Best Practice Tips: When Should a Law Firm Partner Compensation System Be Changed?

Asked and Answered

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

Q.  I am a partner in a 14-attorney business litigation law firm in New Orleans. There are five partners in the firm. We are a first-generation firm and all five partners are the original founders. Each partner has equal ownership interests and is compensated based upon ownership points. While this approach to compensation worked for many years, this system is no longer working for us. Performance used to be pretty close but this is no longer the case. Your suggestions are welcomed.

A. This is a common problem that new law firms eventually face. Here are a few thoughts:

• I think you need to have an open exchange about what kind of firm you want to build and the commitments each of you are willing to make to achieve that. You need to decide what you consider to be contribution and value to the firm – working attorney fees generated, fees originated, responsible attorney fees, marketing, firm management, etc. If your commitments and performance are in general alignment – then maybe you should stay on the current split for a while longer. Another option would be to stay on the same split – but create a special bonus pool – say 25 percent of income that could be allocated on a discretionary basic for unusual accomplishments, etc. Of course, you would have to agree on who gets how much. Another option would be to have a base draw and then either a formula or discretionary bonus pool for distribution of the excess.
• The general trend in compensation systems in larger firms is toward a more subjective based system rather than formula. However, many smaller firms do still use objective or formula based systems.
• Over the past 30+ years I have seen just about every form of compensation system that there is – from “even steven” systems such as yours to “eat-what-you-kill”, other formula systems, profit center systems, objective systems, etc. No particular system is better than another system. It depends upon the firm – the culture – strategic goals – and the environment.
• If the system is working – sometimes it is better to leave it alone. There is nothing wrong with an “even steven” system as long as the contributions (fee generation, fee origination, firm management, and otherwise) made by both of you to the firm are perceived as equal. Frequently, partners start out making even contributions and down the road contributions change (often due to life or family changes) and are no longer in alignment.
• When perceived contributions get out of alignment partners are reluctant to have the candid discussions that need to occur as well as changes in the arrangement or compensation system. It could be the system – percentage interest is fine – but as contributions have changed the percentages need to change.
• Resist the temptation to look at financial contributions in a single year. Look longer term – say the past three years.
• Consider not just the compensation as to whether people are happy with what they are getting – but consider whether the system in encouraging the behaviors that you need to achieve firm goals? For example – management of the firm, marketing activities, mentoring and training associates and others in the firm, etc.

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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 and author of The Lawyers Guide to Succession Planning published by the ABA. 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.