Pumping Up Profits Per Partner

Pumping Up Profits Per Partner

Law firm financial data seldom was discussed publicly before law became big business. Today, however, the legal press ranks the largest US law firms on the basis of gross revenues and other indicators such as revenues per lawyer and profits per partner. (See the American Lawyer’s annual AmLaw100 and 200 rankings and the National Law Journal’s annual top 250 survey.)

Annual profits per equity partner now is the most commonly used measure for law firm success and financial health. From 1987 to 2012, large law firm profits quadrupled. Generally speaking, the higher the profits per equity partner, the easier it is to attract and keep top legal talent. Lawyers want to know that their firms are on solid financial ground and are curious whether they could earn more elsewhere. Thus, law firms employ a number of strategies to bolster their profits per partner — some say even artificially so.In the American Lawyer's 10th annual Law Firm Leaders survey, most respondents said they expect increases in their firms’ bottom line in 2013. Nearly 32 percent expect their partner profits to grow more than 5 percent, up from 26 percent who expected such growth a year earlier. Forty-five percent expect profits to increase by 5 percent or less in 2013.

In the mid-1990’s, partners at top firms earned between $300,000 and $400,000 annually. Today, profits per equity partner exceed $1 million for most of the country’s largest firms, and approach $5 million at the most profitable firms. When a firm adds an equity partner, it must take steps to ensure that the profit per equity partner doesn’t fall as a result. It can raise rates, add leverage in the form of new associates or lower level hires, or increase the number of hours worked by current lawyers, or a combination of the three.

Many factors effect profits per equity partner. One factor is that the market for hourly rates varies from region to region. For example, law firms in the northwestern United States often cannot charge their clients the same rates that are accepted in the Northeast. The size of the firm, types of practice and clients, lawyer and staff compensation, and local cost of living all make a difference in the bottom line. Therefore, the profits per equity partner number isn’t necessarily dispositive when ­assessing the success and financial health of a firm.

When comparing big firms in the larger metropolitan areas, however, profits per equity partner remains the final word; thus, firms go to great lengths to keep that number high, especially in challenging economic times. American Lawyer bases its profits per partner calculations on the number of equity partners only. Cutting the pie into fewer slices results in larger slices; consequently, law firms can raise their profits per partner number simply by restricting their ranks of equity partners. By 2005, nearly 80 percent of AmLaw200 law firms and, according to a 2002 report by the Boston Business Journal, about half of all firms in the 20-100 lawyer size range, had instituted two-tier partnerships.

To restrict the equity partner class, firms employ such tactics as extending the partnership track for consideration of associates for promotion to eight to ten years or more and raising the bar for admission. For instance, some firms admit only proven rainmakers to equity partnership, promoting others to counsel or nonequity/income partnership, and demoting lesser producing equity partners to nonequity status. In top-tier firms, the percentage of income partners increased from seven percent in 2001 to 11 percent in 2010. The percentage of counsel or of counsel rose from six to ten percent in the same period, according to Altman Weil’s 2012 Client Advisory report. There was an even greater increase among mid-tier firms, with the proportion of income partners climbing from 11 percent to 21 percent and the percentage of counsel and of counsel rising from eight percent in 2001 to 11 percent in 2010. Recognizing that law firms could use nonequity partnership to influence their profits per partner calculation, the 2005 AmLaw100 introduced a new measure, “Value Per Lawyer,” which is calculated by dividing the combined compensation of all partners, equity and nonequity, by the firm’s total lawyer head count.

In further efforts to pump up profits per partner, law firms become continuously leaner and meaner. They pressure all lawyers to raise billing rates and to increase the number of hours billed. But, because there’s a limit to the price the market will bear and there also are only 24 hours in a day, some firms experimented with alternative fee arrangements (AFAs) such as premium billing, success bonuses, value billing, task billing, and hybrid hourly/contingency rates. In addition, some law firms that previously billed exclusively on an hourly basis selectively handled cases on contingency, looking for a big win as a way to increase revenues.

Many law firms regularly evaluate their clients and practice ­areas to determine which produce the best bottom-line results. They discard slow and nonpaying clients, and pursue those that pay the highest rates. For instance, some firms shed their estate planning, insurance, or municipal practices because clients in those ­areas traditionally demand lower rates. Lawyers in these practice areas either move to other firms or start their own smaller shops with their existing clients, or they must retool for more profitable practice areas. In an effort to become recession-proof as well as to pump up profits, some firms diversify by expanding into new practice areas, going after clients in different industries, or adding offices in other geographic areas. Having learned hard lessons during past boom and bust economic cycles, firms now know not to put too many of their eggs in too few baskets, even if those baskets look leak-proof at the time.

Obviously, cutting costs is another way to boost profits per partner. Salaries are the largest expense of virtually all law firms. Therefore, in addition to deequitizing some partners, law firms push out the least productive partners and lay off under-utilized associates and staff. During the Great Recession, tens of thousands of associates and staff lost their jobs as firms attempted to cut costs while preserving high profits per equity partner. For those who remained employed, lockstep raises and promotions moved towards merit-based advancement. To encourage greater productivity, associate bonuses depend upon hours billed, and partnership compensation systems reward rainmaking, cross-selling, entrepreneurship, and productivity. Some firms publish productivity and compensation numbers for each lawyer on a regular basis and distribute the reports to all partners, and sometimes even to all senior attorneys.

The office lease usually is the second largest law firm expense. At the height of the legal market boom, many optimistic firms overextended themselves by taking on more space than they needed, often at high rates. During slow years, however, it proved difficult to find subtenants to absorb the excess, and firms had varying levels of success in renegotiating their leases. As a result, several firms eventually disbanded. Further trends toward more economical utilization of office space include reducing square footage per lawyer, significantly cutting the size of libraries as more research is done online, and equalizing the size of partner and associate offices. A few firms moved their administrative personnel offsite to separate, less expensive office space. In fact, there is a trend toward outsourcing all sorts of law firm administrative functions and lower level legal work.

Law firms scour their expenses in search of other ways to reduce costs. They tighten up on billings and collections, scrutinize travel and entertainment costs, and cut such benefits and perks as parking and in-house meals. Videoconferencing replaces some business and recruiting travel. And the smart use of contract attorneys, paralegals, technology, and standardized forms reduces the cost of doing business.

While taking steps to boost profits per equity partner is essential to a law firm’s economic survival, it has the added benefit of enhancing the firm’s ability to attract and retain the most successful lawyers and strongest clients.

 

Valerie Fontaine
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