In an article for the upcoming issue of the National Law Journal  (NLJ) posted yesterday on their site, law firms are not taking their own advice when it comes to arbitration clauses in employment disputes.

Is this a case of what's good for the goose isn't good for the gander?  Why would arbitration be a good idea for other businesses but not good for law firms?  The answer brings into question the utility of arbitration. 

The arguments for arbitration come from those who have been burned in litigation.  Litigation can have you sitting in front of a jury that likely has no experience in the subject matter at hand and may in fact have motives other than the subject matter at hand to deliver a large award to a plaintiff.   Arbitrators, on the other hand, are picked from within the industry from which the dispute arises and ostensibly provide a more fair, though equally binding, resolution at less cost than litigation.  Where litigation can hinge on perception, arbitration decisions are meant to be grounded in experience-laden fact.

According to the NLJ story, however, only 10% of 200 law firm respondents to a 2003 survey had "mandatory arbitration in place".  I assume this means that equity partners were bound by it through the partner agreement and that other employees were bound by it as a condition of employment, though it isn't specified in the article.  One reason cited is that arbitration clauses may have a detrimental effect on the workplace.  Said a partner with DLA Piper, "Your attorneys can perceive that you are materially changing their position vis-a-vis the firm and attempting to circumscribe the rights they might otherwise have."

I believe that statement holds true to any situation where arbitration exists, not just when applicable to law firms.  Any other reason to not have them?  The article paraphrased a partner in the New York office of Greenberg Traurig, writing "Arbitration [] no longer offers the benefits of a speedier, cheaper resolution, as proceedings have become bogged down in discovery and quasi-motion work that mirrors litigation."

If that is truly the case, then arbitration has a gloomy future indeed, and not just with law firms.  I brought up the article to an attorney I know who defends clients in arbitration and he told me some of his concerns with it:

• Arbitration has become very inefficient, with no control over evidence admission (ie, evidence can come in at any time);
• The arbitrators do not have the same fear of appeal that judges do and thus are unafraid to ignore precedent;
• The quality of arbitrators has declined.

This indicates some serious problems with the arbitation system for dispute resolution.  As the attorney I spoke with said, "Our clients used arbitration to get away from runaway juries.  Now they are going back to the courts to get away from runaway arbitrators".

We have begun taking submissions for the 2008 Law Firm Economic Survey.  If your firm is interested in participating, please contact Brian by clicking here.

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I have suggested utilizing a non-equity partnership tier as a way to reward attorneys who are not yet ready for firm ownership.  Jim Cotterman has made an argument against it.  In my assessment, non-equity partnership can be a tier to place attorneys who excel in some things, such as working files, but don't have the skills to bring in new clients or matters or don't have the requisite discipline to be a firm owner.  Cotterman, however argues that non-equity partner tiers can end up being dumping grounds for the mediocre.

Cotterman cites a May 2006 study, An Empirical Study of Single-tier Vs. Two-tier Partnerships in the AmLaw 200, by Professor William Henderson at the Indiana School of Law.  The study documents that average per equity partner income in single tiered partnerships are significantly higher than two-tiered partnership firms.  The study noted:

The higher profitability of single-tier firms appears to be a function of higher levels of prestige, which enable single-tier firms to (a) attract and retain a more lucrative client base, and (b) run a more rigorous promotion-to-partnership tournament in which associates work longer hours and are less secure in their futures with the firm. 

Cotterman does believe there are certain situations where establishing income partners could be a good idea, including the reasons I mention above.  How do you feel about this?  In the 2008 Law Firm Economic Survey, we are asking respondents if they have a non-equity partnership system in place.  With this information, we will be able to determine whether equity partners in two-tiered partnership firms make more or less than those in one-tier firms.  It will be interesting to see if our results, which focus on small and mid-size law firms, mimic or contrast the findings in the Amlaw 200.

We have begun taking submissions for the 2008 Law Firm Economic Survey.  If your firm is interested in participating, please contact Brian by clicking here.

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The previous host for morepartnerincome, Tom Collins, has strong feelings about the importance of recognizing the monetary value of law firm ownership. He believes that incoming partners should purchase their share of ownership and that retiring partners or their estate should be fairly compensated for the value of the partner’s shares. I asked him for a post on the subject and here it is:

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Pull out that partnership agreement and take a read through. Over the course of the years, I have helped a number of firms contemplate the future. I always ask for a copy of their partnership agreement. What surprises me every time is how irrelevant the agreement has been treated. Invariably, practices in the firm are at odds with the agreement. And the departure from the agreement’s provisions usually involves the sensitive areas of partner distributions and capital contributions. Unfortunately when trouble develops, the first thing that happens is that the partner who feels aggrieved points to the agreement, i.e.,” It is all fun and games on the playground until someone gets hurt.”

Make it a habit to review the agreement annually and amend the document as appropriate. Small deviations between firm practices and the agreement accumulate into wide divides. The reason for deviating from the exact verbiage of the agreement may have been sound and partners may have mutually agreed informally, at the time, to each deviation. But the reason and the informal agreements are forgotten with the passage of time.

There is another reason to review your partner agreement: retiring partners will be a bigger issue for many law firms over the next ten years. The treatment of capital accounts and unfunded liabilities imposed by continuing origination credits or other post-retirement payments can sink the ship if excessive. When a firm goes belly up, unfunded liabilities become worthless to those who were expecting future payments. For the benefit of the partners who will be retiring and those remaining, overly burdensome provisions need to be addressed now.

Morepartnerincome.com is sponsored by Juris®. For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

877/377-3740, e-mail info@juris.com or go to www.Juris.com.

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Bruce Marcus lays out the case the ABA overlooked in addressing the issue of mandatory retirement. The ABA delegates voted to encourage firms to discontinue the practice, but as Marcus notes, ” …they came up with the lesser solution to the greater problem, which, is, I think, the question of judging a lawyer’s capabilities by his or her age, rather than by capability.”

He then proves his case that older can be (and often is) better. As he puts it, “A stupid lawyer at 30 will be a stupid lawyer at 80. A smart lawyer at 30 will be a smarter one at 80 (which, I’ve been told, is the new 39).”

Being on the other side of 65, I agree with Marcus regarding prospects of improving with age, but there is more than just competence at state here that lead one to ask, if not mandatory retirement, then what?"

Mandatory retirement has been crutch, a mechanism, for achieving the transfer of control and earning from one generation to the next. That transfer has to happen. As I often say, you will eventually leave. The question is, do you walk out, run out or get carried out?

There are two recurring problems, other than professional competence, related to the retirement issue that have to be addressed successfully if a law firm is to have a life of its own. The first problem is the founding or senior partner who is reluctant to give up power and control as the risk grows that illness, disability or death will leave the law firm headless. The second problem has to do with disproportionate compensation. It is a frequent problem. Many maturing partners shift their priorities in their life. They began to devote more time to leisure activities and non-firm activities. The problem isn’t with the diminishing work load. The problem arises as the compensation they are pulling out of the firm becomes disproportionate to the aging partner’s continuing contribution.

No question about it, law firms benefit from retaining their most senior talent—they are often the best rainmaker and there will never be a substitute for experience. But the peaceful coexistence of generations requires an orderly transfer of power and earnings. For midrange law firms, the lack of continuity planning, of which mandatory or voluntary retirement plans are a part, puts survival of the firm at risk and the disproportionate distribution of income usually leads to a revolt or splintering of the law firm.

Bruce W. Marcus is an author, consultant, and pundit for professional services marketing. In addition to his books and articles, he shares his insight and wisdom through his blog, THE MARCUS PERSPECTIVE. His 424-word essay on the ABA mandatory retirement resolution is titled They Labored Like Lions and Produced a Mouse.

Morepartnerincome.com is sponsored by Juris®. For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

877/377-3740, e-mail info@juris.com or go to www.Juris.com.

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Authors Mortimer Feinberg and Aaron Levenstein, when noting that talent and ability are not enough, quoted the famed actress Helen Hays: “Nothing is any good without endurance.”  Their article Building Endurance appeared in the Wall Street Journal in the 1980s.   Nothing has changed. Endurance is still the essential element that makes for an effective law firm partner or an effective leader.

With the aging of the baby boomer generation, the retirement issue has become increasingly important, especially as many key rainmakers and law firm leaders brush against retirement age.  Age isn’t the issue.  Endurance is. Unfortunately, endurance declines as we approach that all-too-unwelcome age marker—65.  Granted, some people do not experience a decline in endurance until later. On the other hand, it can come sooner. As we enter our 50s, the chances of disability and energy-robbing illnesses become more likely

There are things that each of us can do to maintain and build endurance.   Feinberg and Levenstein set out four:

1.     Know how you recharge your batteries.  For some, this may be music, golf, or a long leisurely walk.  For others, it may be extreme physical activity—cycling, running, the gym.  Know what yours is and take advantage of it to avoid burnout.

2.     Keep a sense of humor, including the ability to laugh at yourself. It relieves stress not only for you but for those around you.

3.     Multiply you own resources of stamina by recruiting the strength of others.  In short, delegate and ask others to do for you.

4.     Recognize your failings (weaknesses) as well as your strengths and virtues.  Don’t waste energy on weaknesses; put your energy behind your strengths.

For most partners, declining endurance doesn’t come from burnout.  It comes from an actual decline in physical stamina due to age and age-related illnesses.  The best advice here is two-fold: 

·         It is never too late to adopt a disciplined exercise program to maintain and improve physical strength.

·         With increasing age and experience, shift your emphasis from “doing it yourself” to “doing it through others.”

No matter what measures we may take to maintain our individual endurance, it will eventually lower our ability to contribute on an equal footing with younger members of the firm.  Regardless of when it happens, it will happen.  For the benefit of both firm and its senior members, the transition out of the partner role needs to be planned and carried out in an orderly fashion. 

By the late 50s, there should be an understanding between a partner and the firm as to the path toward retirement.  Usually this involves a change in the partner’s role from working attorney to manager, mentor, statesman, goodwill ambassador, community mover and shaker, etc.  As long as we have the desire and the capacity, there are many ways other than long hours and high-energy lawyering to continue as a valuable contributing member of the firm.  There are successful partners continuing to make important contributions well up into their 70s and 80s.  They may represent the firm’s brand.  They know who is who.  They are respected in the community.  They can give important clients top-level attention to cultivate the firm’s relationship with those key clients and, while at it, cross-sell services.  They can publish, speak on behalf of the firm, and fulfill the firm’s obligations for community and charitable duties.  Along with a changing role, the firm may need to refine compensation for partners in the transitioning process by moving to a compensation plan that places the emphasis on management, rainmaking, and handing off business and origination to the younger partners.

Plans can change quickly.  Even for the mature partner with no plans to retire there should be an annual conversation concerning retirement plans.  That conversation will eventually have to turn to the firm-driven need to prepare for the partner's inability to continue in his or her former capacity.  

 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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On September 21, 2006, Juris played host to its managing partner forum, a roundtable discussion between managing partners. What was on their minds?

Talent (attorney) retention

Motivating attorneys to do right

Problem attorneys

Collection speed

While not on the list, the subject that dominated discussions regardless of the topic was compensation. Compensation seems to be both the root of the problem and the suggested solution to virtually every management issue in the law firm.

One of the attendees said it better than I could have. I have to paraphrase since I did not make an exact recording of his comment. Prior to joining the law firm, he had worked in the corporate world. He said that everywhere else the focus was outward, on opportunities; in the law firm everything always turns internally—to compensation.

Compensation is a motivating force, but it is also the destructive force that ends the lives of many midsized firms.

The day before the forum, I attended a symposium on benchmarking. A speaker from Austria showed the attendees a chart of the aging Austrian attorney population. It illustrated the same time bomb about to explode in our country. Our existing midsized firm partners are nearing retirement. Many of those are looking to post-retirement payments from “their” law firm to partially finance their retirement. The young guys are looking forward to the compensation benefits the old guys have been enjoying. They aren’t so enthusiastic about sharing the rewards of their labors with retired partners.

The developing demographic crisis may force a new model among law firms that finally separates the issues of ownership and compensation much like what is taking place in the U.K.—the UK no longer even limits ownership to attorneys.

Under the prevailing U.S. law firm model, partner compensation is that which is left over in a law firm after paying all expenses other than partner distributions. In the rest of the business world, it doesn’t work that way. In other types of businesses, an owner who also works in the business receives compensation for his or her effort, and that compensation, like salary payments to non-owners, is treated as a business expense. What is then left over after all expenses, including their own compensation, belongs to the owners—the shareholders. However, it represents risk income rather than payment for effort. That risk income (profit) can be distributed in proportion to ownership or accumulated to finance growth in the business.

Moving to such a model could solve a lot of issues. It means that new owners (partners) are investors with an investment expectation and retirees (selling investors) can expect to benefit from the increase in the value of the business during their tenure.

Deciding on the salary portion of payments to partners and the business valuation isn’t easy, but the owners of closely held businesses and the key employee owners of those businesses agree to acceptable numbers all the time.

First, let's deal with the salary side.

Start with the notion that every job has value. The newcomer to that position will earn about 80 percent of the incumbent that is fully experienced in the position. The compensation of the long-timer who continues to increase their effectiveness in the position can continue to increase up to 120 percent of the value. The range could just easily be 70 percent and 150 percent. The point is that there is a minimum and a maximum job value level.

If competent associates in your area earn $100,000 annually, your newest associate will earn about $80,000 and your seniors $120,000. From time to time, the 100 percent value has to change for inflation and competitive reasons. This is a simplified example. In real life, tax associates might have a different job value than an associate without a specialty; or, you might have one job value for associates with 1 to 3 years of experience and another for those with 4 to 8 years of experience.

Staying with our $100,000 associate value example, what should the salary value for a partner be (excluding any distribution as an owner or required capital contribution to fund growth and/or to recover losses)? The recent Juris® Law Firm Economic Survey indicated that the average partner compensation is around $250,000. That, I might add, is also the compensation level earned by law firms in the second quartile. In other words, that is the partner compensation level for firms that are neither the best nor the worst. We have to pick something, so let’s set the job value of a competent partner at 2.5 times the value of a fully competent associate.

The job values in our example for fully competent and experienced incumbents would be as follows:

Associates: $100,000, ranging from $80,000 to $120,000

Partners: $250,000, ranging from $200,000 to $300,000

Now we have to deal with equity. Associates moving to partners would have to buy in. That means that while their salary may jump significantly upon making the move to partner, a portion of that higher compensation will go toward the buy-in over 3 to 5 years. Who does that buy-in go to? It goes to existing owners giving up some ownership share to the newcomer, or it funds additional growth of the firm, increasing the value of the business for all of the owners.

How do you value the ownership? If the firm was selling (merging), the value would be determined through negotiation. For the purpose of passing the firm from generation to generation, we need to just pick a method that all the parties can accept. Generally, the value used for passing on minority interest is a discounted value—it is likely to be 75 percent to 50 percent of what the business value might be if 100 percent of the business was being sold. For the purpose of determining value, you could use any of several following methods, including the following:

• Book value (Assets less liabilities) computed on an accrual basis so that the collectable value of work in process and accounts receivable is included
• Some percentage or multiple of “fee” revenue
• Some percentage of the pretax profit after all salaries, including the “salary” portion of partner compensation

Each of the above methods has its negative and positive aspects depending in part on whether you are a buyer or seller. Rather than pick any one, I suggest you use all three methods and average them. I will leave it to you to apply this approach to your firm, but here is a formula that you can refine for your particular case:

• Book value (assets less liabilities) computed on a cash basis plus 90 percent of billed but uncollected fees and expenses less than 120 days old and 70 percent of unbilled fees and expenses less than 90 days old.

Plus

• Annualized “fee” revenue for the current year plus the fee for the prior two years divided by three for an average of the three years. That average is multiplied by a factor. I suggest a multiplier of 1 for most cases. If the firm depends on a small number of clients, the percent should be lower, .75 for example. If no one client accounts for 10 percent of the business, it could be higher, 1.25 for example.

Plus

• Income before taxes and interest (after all expenses including the salary portion of partner compensation) times a multiple of 5. Reduce this value by any interest-bearing debt. In computing this number, use the higher income of the most recent year ended or the average of the annualized current year plus the two immediate prior years. For this purpose, partner salaries can be imputed using 2.5 times the average associate’s salary.
• In the final step, average the above three values by dividing by three.

Right, wrong, or approximate, you now have a value for admitting new partners and buying out the retiring partners consistent with the rest of the business world. Ideally, you will have an option to make the buyout payments over a three- to five-year period.

PS: The above replaces origination credits to retiring partners. The two concepts are not compatible. You can’t do both. Post retirement origination payments are substituted for equity buyout payments that are based on the “going concern value” of the law firm.

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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Back on January 18, 2006, Ed Wesemann posted Avoiding the Nuclear Option, which addressed the issue of the underproductive partner.

Ed listed the following likely causes for this turn of events:

• The partner is lazy
• An outside event—midlife crisis, drugs, alcohol, health or emotional problems
• The area of law in which attorney practiced no longer keeps the partner fully productive

Wesemann’s observation is that the latter reason is the most common and suggests that the partner can be redeemed by retooling the partner for a new and growing practice area. I wish I could agree with Ed about the practice area problem. I do agree that a previously successful partner isn’t likely to suddenly become lazy.

My experience is that the personal issues are the most common and they are the most difficult for the law firm to resolve. Granted, drugs and alcohol are relatively clear issues, and the partner can either make a comeback or continue to spiral downward. The area that appears most difficult is the loss of energy that occurs in what should be the final 10 to 15 years of a successful career. At times, it is often related to health issues. I don’t have a good answer for it once it becomes a problem. But I do stress that the firm should have a formal program for involving each individual attorney in successful planning around 50 or 55 years of age.

The firm needs to know what the attorney is thinking. The attorney’s interests and goals concerning retirement should be openly discussed at this point, and the discussion should be updated each year to detect any changes in the partner’s thinking. The firm needs to know if the attorney is beginning to consider early retirement. The firm needs to know and participate in the decision, certainly if the attorney is considering working as long as he or she is productive. By 55, the role of the attorney should begin to shift away from client control to management, supervision, mentoring and new business development. Client relationships, practice area knowledge and relationships should be transitioning from the senior attorney to the newer ranks of the firm’s leadership.

If the firm’s expectations for its maturing partner changes in synch with the transitioning role described above, then the standards by which performance is judged should also change. Likewise, best practices would call for compensation plans that have the flexibility to compensate the maturing partner differently. “Old guys bring wisdom and experience—not muscle—to the hunt.”

But what if you have a problem that has to be addressed? I believe in a process called “three-step termination”.

• Step one: Meet and reach an agreement about the problem. [If an agreement can not be reached, go directly to step three.]
• Step two: Agree on a solution to the problem and a target date. [If an agreement can not be reach go directly to step three.]
• Step three: End or terminate the relationship.

It is called the “three-step termination” because the odds are that the termination is where it will lead. But there are exceptions. Sometimes, steps one and two solve the problem. The partner or employee returns to being a positive, happy contributor, and the firm wins by saving a valuable member of the professional team. As Ed says, don’t go straight to the Nuclear Option. Take the time to understand the cause. Maybe they are being judged in the wrong categories or they need to retool for a different area of law. If you have a problem that cannot be allowed to continue, then agree on a plan. Only go nuclear if the plan is not followed to a successful resolution of the problem.

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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Ed Wesemann posted an article on Creating Dominance dealing with underperforming equity partners. It is worth your time to read this. The post suggests that the firm needs to develop a standard (minimum performance level) and even gives an example method of analyzing and ranking the performance of your current partners.

The interesting twist is that once you chop off your current underperformers, you raise the standard of performance for those remaining and create a new class of underperformers.  Of course, this assumes that one’s performance is to always be measured by the individual’s relative performance compared to peers.  Whatever your feeling about judging performance based on the curve, Wesemann’s post gives you a powerful new way to look at your current equity partners.

If I recall correctly, it is David Mastier who talks about a hygienic level of performance.  In other words, rather than always judging relative performance compared to peers, the firm should decide what a healthy level of performance is—the hygienic level.  An equity partner that meets the hygienic level is considered a positive contributor to the firm.  Compensation may vary to reflect different levels of performance above the hygienic level (up to a maximum point), and those that don’t make it to the hygienic level must move out of an equity partner position.  Why would you set a maximum for awarding compensation for performance in selected areas (most often billable hours)? Because too much of a good thing can be destructive to the individual and his/her long-term success as a contributor to the firm.  Too many billable hours means something is being neglected, either in the firm or in the partner’s life. 

At any rate, Ed’s post, Looking Tall by Standing Next to Short People, is a must-read item.

 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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In a previous post I asked, “How old is your partner team?” An even more critical question is, “Does your partnership agreement or operating agreement create an unfunded liability?” If so, it could be a fatal flaw unless corrected.

Partner agreements can call for significant continuing compensation to retired partners. Given our tax laws, law firms pay out their profits on an “as they go” basis. There is no material retained earning—no significant ownership equity for the retiring partner. Law firm income isn’t distributed based on monetary investment. It is required to compensate active partners for their relative contribution to revenues and profits.

Agreements that provide for continuing origination credits, or other amounts, to be paid to an inactive partner place a burden on the next generation of partners. As baby boomers reach retirement age, the problem is worsening. The number of situations where the burden has broken the backs of remaining partners is increasing. Their response isn’t surprising—they simply dissolve the firm.

Retirement plans need to be funded by the individual or jointly by the firm and the individual during their productive years. Because profits have been paid out as earned, the retiring partners have no claim on future income once they are out of the picture. If your firm has this problem, it is in the interest of all parties to find a win/win solution that will preserve the firm and treat all the partners fairly.

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