Owner Compensation Systems in Law Firms

• Publication year: 2000
• Pages: 89
• Citation: Vol. 29 No. 11 Pg. 89

29 Colo.Law. 89 Colorado Lawyer 2000.

2000, November, Pg. 89. Owner Compensation Systems in Law Firms

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89

Vol. 29, No. 11, Pg. 89

The Colorado Lawyer
November 2000
Vol. 29, No. 11 [Page 89]

Specialty Law Columns
Law Practice Management
Owner Compensation Systems in Law Firms
by Jonathan A. Goodman

Through insurance, retirement plan contributions, and other benefits, 75 percent of every fee dollar a law firm earns goes toward employee or owner compensation.1 A law firm’s compensation plan is one of the firm’s most important systems, and a properly designed and implemented plan can enhance productivity reduce turnover, and contribute to a firm’s morale These benefits contribute to client satisfaction, which enhance firm profitability. This profitability, in turn feeds the compensation system in a way that can further reduce turnover, attract talent, and enhance firm morale. This upward spiral of prosperity has the potential to shower ever-increasing benefits on employees and owners. On the other hand, a "bad" compensation system significantly handicaps a firm.

Although compensation systems for associates and non-attorney staff are as important as those for owners, it is beyond the scope of this article to discuss employee compensation systems. Instead, this article focuses on partner2 compensation systems by identifying the challenges a firm must overcome to develop the appropriate compensation system and the basic structure of systems law firms commonly use. Whether developed through conscious effort or not, all firms have some type of owner compensation system. For example, a nominal partnership that actually operates as a glorified office-share arrangement may have an "eat what you kill" approach. Each partner receives the revenue from that owner’s efforts, and the partners have some mechanism for dividing shared expenses such as rent and staff wages. This article should be of interest to firms wishing to change their current compensation system and lawyers seeking to establish new systems.

Partner Compensation Systems: Three Challenges

The decisions owners make about compensation systems often are controversial. Partners differ in their perspectives about the relative value of client origination, firm management, and client servicing. This portion of the article explores three challenges: (1) developing a fair system; (2) valuing "rainmaking"; and (3) valuing management.

Developing a Fair System from "Within the Circle"

A successful owner compensation system must be fair. While it is important that the system is fair objectively, it is equally important that the partners perceive it as fair. Firms often contain divergent interests. For example, older owners nearing retirement may have a different perspective on a pay system than younger owners. Litigators may have different interests than transaction attorneys. Rainmakers tend to place a higher value on their efforts than the shareholders who serve clients.

Moreover, some attorneys produce a steady flow of revenue; other attorneys receive infrequent, but substantial payments. Some areas of practice require substantial use of staff, while others require minimal staff use. Some practices keep paralegals and associates busy and billing, while other practices produce little work to be done by others. Additionally, individuals have differing psychological perspectives. For example, partners have varying tolerance for risk. This list of divergent perspectives could continue indefinitely.

The problems resulting from differing perspectives are magnified because owners must deal from "within the circle" on these issues. At least in the short run, a change in the system will cause some to receive less and others to receive more. Fear of dredging up these conflicts within a firm often inhibits proactive change. However, ignoring an entrenched but unfair compensation system foments turnover and its accompanying problems. The architects of a compensation system may enhance perceived fairness by: (1) genuinely striving for objective fairness; (2) seeking input from all of the firm’s differing interests; (3) developing the system "in the open" at a pace that allows for feedback from the owners; (4) studying literature and market practices about owner compensation; and (5) using outside consultants.

Valuing "Rainmaking"

A law firm cannot survive without clients. The strength of a firm depends on the quality of its work. The rainmakers are the lifeblood of most firms. The ability to bring in and control clients establishes the authority of the rainmaker in the firm. Therefore, a firm’s compensation system must reward attorneys who originate more than their share of the work. Nevertheless, in addition to the problem of determining how much credit to attribute to an originating attorney, systems that reward rainmaking face at least two substantial barriers: (1) valuing attorney revenue and (2) determining origination credit.

Some Rain is "Wetter" than Other Rain: Who is more valuable, Attorney A or Attorney B? Attorney A brings in all the work she does. Her rainmaking does not produce work for other shareholders or associates. The revenue from Attorney A’s billings...