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INCREASING PROFITS

How to pay the partners

Is your compensation system driving away the talent you need to grow?

What approach did your firm take when establishing its partner compensation plan? It’s likely you chose one of the three traditional systems. There’s the old “eat what you kill” method, which is based on individual performance; the seniority/lockstep system, which is determined by the partner’s role in the firm’s hierarchy; or a variation of the Hale Dorr system, a formula long considered to be the least contentious approach to determining compensation.

Kristin Stark, principal of Fairfax Associations, suggests that compensation is a hot topic because slow growth and flat profitability, as well as a growing disparity between top and bottom performers, is putting a great deal of pressure on compensation systems. So maybe it’s time to take a good look at yours.

Looking at the formula

When determining a compensation plan formula, Ronald L. Seigneur, CPA/ABV/CFF, ASA, CVA, CGMA, of Seigneur Gustafson LLP, says there are three primary elements:

  1. Origination: What book of business does the partner control or what business have they brought to the firm?
  2. Productivity: What effort has been expended by the partner? This is sometimes determined by billable hours or collection rates.
  3. Intangibles: What is the partner’s level of involvement in practice management or community matters?

When it comes to allocating percentages to these elements, some firms are creative and others use traditional methods. Traditionally, the rule of thumb was to allocate 30% to origination, 60% to productivity, and 10% to intangibles. But, Seigneur cautions, there is no perfect formula. For example, for many firms, the contentious element of this formula is origination. Identifying where a client matter originated is difficult and controversial. In her presentation, Stark suggested that origination be defined as fiscal year collections attributable to the partner or partners who are the reason why the client or matter is currently at the firm, as opposed to first touch. But no matter how you define it, today’s model has changed the value of origination from 30% down to somewhere between 10 and 20%.

Another tricky aspect in this formula is billable hours. For example, how hard a partner works may depend on where the firm is based. Some law firms on the West Coast, encouraging a healthy work/life balance, might view 1500 billable hours per year as commendable; law firms in the East, however, might balk at that low figure and consider it grounds for termination.

Ultimately, Seigneur says, there is no “Holy Grail” formula. You simply can’t take everything into account, such as the partner who generously mentors associates with guidance and advice or the one who daily frightens them with curmudgeonly behavior.

“Complex formulas confuse what is being valued,” says Stark. “But,” she says, “subjective data lets you deal with problem partners and client hoarders. People shape their behavior based upon rewards system.” Stark proposes that performance-based or “subjective” systems allow for management to assess a partner’s contribution and reward it accordingly. The system requires the firm to tailor what it is going to value and designate a person to conduct an assessment.

Stark suggests a firm try to value a full range of contributions that work to grow and build the firm. These can include:

  • Financial contribution,
  • Client service and management,
  • Marketing and business development, or
  • Practice group and people management.

But, she stresses, be sure you establish a minimum bar and identify what is considered to be going above and beyond that bar. You don’t want to reward someone for what he or she should be doing anyway.

When assessing this performance data, you need to have a range of metrics. There will be no single perfect indicator. Some of the metrics will include the traditional elements set out earlier, perhaps adjusted due to new influences, such as alternative fee arrangements and staffing model changes. Stark believes that some possible future metrics include:

  • Profit per share of practice managed,
  • Total profit of work originated,
  • Unit cost of work originated/managed,
  • Client satisfaction rating,
  • Expansion of key relationships,
  • Employee satisfaction rating, and
  • Cross-selling and cross-working.

Forget the formulas

Another approach to consider is a tiered arrangement, with each partner in a tier receiving the same amount of compensation. To be assigned a tier, the partner must meet certain criteria, as evaluated during a performance review by a compensation committee. This approach reduces subjectivity and provides a clear path for moving partners up or down, based on performance.

The compensation plan can also be a point system. For example, a firm may start with a thousand points. The compensation committee meets and awards points to each partner, with the points determining the partner’s share of the distribution. This method, however, can be difficult to determine in multi-office firms where the members of the compensation committee may never even meet the lawyers they are assigning points to. In these circumstances, says Seigneur, it is particularly important that everyone “trust the judges.”

Still one more system is the Reasonable Compensation System, which suggests that firms “normalize owner compensation”; that is, adjust the compensation to the market. Look at the person’s expertise, the areas of law, read the surveys (such as CityBank’s), and find out what that partner’s peers are making. When it comes down to it, Stark says, “Relative compensation matters more than actual compensation.”

Proceed with caution

Whatever compensation plan you choose, Seigneur counsels cautions: “Adjusting compensation is controversial. Administrators must be careful when talking about changing the compensation method. It’s not always seen as a good thing by everyone. If someone’s compensation is going up, that means that someone’s is also going down,” he says. “And good people will leave; they will talk with their feet.” The best approach? Seigneur recommends great care, forethought, and trepidation, and ultimately, “Do what is best for the firm.”


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