervising that work.
6. Profitable work. Partners should have an obligation to pay attention to the relative profitability of the types of work being handled.
7. Training and supervision of others in the handling of client matters.
8. Firm management and office/practice management.

Compensation Enhancement Tips

As a management consultant to law firms, it is my belief that the key in designing any compensation system is to develop an understanding of the firm's vision and direction.

A well-designed compensation plan becomes one of many tools a firm can use to help reach its strategic goals. There are a number of other variables that partners should consider before “tweaking” their firm's compensation system. This will require the firm to move forward cautiously when considering many of these variables. There may be long-term and/or short-term consequences associated with incorporating any “tweaks.”

When making any changes to your firm's compensation system, it will be important to consider the entire package. Since the vast majority of changes that may be made to any compensation system will be interrelated. It is vitally important that partners understand the likely impact and potential ramifications of these changes when viewed as an integrated package. Unintended consequences affecting partner compensation may have devastating repercussions for a law firm.

Below are 12 tips I have recommended to many of our law firm clients to enhance their partner compensation systems. These include:

1. Generally, changes to any compensation system should be viewed more as evolutionary than revolutionary. The focus of every new compensation plan should be on business production, business origination, business retention, management, delegation and profitability. These are the major determining factors for ownership in many successful law firms.
2. Remember, you get what you pay for. Lawyer managers cannot move the firm in a different direction unless the compensation system goes in that direction too. So, a compensation system must have as its foundation the basic premise of what the firm is hoping to achieve. The factors that the compensation system emphasizes will become the emphasis of the firm, i.e. , business production, new business, hours, management, delegation, transition of clients, etc.
3. Reward partner contributions over a period of time rather than in a single year. Bonuses may be allocated to reward significant performance contributions for the current year. I generally recommend a three-year “look-back” when setting partners' draws. This will avoid making dramatic changes in partner compensation from year-to-year. Some firms that have implemented a three-year “look-back” have found that certain attorneys who have had exceptionally profitable years may work at a more leisurely pace for one or two years, depending upon the more profitable year to carry them. To keep all partners working hard, especially if certain individuals have had exceptionally profitable years, I recommend that the firm weigh the most current year more heavily than the prior two years. The benefit for such an approach would be to reduce any wide swings in partner compensation.
4. Allocating percentages prospectively rather than retrospectively. The advantages of this approach is the ability to establish compensation percentages at the beginning of the year so that increasing firm revenue and profit become the focus rather than working to garner a greater share by individual. Also, it often takes the focus off of one particular year and shifts the focus to trends in contribution over time.
5. Base salary usually serves as the backbone of a firm's compensation system. To manage the firm's available cash prudently, many firms have a salary/draw structure that includes the “hold-back” of a percentage of compensation (that will be distributed to the partners as cash flow permits.) This hold-back may be a set percentage for all partners, i.e. , all partners may receive 75% of their anticipated monthly draws. Or, partners earning higher draws may receive 70% of their anticipated monthly draws up to $150,000 and 65% of all amounts above.
6. Quarterly draws. It is the practice of many firms to distribute monies to partners quarterly, or as cash flow permits. Also, it is the practice of many firms to match their quarterly tax payment. I suggest tying the amount of quarterly tax distributions to base salary, since that forms the basis for the tax requirement. In large part, this is also a cash flow issue.
7. Tax draws should be relatively small. The expectation should be that there is sufficient cash flow generated by the firm's operations to meet the quarterly tax draw schedule. The firm should not be placed in a position where short-term bank borrowing will be required to meet salaries and quarterly tax draws. It is recommended that your firm should err on the side of conservatism when committing firm funds to be distributed to the partners.
8. Focusing on the importance of profitability as a key component of the compensation systems. Consider whether attorney profitability and client-matter profitability are important to the ongoing success of the firm. If so, they need to be a component of compensation. A key factor when assessing attorney profitability is to know how much it costs the firm to retain each attorney. Once this cost is known, the next challenge is to assess the objective and subjective contributions of each attorney to determine whether that attorney is covering his or her total maintenance expense. If the attorney is contributing marginally or not at all, lawyer management has to determine how to deal with that attorney.
9. Hand-in-hand with profitability is the generation of additional business. Again, how critical is the generation of additional business to the ongoing success of the firm? Many compensation plans over-emphasize revenue from personal production, not generation of new business or maintenance of existing business. The latter are two key components in compensation plans in virtually every successful firm.
10. Effective management is a key element in the success of every business. Somehow, that has to be rewarded. Yet, most firms struggle with how to reward partners for their role in management. Resist the urge to base the reward on the amount of time spent by each partner. Many firms attach a stipend to each management position. My recommendation is to reward effective management; it is key to the future success of every business.
11. Many firms adopt a compensation plan that rewards partners for their extraordinary performance during a particular year. They set aside a percentage of distributable dollars that will be allocated to those partners who have made extraordinary contributions to the firm.
12. Allocate overhead cost allocation to attorneys (and paralegals) proportionately. Determining the allocation of overhead is often a tricky proposition for many law firms. We suggest that the calculation be kept simple. Consider following these steps to determine a fair allocation of overhead: Determine the number of full-time equivalent lawyers and paralegals. This is a standard industry calculation. A full-time equivalent is determined based upon the number of months a “timekeeper” (attorney and paralegal) is employed by the firm. A timekeeper employed for four months counts as one-third full-time equivalent; a timekeeper employed for six months counts as one-half. Allocate salary, including quarterly bonus, plus a 20% benefits factor to every timekeeper. Many firms also add a “profit” factor to this equation for non-equity partners and associates. Take the remaining expenses and allocate those amounts to every timekeeper on the basis of their timekeeper classification and full-year equivalent. For allocation of general overhead, we will assume a factor of 1.40 for every partner, 1.00 for every associate and .40 for every paralegal. Based upon my experience, this approach will result in a fair allocation of overhead to every timekeeper.

The results of considering and incorporating these recommendations to enhance your firm's compensation system should result in fair compensation to the partners, when viewed over time. In any one year, there could be some anomalies; however a longer-term view is more appropriate.

Joel A. Rose, a member of this newsletter's Board of Editors, is a certified management consultant and president of Joel A. Rose & Associates, Inc., Management Consultants to Law Offices (www.joelarose.com), in Cherry Hill, NJ. He has extensive experience consulting with private law firms, and performs and directs consulting assignments in law firm management and organization, strategic and financial planning, lawyer compensation, mergers and acquisitions, and legal services marketing. He also plans and conducts retreats, and has special expertise resolving problems within firms. Rose may be contacted at 856-427-0050 and [email protected].