Best Practice: Should capital contributions be required for new equity partners?

Asked and Answered

By John W. Olmstead, MBA, Ph.D, CMC

Q. I am the sole owner of a 25-attorney litigation boutique firm in Los Angeles. I am the only equity partner with nine non-equity partners and 15 associates. I am concerned that if I don't provide a path to equity partnership, some of my senior talent may gradually defect to other firms or split off to create their own firms. I also believe that providing a path to equity partner for deserving non-equity partners is the right thing to do. Therefore, I am planning on admitting two non-equity members this year. Should I require capital contributions?

A. I believe that all new partners should be expected to contribute capital and have some "skin in the game." Whenever a firm admits a new partner, the firm should require the new partner to contribute capital. Increasingly, a partner's capital requirement should bear a relationship to the partner's share of profits. You may want to allow new partners a reasonable period of time to fund their capital accounts - say one or two years via a capital note or help them arrange favorable terms at your bank to finance their capital accounts. Usually capital accounts are tied to working capital needed to operate the firm and the percentage of ownership/income that each partner will have.

Capital contributions are all over the board - ranging from zero to $100,000. In firm's your size I often see capital contributions ranging from $25,000 to $50,000.

There are only three ways to increase a firm's working capital to cover cash flow requirements and fund growth:

1. Have partners put more money in
2. Have partners take less money out
3. Borrow

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John W. Olmstead, MBA, Ph.D, CMC, (www.olmsteadassoc.com) is a past chair and member of the ISBA Standing Committee on Law Office Management and Economics. For more information on law office management please direct questions to the ISBA listserver, which John and other committee members review, or view archived copies of The Bottom Line Newsletters. Contact John at jolmstead@olmsteadassoc.com.