Time To Rethink Partnership?
Partnership, or an equivalent, is the predominant form of organization for law firms large and small. It is a structure that made sense when even the largest firms were under 200 lawyers and were primarily single office operations. Today some firms produce $2 billion or more in revenue, and numerous law firms operate in multiple countries around the world. Given the increased size and complexity of firms and the marked shift to law as a business, as well as the options available to firms in some jurisdictions, there are a variety of reasons why it may be time to rethink law firm partnerships.
Are Partners Behaving Like Owners?
Partnership means that one is an owner of the firm and responsible for driving its success. In exchange for that ownership, partners share in the profits of the firm and other rights and privileges, including a voice in the firm’s overall direction. However, we often find that the number of partners who display a true ownership mentality is actually quite small (c. 20% or fewer of the partners in some firms). This is true in firms of all sizes – even small partnerships are contending with “owners” with an employee mentality. While many of these partners are fulfilling valuable roles in the firm, they are not contributing as owners and as a result, may not merit partnership status.
Are Partners Really Equals?
In a number of firms, particularly those that prize highly democratic cultures, partners share the same voting rights and influence over firm direction in spite of variations in contribution. In fact, many firms have a “one partner, one vote” approach to voting. Talented lawyers are admitted to the partnership 7 to 15 years into their 40+ year career. The difference between a 10th year lawyer and a 30th year lawyer can and should be substantial, yet many firms do not distinguish between them other than in compensation.
In addition, many firms continue to struggle with a material number of underperforming partners. While firms have processes in place to deal with underperforming associates, partners tend to be handled much less effectively simply because they have partner status.
Partners are presented to the outside world as equals, yet clients do not view all partners as equals. Our client interviews regularly confirm the differences clients observe among partners in a single firm. In some cases, the differences are so significant that clients perceive partners offering inferior value as a detractor from the firm’s overall service level.
Is the Guild Model Limiting?
Others have written about law firm partnerships being the last of the medieval guilds. There are two aspects of the law firm guild that may be a problem going forward. First, the guild model operates on an apprentice/journeyman/master progression. While the guild model works well for those lawyers with the skills, abilities, and drive to progress to equity partner, it fails to provide for a meaningful and appropriately titled/compensated role for valuable lawyers lacking ownership potential. A number of firms have filled non-equity partner categories with these lawyers, resulting in more partners than non-partners. Because this group tends to be undermanaged, this approach has created a number of challenges, including compensation creep, ‘blocking’ of associate progression, etc. (For more discussion, see our Fairfax Insight: Too Many Non-Equity Partners?). To compound this issue, clients continue to balk at paying for training apprentices, or paying high hourly rates for journeymen lawyers. Perhaps the time has come to move away from the very flat organization that exists in many law firms and create viable roles for lawyers with different aspirations and different levels of contribution.
A second aspect of the guild model that may be outdated is that in many jurisdictions, including the US, non-lawyers cannot become a partner or owner in a law firm, and thus cannot share in the profits of the firm. While law firms can employ non-lawyer professionals, even seasoned business leaders are often viewed as second class citizens. In major corporations the CEO, CFO and CMO, among others, are the top professionals in the company and handsomely rewarded. In many law firms those roles are undervalued, which limits the impact those professionals have on the firm.
Are Law Firm Partnerships Risky?
As a dramatic recent example of partnership risk, partners of the former Dewey & LeBoeuf have been required to repay compensation received while the firm was insolvent (for those not in the PartnerContribution Plan that was determined to be a point 3 years before the firm actually dissolved). In addition to the clawback suits, former partners were required to repay capital loans to the bank (without any hope of getting their capital back from the firm) and were also sued by the firm’s New York landlord. Some of these obligations exceeded $10 million for a single partner. Several partners have declared personal bankruptcy in the wake of the firm’s demise.
In theory, the shared risk partnership model should encourage partners to be engaged in the firm and self-police, but for various reasons that doesn’t happen. It would be impractical and inefficient for every partner in a large firm to be involved in the financial management of the firm, although there are certainly arguments for partners to be more engaged than they are.
While the Dewey example is an extreme one, we have seen far more instability in the legal market in the last few years and additional dissolutions are on the horizon. Being a partner when you are really on the hook, yet not “in the know” suddenly looks less appealing. Furthermore, sticking it out with the firm when things start to look bad may mean getting stuck with a big bill. If these financial risks create incentives for partners to leave at the first sign of trouble, more firms will likely face unraveling and more rapid dissolutions in the future.
What are the Alternatives?
We can look to other professional service firms for models that might be applied to law firms, if not now, then perhaps at some point in the future when alternative business structures are permitted. A few examples:
Accounting firms maintain partnership models, but have much smaller partnerships. Partners make up just 6% of the client service staff at PwC, compared to 50% or more of the client service staff in many typical law firms. It takes 15-17 years to make partner in a Big 4 and some studies report that partners are expected to generate and manage practices of $3 million plus for admission. By contrast, law firms typically admit partners earlier and with $500,000-$1 million in business or potential business. While the practices and needs differ, the key difference is that Big 4 partners are a smaller group and are in fact responsible for driving business for the firm. More significantly, there is a clear career path and multiple levels of responsibility in the 15-17 years professionals are moving towards partnership, rather than simply being treated as a maturing “associate”.
Consulting firms operate as public companies (Accenture, Huron), private partnerships (McKinsey, Bain) and private equity owned/invested companies (Booz|Allen|Hamilton) among other structures. Like accounting firms, the partnership or director group is much smaller than in law firms and is expected to manage large portions of the business. Consulting firms structured as public companies benefit from outside boards advising the business. While some law firms have established outside advisory boards, those boards lack the fiduciary responsibility of a public company board. And the private equity model is one that is certainly possible in some aspects of law even today, as observed with legal outsourcing companies.
While the traditional partnership model has served law firms well historically, it may be time to rethink the structure and function of the partnership. Firms should be asking themselves what it means to be a partner and how to ensure that partners contribute as true owners of the business. They should also consider if their current partnership model is most appropriate in terms of governance, management and financing. While the current model may continue to work well for some firms, others may need to rethink how they apply the partnership structure more effectively and still others may want to consider alternative structures. Ultimately, in order to sustain growth and competitiveness for talent and clients over time, firms need to look ahead and think about new approaches to structuring the provision of legal services.