December 14, 2006
Continuity or How Law Firms Acquire a Life of Their Own
One of the business rules I have lived by is the motto “Fix it before it breaks”.
It is an understanding that all things have a life cycle. If it exists, it is aging. It is wearing out. It is becoming obsolete. It is breaking. Change is constant. We either change up or natural forces change us down.
This past week, Bruce MacEwen posted an item on his blog Adam Smith, ESQ dealing with partner retirement, Mandatory Retirement” Idiocy or Atrocity? Also this week, The Wall Street Journal Online commented on a forthcoming study by two economists, James Rebitzer and Lowell Taylor, which delves into the predatory behavior behind the current “up or out” model of larger law firms.
To understand what is going on, one only has to understand the Life Cycle. The life of a law firm without a succession plan resembles the classic bell shaped curve.
It is created by the original partners. The firm then continues—prospering for a period of time. Eventually, as the productivity of the partners begins to decline, performance of the law firm turns downward. Finally the law firm goes out of existence with the retirement, disability, or death of the partners.
Law firms that succeed in taking on a life of their own have found a way to transition from one generation to the next. To understand such a law firm, visualize a series of life cycles as illustrated below:
The life of a continuing law firm is measured by its successful movement across the multiple life cycles of productive practicing partners and leaders. The point is that the continuing life of a firm depends on the hand off from one generation to the next. It is not surprising that Altman Weil’s survey disclosed that the majority of larger firms have a mandatory retirement age policy. While Bruce MacEwen correctly sees a tragic waste of accumulated wisdom in mandatory retirement policies, the naked-in and naked-out tradition of large firms coupled with their mandatory retirement age is an effective way to institutionalize law firm survival—placing it beyond the reach of politics and power.
From the standpoint that survival depends on the hand off from generation to generation, law firms are not unique. While mega law firms have found an answer through mandatory retirement, the corporate world’s answer has been independent ownership—i.e., shareholders. Shareholder interest supersedes “management’s interest” and that places shareholder interest and business survival as the primary objective of the business. On the other hand, a family-owned business does not have an independent ownership and faces the same problem as midsized law firm. Survival depends on having someone to hand the business off to and it depends on the existing owner/management wanting to hand the business off to that someone.
Of the two necessary ingredients, the available talent to accept the handoff and the current owner/management motivated to make the handoff , it is the latter that is most often missing in midsized firms. The old guys and girls need something to motivate their hand off of power and income other than just a philanthropic desire to help the newcomers. The person handing off something of value should receive something of value—they should be paid for the value of what they are turning over or “selling” to the newcomer. Unfortunately, law firms haven’t been able to figure out that part of the equation. Without any consistency, law firms apply a variety of approaches that involve continuing compensation to retiring partners for some limited period of time—origination credit being a favorite. Often, the burden of those unfunded liabilities has had the opposite effect from their intended purpose. The incoming generation would rather dissolve the firm and move across the hall than share their income with the retired partners.
What is missing among law firms that is present within the commercial world is a concept of ownership and transfer of the going-concern value of the business. The new generation should have to buy its way in and exiting partners should be able to sell their ownership shares back to remaining partners. For a “how to do it” approach, see the prior post “Law Firm Value, Partner compensation and Continuity”.
The alternative strategies for long term survival can be summed up as:
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Mandatory retirement usually coupled with a naked-in/naked-out tradition—the prevailing U.S. mega firm model among law firms
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Ownership independent of management and workers—the corporate model to which the UK appears to be moving
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Partner buy-in and buy-out agreements—the closely-held business model prevalent in the commercial business world
The alternative is either a law firm that fades away or one that survives for at least one more generation through an ugly or quiet revolution. We old guys leave one way or another. It needs to be by a win/win arrangement.
This overview should bring home to the existing generation of baby boomer partners the importance of continuity planning. The new guys and girls can go across the street to another firm or break away and start their own. The needs of the law firm’s clients will be met, no matter what happens to you or your law firm. There are always alternative law firms ready to serve. Continuity planning is most important to the entrenched partners. Without planning for the handoff to the next generation, it is the entrenched partners and their heirs who will lose the value of the legal service business they built (or improved) during their tenure.
Morepartnerincome.com is sponsored by Juris, Inc. For information about Juris® products and services for increasing law firm performance and partner income, go to www.Juris.com.
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Filed under Planning by Tom Collins