Best Practice: At what point does associate and non-equity partner compensation max out?
Asked and Answered
By John W. Olmstead, MBA, Ph.D, CMC
Q. I am the managing partner of a 16 attorney insurance defense law firm in Kansas City. We have two equity partners, four non-equity partners, and 10 associates. Only the two equity partners bring in client business. Since our clients are insurance companies, most of our work is new business from existing clients. Unlike other firms doing insurance defense work our billing rates are low and we have to put in a lot of billable hours and maintain a high ratio of associates and non-equity partners to equity partners.
In the past our associates stayed for a while and left after several years. By the time they reached the higher compensation levels they left and we replaced them with lower cost associates. In the last few years - with the economy and the oversupply of lawyers - they are staying much longer. We are concerned about our reducing profit margins and at what point an associate or non-equity partner's compensation is "maxed out." We would appreciate your thoughts.
A: Law firms of all types of practice are experiencing this dilemma. The problem is even more evident in insurance defense firms where much of the work is routine discovery work that can be handled as well by an attorney with two years' experience as by an attorney with 10 years' experience at lower cost. Here are a few thoughts:
1. Use the formula - 3 times salary as a general guide to determine where you are regarding working attorney fee production from each of your attorneys. If you are paying an associate or non-equity partner $100,000 a year salary you should be collecting $300,000. The goal is that 1/3 of each fee dollar goes to association of the attorney, 1/3 to overhead, and 1/3 to profit - for a 30% profit margin.
2. Dig into your financials and determine your contribution to profit from each of your attorneys. Allocate all direct expenses and indirect overhead and calculate profit margin. Click here for an illustration on how to allocate overhead
3. Profit margin should be between 25%-30%.
4. Use the margin to establish a theoretical salary limit in absence of other contributions such as management, client origination, additional business from existing clients, etc.
5. Consider capping salaries at the theoretical level with the exception of periodic cost of living adjustments.
6. Use a client or referral commission bonus, production/hours bonus, and bonus pools to reward exceptional performance.
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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.