Partner (Shareholder) Compensation
The financial principles you need to understand in order to reach your financial goals.
- Billing for Professional Fees, Disbursements and Other Expenses, ABA Comm on Ethics and Professional Responsibility, Formal Op. 93-379
- Ethics Tip: ABA Formal Opinion 93-379: Overhead and Billing for Disbursements, In-House Provision of Services and Tuna Fish Sandwiches
- Partner Compensation Plans: A Primer (by Joel Rose)
Cross references (essential reading):
- Policy excerpt: Terms of Employment—Performance Indicators & Rewards
- Policy excerpt: Terms of Employment—Salary Growth
- Policy: Hourly Billing Requirements
- Policy: Case Approval & Retainers
- Video: Billing 1: Hourly Billing: Introductory Concepts
- Video: Billing 2: Dangerous Billing Entries
- 2016 Partner Compensation Survey (Jeffrey A. Lowe)
- Partner Compensation Plans: A Primer (Joel A. Rose)
- Your Partner Compensation System Can Be Better: Here’s How (Aderant)
- Everything You Ever Wanted to Know about Law Firm Compensation Plans
- Top 3 Methods to Determine Compensation of Law Partners (Raza Hasan)
- How to Navigate the Complexities of Creating a Productivity-Based Compensation Model for Your Law Firm (CosmoLex)
- Partner Compensation Systems in Professional Service Firms (Michael Anderson, Edge International)
- Law Firm Management Concepts: Partner Compensation (Jan Sander, Perform Law)
- What are some formulas for calculating non-equity partner compensation in a small law firm (>10 lawyers)?
- New Data on Law Firm Partner Compensation (Above the Law)
This Policy will give you a detailed understanding of exactly how the Firm evaluates lawyers and and determines how they should be compensated. The philosophical approach we use, and the method of computing salaries for shareholders as well as associates is explained in detail below. This document will provide you with an X-ray view of the financial thinking we employ in determining how much money you can make as a shareholder. For guidance on how to become a shareholder, read the Policy excerpt: Qualifications for Employment—What It Takes To Become A Shareholder.
How Lawyers Are Compensated
There are lawyers who make less than $30,000 per year, and there are lawyers who earn far more than $1 million annually. What sets these lawyers apart? How does a lawyer go from being paid standard associate wages to becoming truly affluent? These are important issues for you to understand if you are in search of significant increases in your compensation. We will begin with a review of some basic principles of law office finance and accounting.
There are various paths that typically lead to a high income as a litigator. Most of these are easy to describe in general terms. None of these paths result in significant affluence as a function of the passage of time alone. Some involve a component of luck. For litigators, most of the roads to riches are based upon a variety of carefully developed skills, persistence, determination and good decision making regarding the way an attorney spends his or her time.
Before becoming a shareholder or partner in this or any other firm, salaried associates typically earn raises over time. These raises are sometimes tied to various objective and subjective factors: increasing billing; improved knowledge, skill and ability; greater efficiency; proven commitment to the organization. In some firms, modest raises are given annually in many organizations to keep pace with the rising cost-of-living.
Associates become accustomed to these models, while hoping to become a partner or shareholder in their firm, expecting that from such a promotion to become affluent. Shareholder status is not an automatic path to affluence, but it is a first step.
How To Get Rich As A Lawyer
Before we discuss the rest of the steps needed, consider the three most common ways lawyers become wealthy from practicing law:
- Own a significant share of equity in a successful firm;
- Generate substantial legal fees and retain a worthy portion of those fees; and/or
- Negotiate a large base salary.
So how do you do each of these things?
You’ve Become a Shareholder: What Comes Next?
You are likely reading this Policy because you have just become a shareholder and you want to know the formula for shareholder compensation, or because you expect to become a shareholder and want to know how shareholders are paid. In either case, what is driving your curiosity is likely the desire to learn how to reach a much higher level of compensation than associates are paid.
Implicit in this notion is that shareholders are paid differently than associates, which is true only partially true. There is no magic formula by which the transition to shareholder opens the door to wealth. The economics of law firm accounting govern the compensation of shareholders and associates alike.
The typical young associate in a law firm expects to someday make a great deal of money as a lawyer, but young lawyers often fail to realize that salary growth is directly tied to growth in his or her generated revenues, generated business and other value contributed to the firm. A lawyer who believes that they are entitled to ever-increasing salary merely by the passage of time fails to recognize the hard realities of business accounting.
Particularly in an hourly billing context, an attorney’s ability to generate ever-increasing revenues is limited to that attorney’s billable hours and that attorney’s hourly rate, and more importantly, that attorney’s ability to generate new business, as well as the value of that attorney’s other contributions to the Firm, which come in the form of leadership and supervision skills and other administrative contributions. For this reason, unless a lawyer drastically increases the rate that clients are willing to pay for his or her services or becomes adept at bringing in new business, the revenues associated with that lawyer’s efforts may grow somewhat, but eventually level off, while that person’s salary expectations fail to keep pace with his or her production.
Governing Financial Considerations
Consider the relationship between revenue and overhead (including salary, insurance, support costs and other items) depicted in terms of an individual lawyer’s profitability. This graph depicts what we have observed to be the typical salary expectations of a new lawyer (in red), plotted against that attorney’s likely ability to generate hourly income over time.
In the early stages of employment, the attorney’s compensation (salary, insurance and other benefits) add up to approximately one-third of what that lawyer generates in revenue, which is a nearly universal standard in professional service industries such as law, accounting and consulting. This differential leaves room for the Firm to cover overhead other than just the attorney’s salary, such as support personnel, insurance, office space, utilities, supplies, corporate tax and a myriad of other expenses, and still make a profit on that lawyer’s professional services.
If that lawyer were to triple her income without first generating significantly greater revenue for the firm, she would be about one fifth as profitable after four years, and after six years would become a financial drain on the firm.
The problem is worsened by the fact that the overhead associated with each lawyer goes up with time. Health benefits, malpractice coverage and other insurance costs are constantly increasing. Those growing overhead costs can consume what little profit may be represented on paper as the difference between what the lawyer generates and what the lawyer is paid.
The more revenue a lawyer generates and the more quality business a lawyer generates, the more the Firm can afford to pay him or her. The value generated by a lawyer in managing, supervising or administering Firm policy and procedure is also a significant indicator of a lawyer’s worth to the organization. Lawyers who press for ever-higher pay without generating additional value are working their way to the edge of a cliff, in the sense that they become identified as lawyers who should be replaced with more profitable candidates (either based upon lower pay or higher performance).
A lawyer who expects his compensation to rise faster than his generated revenues is actually expecting to become less and less profitable over time, while expecting to make more money over time, and enjoy ever-greater job security over time. This is not a realistic expectation.
The Source of Mismanaged Expectations
Before we delve into the specific mechanics of shareholder compensation in this organization, it is important to understand the psychological barriers that prevent these principles from empowering lawyers in their quest for financial growth.
Employment and shareholder status are the product of negotiated agreements. The wise lawyer must understand what actually increases his or her bargaining strength, and what happens when he or she fails to develop those elements as the basis for significantly greater compensation.
As mentioned above, some lawyers believe that large salaries are merely a function of time. One may obtain credit for time served as a criminal defendant, but not as a lawyer in an elite law firm, which uses a different compensation system than a correctional facility. This should come as no surprise, but we have often been confronted with the management problems that arise when a lawyer fails to realize that in a profit-based business, the word “entitlement” is reserved for top performers.
When time passes and large salaries do not follow, some lawyers blame their employer for failing to realize how intrinsically wonderful they are as people. They confuse self-worth with economic value in a business setting. The truth is this—if we could afford to pay people on the basis of their intrinsic value as people, everyone in the Firm would be making millions!
Lawyers have a lot more control than they may think when it comes to controlling their financial destinies. Our bonus plans can produce significant supplemental income even for junior associates. The Marketing Incentive Bonus Plan and the Hourly Production Bonus Plan can result in significant additional income for the lawyer who makes skillful and ethical use of them. We have had second-year associates earn more than $300,000 in a given year by generating highly profitable business while at the same time billing a lot of hours. When lawyers rarely qualify for either of these bonuses despite years of tenure here but nevertheless seek substantial additional compensation, we know we have a problem on our hands.
We have observed interesting psychological phenomena that emerges when lawyers lose faith in the notion that long tenure ensures high pay. Lawyers who do not understand how to generate significant business or revenues—above what they can generate only by performing the hourly work they are given—are often reluctant to confront the fact that this gap in their knowledge and skill is the reason they are not enjoying substantial financial growth. We have actually had lawyers demand raises on these grounds alone: (1) they have been here a long time (even though their revenues are flat); (2) they are having financial problems as a result of overspending on homes and lifestyle; and (3) the lawyer could easily find another job somewhere else.
Lawyers who perceive that they have reached their maximum salary potential often become disillusioned. Some of these lawyers engage in genuine soul-searching and figure out how to do what is necessary to reach higher economic strata. Others give in to disappointment and refuse to question whether their views about professional life are realistic. Out of frustration, fear or because of imagined justifications, lawyers in this latter category tend to “job-hop,” thinking that they can work their way up the compensation ladder by selling themselves as a “star player” to new firm after new firm, as though they were celebrity players in the NFL. Because some firms bill more per hour than others, this strategy might work once or twice as the associate moves from a less profitable firm to a more profitable firm, but the problem with this approach is that it is ultimately doomed to backfire because all it offers is a temporary escape from the financial realities that apply everywhere.
Firms that pay at the top of the scale for associates tend to grind associates into pulp, treating them as short-term replaceable commodities. The “end-game” of this strategy tends to be a path to career oblivion for most young lawyers.
A small number of firms pay associates more than $175,000 per year, but those firms usually have rigidly enforced annual billing requirements in excess of 2,000 hours. Those firms tend to be large, associate-heavy and charge very high hourly rates; they actually plan to take advantage of the “job-hopping” strategy of associates who will not be able to meet the requirements for partnership. They routinely replace associates who do not qualify for shareholder status within a particular period of time, asserting, “if you can’t make partner within six years, you are not the material we are looking for,” because these firms correctly perceive that the long-term low producer should be replaced as a matter of sound fiscal policy. “This is a for-profit business, not a home for wayward boys,” one prominent lawyer said at his firm’s annual partner banquet.
We concur with that sentiment to some degree. If we have one job slot to fill and must choose between a known lackluster performer who has been holding that position for some time and another person who might become a superstar, the mere chance of improved revenues outweighs the known deadbeat’s mediocre performance. Where we disagree with that sentiment is when we find that a lawyer’s long-term failure to generate quality business and high revenues can be remedied by additional training and counseling and we hold a high opinion of that lawyer based upon valuable contributions that are not directly tied to business and revenue generation.
Most firms have learned how to protect themselves from the unrealistic compensation expectations of young lawyers, while at the same time preying upon those hopes and dreams to create a more stable basis for partner compensation, inducing young lawyers to either burn themselves out OR do the kind of work that truly entitles them to be shareholders or partners. Those who make the grade live comfortably as highly compensated shareholders, not only on their own continually growing contributions, but also by living on the backs of the “disposable” associates who are worked to the bone until they burn out and are replaced. Associates who are unable to meet the criteria for shareholder status eventually fade away and are replaced with “fresh meat.”
Higher salaries, higher billable hour requirements and high turnover rates are what make this economic model work for most successful litigation firms. Lawyers who are not able to make the grade to achieve shareholder status are encouraged to “job-hop” themselves into an eventual “wood-chipper.” A young attorney can work himself or herself into a situation in which the only way to survive is to face the realities that once were easy to handle, but which become more and more untenable. Do not job-hop your way into a position from which the only means of survival is to achieve what you once thought you could never achieve. There is no easy way out.
Our Model and Standards
When a senior associate becomes a shareholder, it is normally the case that a small number of shares are gifted to that lawyer by the Firm without the attorney having to pay for them.