As a result of increanon-hourly billing agreementssing client demands for efficiency and cost control, many law firms are considering ways to offer non-hourly fee pricing to clients.  Some of the friction causing some law firms to remain hesitant about implementing a non-hourly billing approach include:

    • An hourly culture and mentality;
    • Fear of losing money;
    • Fear of changing existing client relationships;
    • Administrative systems and procedures all built to support a billable hour practice;
    • Compensation systems that reward individual production as measured in hours;
    • Lack of pricing support and knowledge;
    • Fear that clients will not embrace a fixed fee approach; and
  • Philosophical differences.

Any one of these challenges is enough to sink a non-hourly billing initiative, and without client pressure, law firms are resistant to change.  How then can entrepreneurial lawyers pursue non-hourly billing approaches without running afoul of firm management?

Non-hourly billing approaches have existed in some practice areas for many years, but for firms who have never done them or applied them to a broader range of practice areas, the fee setting process is uncomfortable and sometimes beyond their internal capabilities.

Let’s discuss some of the more challenging aspects of moving beyond the billable hour for most defense firms.

An hourly culture and mentality

In most defense firms, hourly billing is the dominant billing method and has been for decades. If fact, many clients are increasing their investments in software and personnel to manage hourly billing agreements. The focus of many of these investments includes ensuring adherence to billing agreements and controlling legal expenses by evaluating costs at the task level.

Smart law firms have responded by improving their timekeeping systems, improving time descriptions, training lawyers to describe their time correctly, and adjusting cost structures to offset reduced realization rates. Some have gone as firm far has hiring outside bill review services.

The battle seems never ending and not likely to abate soon. Some lawyers, however, are actively searching for solutions that address client legal cost concerns while allowing for more professional judgment regarding the defense or prosecution of a client’s case.

Trying to mesh hourly billing and non-hourly billing cultures is difficult, but requiring time accounting across all billing agreements is a one way to at least ensure that an accurate comparison between approaches can occur.

Fear of losing money

In our experience, the definition of losing money can differ among law firms. Some consider a fully loaded (collected fees minus salary, benefits, and overhead) profit calculation, while others consider a gross margin approach (collections minus salaries, and benefits), and others only compare realized rates to a standard rate.

Defining profitability using an opportunity cost approach (comparing effective rate alternatives) is okay assuming the opportunity costs are real. Additionally, when using cost approaches to evaluating profitability, it is useful to consider any cost efficiencies related to a non-hourly billing method.

For example, the absence of billing and possibly collection costs (carrying costs and invoice follow up) can reduce overhead. Use of different levels of timekeepers at the firm’s discretion may also provide staffing efficiencies leading to lower payroll costs.

A quality cost accounting system can provide needed data for setting fee agreements. A comparison of actual costs to estimated staffing and overhead costs will enable a firm to refine pricing algorithms over a series of cases. Making these comparisons requires a different approach to time accounting. Instead of detailed time entries designed to pass billing muster, it is more important to track hours by task or phase of a case. For example, grouping all time by timekeeper and task within the discovery process can provide needed data for future fee estimates.

Law firms can mitigate the fear of losing money with a good pricing process, accurate cost accounting system, and a comprehensive data collection and reporting approach.

Fear of changing existing client relationships

The cliché “if it ain’t broke, don’t fix it” comes to mind when considering wholesale changes to the pricing model for an existing client. The problem is the many firms are in unprofitable relationships and do not realize it. Overcoming a firm’s resistance to running and detailed profitability analysis on a client is often very difficult. It is even more challenging when a client is large and when there are potential compensation implications.

Firm’s that have a well-developed profitability reporting system have an advantage. Partners in these law firms benefit from knowing how much profit they are risking when entering a non-hourly pricing discussion with a current client.  Even with this information, it’s hard to accept change. Many lawyers prefer cutting costs and increasing production requirements to changing billing models.

Firms that link compensation to profitability incent partners to improve results. Firms that combine rewards based on contributed profit with the freedom to take educated pricing risks can help their partners overcome this fear of change.

Administrative systems and procedures all built to support a billable hour practice

As with most people, administrative personnel can find change difficult. Imagine coming to work day and having to change many of the current systems, processes, and procedures. On top of all the daily pressures, who has time for an experimental change? As unappealing as such an administrative undertaking sounds, it is often necessary.

Lawyers who do not bill hourly, need different types of information and different reporting metrics. For example, a lawyer who is using a fixed fee pricing model would likely prefer metrics that indicate efficiency defined by who is completing tasks in the least amount of time. This lawyer may want base rewards on speed and accuracy instead of gross billable hours.

Administrative systems must adapt to the information needs of non-hourly billing practices. Compensation formulas, policies, and procedures must allow for the assignment of premiums and discounts on cases. Salary and bonus programs may need alteration.

Depending upon the actual billing method used, a firm’s workload distribution, and potentially different support needs, administrative systems and procedures built to support a billable hour model must change.

Firms that do not fully support differing billing methods run a risk of losing valuable partners to more accommodating competitors or even a new start-up.

Compensation systems that reward individual production as measured in hours

Perhaps the most significant obstacle for lawyers who want to move past billing hourly is a firm’s compensation system. Many firms reward for personal production defined in hours or timekeeper collections, origination collections, profitability, equity and other factors.

Firms that pay based on profitability have an easier time handling different billing methods. All that these firms need are policies regarding cost accounting and the assignment of any positives and negatives related to over and under realization.

Firms that consider billable hours, gross individual and origination collections may have a harder time compensating partners with different billing methods.  Resentments can surface when partners with low personal billable hours generate high profits and command high pay. Many lawyers are thoroughly ingrained in a billable hour mind set and will resist paying market pay to partners with low billable hours.

To overcome compensation challenges, we recommend that law firms shift to a system of paying based on contributed profits.

Lack of pricing support and knowledge

Pricing in most small and mid-sized firms is usually not a refined process. Most rates are set based on what the lawyers believe clients will pay. In some instances, our clients ask us for cost and profitability data. Overwhelmingly, these law firms request information about profit assuming certain hourly rates.

Typical questions include:

  • What is the lowest hourly rate we can accept and still make money?
  • If I staff a client’s account with a particular set of timekeepers, how much will I make?
  • A client has offered more volume in exchange for a discount; is it a good or bad deal?

Periodically, we encounter law practices with non-hourly billing methods. Plaintiff representation, collections, certain estates and trust work, and individual loan closings frequently billed at a fixed amount. Even in these well-established areas, however, pricing is either dictated by the market, statutorily set, or based on authoritative guidance and professional norms. The science, if there ever was any, was applied long ago.

It has been our experience that most law firms do not consider pricing as a professional discipline. Often it is thought as a financial concept only, which is a mistake and leaves out important strategic elements. This lack of pricing support and knowledge handicaps many firms and stalls efforts to move to a non-hourly billing approach.

Smart firms who are committed to a more informed pricing approach, even with their hourly clients, seek pricing support in the professional services market.

Fear that clients will only want the best elements of a non-hourly billing approach

The predisposition that many clients and lawyers have is that a non- hourly billing agreement will end in either the client or the lawyer winning or losing.  This mentality can make it hard to negotiate an appropriate legal fee.

Lawyers who are in demand and have experience setting legal fees can better communicate the value of their services.  Clients can assess the lawyer’s track record, consider the importance of their legal issue, and effectively lean on the market to set the price.

Alternatively, a sophisticated client experienced at setting fees can reassure less experienced (pricing) lawyer by referencing previous deals with their competition. In these instances, one party has experience, and one party does not. Reputable attorneys and clients understand that if they drive too hard of a bargain, it will harm the long-term relationship and potentially the result.

When both client and attorney have experience, the situation is optimal. When neither party has experience, failure is more likely. To address the higher likelihood of an adverse pricing agreement, we recommend negotiating safeguards. For example, a firm may set a price for the discovery phases of a litigation matter but convert to billing hourly if a case goes to trial.

Philosophical differences

The philosophical differences related to billing clients can make it difficult for firms to change billing methods. It has been my experience that lawyers who do not bill on an hourly basis resist keeping time records. In some instances, they may believe that recording time on client matters and setting future fees based on these time records is a way to mask hourly billing.

Further, they may feel pressure to cut the bill if they can achieve a result for a client in less time than anticipated. Fundamentally, many non-hourly lawyers price based on the result delivered and not the effort expended.

Others believe that keeping time may incent cutting corners when the hours reach a certain level. Finally, the evaluation horizon for a non-hourly pricing agreement may include more than a single engagement, and trying to “make money” from each case can undercut an implied bargain.

Lawyers who are committed to an hourly billing model believe that it is fair for the client and themselves. These lawyers view pricing as a function of effort expended expressed in units (fractions of hours). Lawyers who bill hourly may believe that non-hourly fee agreements are acceptable for certain types of work, but are not a mainstream approach for all legal work.

When a lawyer’s value expressed as dollars per hour, it is tough to move away from hourly billing. Many clients are also conditioned to focus heavily on price per hour more that the total case cost or ultimate result.

For these reasons, it is just easier for many to stick to the billable hour method. Essentially, it is what most clients want, and it makes no sense to try to change billing approaches.

Regardless of philosophy, we believe that both (hourly and non-hourly) can work if the right data is available. Most defense firms are not good at setting non-hourly fees. Many of their systems, procedures, and rewards support hourly billing. Hourly firms tend to oversimplify the estimating process and lack the training and support to implement more efficient case handling approaches.

Combine all of this with a substantial amount of client hourly demand, and there are more reasons not to change billing methods than to try something different.

We believe that defense-oriented law firms should at least try non-hourly billing approaches in instances where a client relationship is not working economically. Clients on tight legal budgets may appreciate a legal billing agreement that saves them money by eliminating the combined cost (Client and Law Firm) of reviewing legal bills.

Law Firm Recruiting, Lateral Hiring

Lateral hiring normally makes the top 5 list of priorities for law firms desiring growth. Some firms follow a process for lateral hiring that focuses on preserving its culture and values.  Other firms believe that it is more important to break down entry barriers and seek laterals at an expedited pace.

Regardless of a firm’s approach to lateral hiring, a process that is too rigid will scuttle most deals.  A process that is too loose normally ends in unmet expectations – or worse. To temper these extremes, I recommend that firms create a process that includes the creativity of art and the discipline of science.

Specifically, firms desiring to improve their lateral hiring success should consider the following factors:

Cultural attributes

A firm with a strong history of successful results is likely to maintain its dominance in a lateral transaction, but even these firms may benefit from the thinking of lateral hires. Firms that are most successful are open to incorporating the ideas of lateral hires into their culture. Having just evaluated the firm from a buyer’s point of view, lateral hires are positioned to provide a firm with valuable external market insights.

Economic attributes

It is important to understand how a lateral transaction is supposed to be accretive to the firm. Some firms believe that laterals must contribute actual profit to the firm while others are satisfied with help covering fixed overhead. Laterals may also be accretive in terms of new client and or new practice area opportunities. As for timing, I recommend that firms plan on 18-24 months before any real economic benefits are derived.

Recruiting attributes

Firms that are actively seeking laterals are more inclined to engage the services of a recruiter while firms that are in a more passive mode are more likely to be patient and work through their existing network of contacts. Regardless of whether a firm is in an active or passive mode, it is essential that they have a clearly defined approach to engaging a lateral when the opportunity arises. Any ambivalence or ambiguity on the part of the firm will likely scare laterals off.

Implementation and follow up

It is essential to incorporate laterals into the mainstream of the firm as soon as possible. As with a new client procurement, consistent execution is what separates the good from the great. Well executed implementation not only increases the potential for success of an existing lateral transaction, but the ability to have previously recruited laterals assist in the courting process for new laterals is a real edge.

Results evaluation and course correction

There is much to be learned from objectively reviewing the results of a lateral transaction. Skipping this process is a missed opportunity to improve future transactions and to make adjustments to the current situation if necessary. A predefined evaluation process and system for making adjustments will remove the emotion from these decisions and will have the added benefit of encouraging laterals be more candid about their expected future performance.

Lateral hiring will never be without risk. The consequences of a bad deal may include economic loss, morale loss and damage to the firm’s reputation. Creating a process that considers the attributes described above will help to increase a firm’s likelihood of success.

 

law firm, strategic plan, consultant, New Orleans, Louisiana

I am frequently asked whether a strategic plan really makes a difference in firm performance. As I have encountered many firms without strategic plans who have achieved high levels of success, this is a fair question.

The reality is that the survival instincts and talents of the partners in many firms are the primary drivers of their success. These firms operate at very high energy levels, emphasize clients and cases, and measure success in mostly economic terms.

As firms mature, however, it becomes more difficult to compete using this two dimensional approach. To be consistent winners, firms need a strategy to identify opportunities that allows for real growth in capacity and capability.

A strategic plan is most effective for achieving the following:

  • · Sustained success in the long term;
  • · Alignment of leaders and future leaders;
  • · A basis for choosing between opportunities; and
  • · A basis for measuring performance.

Education Before Plan Development

While many attorneys agree that a strategic plan could make a positive difference in their firm performance, they fear that the process of creating a plan will not result in meaningful change. Having read a number of strategic plans that were never implemented, this also seems be a valid concern. I recommend a process that consists of education before actual plan development.

The main areas of concentration include:

  • · Marketing and client service
  • · Attorney development
  • · Staff development
  • · Recruiting
  • · Technology
  • · Finance
  • · Succession and transition
  • · Leadership development
  • · Short and long term incentives

Partners and other key personnel who can view issues from a common frame of reference are more likely to produce a meaningful plan. A plan built on a solid understanding of the market-based fundamentals that includes sustainable incentives is more likely to be embraced by the full firm.

Determining Value of law firm

As any other business, a law firm can have market value to the remaining partners. Determining its actual value can help a firm to make informed decisions involving transition planning.

Valuing a law firm can seem complicated, but mainly, it comes down to three elements:

  1. Book Value of Equity

  2. Platform Value (going concern value)

  3. Value of any transitioned business

 

1. Book Value of Equity

Book Value of Equity is the easiest of these to calculate and most firms can get to this number without too much difficulty. To calculate, a law firm needs:
–  An updated A law firm needs an updated balance sheet as of the valuation date
–  Current accounts receivable
–  Unbilled Sub-ledgers

Most small and mid-sized law firms maintain their books on a cash or modified cash basis. Revenues are recognized when received, and expenses are recognized when paid. Income and expense accruals beyond the current year pension liability are rare.

Book Value of Equity is a simple calculation the includes subtracting total liabilities from total assets.

total assets

Most firms reflect this difference in each member’s capital account.  Given the tax structure of the typical small and mid-sized law firm, all income is allocated each year and flows through to the individual members.

The equity section of a typical law firm balance sheet includes any fixed capital contributions and the undistributed earnings (income less draws and payments on behalf of partners) of the members. Accounts receivable and unbilled fees are typically not included unless a firm prepares an accrual basis financial statement.

Many firms have provisions governing dissolution, withdrawal, disability, retirement, and death in their operating agreements.  In our experience, the most common approaches to handling unallocated book value at retirement include:

  • None (no buy in /no buyout);
  • Stated amount (agreed value among the partners);
  • Based on retirement year equity; or
  • Based on a measure of originations or profit.

Regardless of the method, allocating book value is the easiest to understand.

2. Platform Value (going concern value)

Assigning a value to a law firm as a going concern can include tangible and intangible assets.  Admittedly, valuing a law firm is not likely to follow traditional business valuation approaches, and will probably lack any fair market value comparable.  Paying retiring partners for anything beyond book value and shares of future client receipts is rare, but in some instances, we believe there is a legitimate case for paying for the value of a going concern.

Comparing the costs to start a new firm, which includes cash outlays and lost time, to the cost of buying retiring partners interests is an initial starting point.  One challenge can include the reality that the existing platform is inefficient and lacking in competitive advantage. In these instances, it is necessary to include modernization costs and difficulties into the analysis.

The items that can add going concern value include:

  • Any client master service or panel agreements that can potentially survive a transition;
  • Marketing automation system contacts, workflows, blogs, resources, infographics and any other unique client or contact engagement data;
  • Website and SEO rankings;
  • Billing and financial histories;
  • Document management infrastructure, document histories, and document creation templates and utilities;
  • Efficient accounting and billing systems;
  • Trained staff;
  • Branding and name recognition;
  • Reputational advantages with clients and judiciary;
  • Office leases;
  • Difference between the book value of equipment and the cost of buying new equipment;
  • Established trade credit and banking relationships;
  • Repeatable processes and procedures; and
  • Ability to buy increase errors and omissions insurance.

While this list is not all-inclusive, it does indicate several potential advantages for evaluation. Firms who have built an efficient platform can offer junior partners compelling reasons for paying retiring partners for going concern value. Firms who do not score well in these areas have a difficult time convincing junior partners to assign a value premium to the going concern.

Assigning a value to a going concern requires a careful analysis and comparison with the benefits and costs of starting a new firm.  Developing a 3-year profitability model that compares the results of maintaining the current platform to those associated with starting a new law firm.

As mentioned previously, paying a retiring partner for going concern value is not an exact science. Each situation will differ and depend on the clarity of advantages.

3. Value of Transitioned Client Accounts

Paying retiring partners for clients that a firm retains is handled in several ways, but in small and mid-sized firms, we prefer individual agreements between retiring partners and those benefiting from the transitioned client relationships.

For example, if a retiring partner facilitates a client transfer to a junior partner, the junior partner would absorb the cost any compensation paid to the retiring partner for any transferred clients.  If more than one partner benefits from a retiring partner’s clients, each partner will participate in defraying the cost of the retiring partner’s compensation in proportion to the benefit they receive.

Firms that have client and matter profitability readily available have an advantage and can negotiate sustainable agreements retiring partners.

We recommend paying retiring partners over a period of years (3-5), depending upon the role of the retiring partner and the transition period. We recommend compensating based on each client’s contributed profit before transition costs.  The level of payout that retiring partners receive can vary based on profitability.  Many law firms do not run client level profitability and paying based on gross fees is common.  Paying based on gross fees can create an unprofitable situation if the payouts are more than the profitability of the transitioned work.

A firm can set guidelines on how much a partner receives on a percentage basis and the duration of the payouts, but each retiring partner agreement can differ.

Other approaches to paying retiring partners include:

  • historical compensation based formulas,
  • arbitrary stipends, no benefit,
  • founder’s bonuses,
  • and other guaranteed payments.

Additionally, most small and mid-sized firm partners receive performance-based compensation throughout their careers, and many firms do believe that additional post-retirement compensation is justified. In these instances, partners are likely only to receive their capital account balances.

Transitioning clients requires planning and active participation on the part of a retiring partner. Creating the right incentives can increase the likelihood of perpetuating the firm.


A progressive approach to developing and executing a transition plan requires a sustained focus, which is often difficult for administrators and lawyers who must manage daily business demands and be pressing client service issues. Outside support, working in conjunction with in-house resources, ensures that the planning process remains focused and deliberate.

Law Firm Best PracticesTo read more about developing an effective transition plan for your law firm,  click here to visit PerformLaw’s main website.

Grow law firm going-conern valueLaw firm transition planning is trying enough to firms. The process is often further complicated when determining the value of a firm as a going-concern. Senior partners are often dismayed at the unwillingness of junior partners to attribute any value to the firm beyond asset value, including AR and WIP, less any debt.

Most transitions are dependent upon keeping a retiring partner’s clients and on having junior partners willing to share a portion of future profits of any transitioned clients. Beyond future income sharing, going-concern value, if any, is typically limited to the amount it would cost the remaining partners to start a new firm and possibly a convenience factor.

It is helpful to organize the valuation process into components as follows:

  • Net realizable value of the firm’s assets less liabilities;
  • A convenience factor related to a functioning firm;
  • The value of ongoing client relationships;
  • “Going-concern value” which is the value of a firm’s intellectual property, systems, processes, procedures, and trained staff, reputation, surviving panel counsel appointments, and any unique distinctions*.

*Adapted from http://www.businessdictionary.com/definition/going-concern-value.html

Valuation techniques are discussed separately in the valuation section and our purpose now is to answer the following question:

What can a law firm do to create more going-concern value?

To start, a law firm can build repeatable processes that encourage consistent client service and practice efficiency.  As an example, a client of ours is adapting a popular cloud-based application and related plugins to manage client case communications and internal case management. Using this automated communication workflow, the firm’s lawyers and staff communicate significant case developments in real time and simultaneously enable a consistent case handling and client communication process.

Marketing automation software is another example of how a firm can lessen its reliance on the relatively few lawyers who develop business.  Good marketing automation software contains built-in best practices and marketing tools that can raise the level of the firm’s marketing competence.

These systems enable all lawyers to contribute to the firm’s marketing effort. A junior lawyer can increase her visibility by developing content that is relevant to a target audience. This audience can eventually become followers and contacts.

Dedicating a portion of the firm’s resources to building a competent marketing and business development system is another important step in creating going concern value.

Creating going concern value requires modernizing the firm’s business processes to the point that they become a platform. Many firms suffer from business processes, procedures, and systems that are ad hoc and intermittently efficient. Most firms struggle to invest the time and money to create any real institutional value.

Firms who fail to invest in building repeatable processes can only claim minimal going concern value.  In instances where technology, process and personnel skills are outdated, negative going concern value is indicated.

If the company can create a platform with a value that extends beyond any one client relationship, institutionalizing many of the current administrative processes is necessary.  Adopting cloud-based technologies and software applications that can provide needed structure are recommended.

We recommend the following applications for consideration:

  1. Client case management and engagement software;
  2. Cloud-based email and Office;
  3. Automated Forms and Electronic Signature Application;
  4. Integrated Document Management with Secure Email Transfer;
  5. Web Development;
  6. Automated Planning Software;
  7. CRM Software; and
  8. Marketing Automation Software.

Each of these applications can transform the companies ad hoc process and create going concern value. Building a perpetuating firm will require institutionalizing many of the manual processes and procedures. It will also require a substantial knowledge transfer from the senior partners. The idea is to institutionalize as much of this knowledge as possible. Combined with talented lawyers and staff, a firm can significantly increase the chances of a successful leadership transition.

The right software applications can capture best practices and turn them into repeatable processes. Building going concern value that transcends the reputation and referral network of the senior partners is an essential element in the creation of going concern value (something worth buying).

  1. Client engagement applications, when adapted, are designed to create a consistent interface for clients, lawyers, and staff. Creating service levels and tracking performance can lead to insightful performance metrics. Automated workflows can provide clear and timely communication. Escalation workflows ensure that service levels remain high.

Combined with competent lawyering, a firm can become an easier choice for clients, which is a deterrent to switching to another law firm.

  1. Cloud-based email and Office (Work, Excel, PowerPoint, Skype, etc.) applications ensure that the firm’s licensing and software versions are all up to date. Additionally, as all email is in the cloud, a much simpler disaster recovery process is available.

Many firms have already converted to cloud-based email and Office applications. Firms that are using non-Microsoft applications can enjoy the same benefits. Lawyers and staff benefit from the most current versions of the most popular office applications. Once fully converted, a firm can redirect resources into higher impact areas.

  1. Automated forms, templates, and electronic signature applications create consistent processes where they to do not presently exist. Uniform document templates, forms, and electronic signatures will significantly reduce paper filing and enable fast and efficient workflows

Once created, this collection of forms, templates, and document signature workflows will create a compelling reason to maintain the current firm. Recreating these processes during a new law firm start-up or lateralling to another firm could require a prohibitive amount of time and cost.

  1. Integrated document management and secure email applications provide encrypted email, robust document storage, advanced file sharing and basic to complex document management. Cloud-based systems eliminate the need for most in-house servers, which can improve functionality and reduce IT expense and downtime.

Integrating a fully functional document management system with the firm’s other client service applications also creates a strong argument for enhanced going concern value. It also increases the risk and complexity of starting a new firm.

Bootstrapping or recreating these processes, assuming they are competitively superior, is expensive and challenging. Clients would likely notice a negative difference, which can create an opportunity for competitors. 

  1. Web development is necessary to improve the company’s website and online presence. Creating a website that is a resource for clients and prospective clients can lead to more business and can keep the firm competitive in an increasingly more digital market. Successful web development requires an ongoing commitment.

Building value in a website is a primary consideration in going concern value. Building out a great website takes hundreds of hours of time and significant monetary resources. An effective website can solidify a firm’s competitive position in search relevance, elevate the visibility of the lawyers and draw prospective client traffic. It also serves as a strong reassurance to current clients that their buying decision is a correct one.

  1. Automated planning software, especially in sales and marketing can enable a consistent planning process. It can also improve the effectiveness of the sales and marketing personnel. Firm-wide planning software is most useful.

An automated planning process the promotes collaboration among the firm’s lawyers, and management can ensure the efficient application of marketing resources. A well-formed plan that includes clear goals and actions is more likely to receive funding and other resources. Management can then gauge the plan’s effectiveness recommend improvements.

Firms that can add to a lawyer’s personal marketing success can demonstrate a higher going concern value. Alternatively, creating or plugging into a new planning process is disruptive and can stall momentum.

  1. CRM (Client Relationship Management) software ensures the consistent maintenance of client and prospective client relationships. Automated workflows are available to provide regular communication. A detailed mailing list, buyer personas, indications of client interests, important dates, and contact histories are all components of an efficient marketing process and add to going concern value.

Many law firms are uncomfortable with the active pursuit of new clients. For good reasons, law firms are careful with any direct solicitation. Creating a way of engaging prospective clients on a level dictated by them is most effective.

For example, if a firm creates informative content and experiences high-interest levels (tracked by the marketing automation software), it may decide to create a seminar or webinar and invite the interested prospective clients to participate.

 Again, much trial and error are necessary to perfect a procurement strategy, but once completed, the addition to going concern value is significant.

  1. Marketing automation software (MAS) is a powerful tool for lifting a company’s image and raising awareness among a larger group of prospective clients. MAS applications are the heart of a digital marketing strategy and management of a company’s web presence, social media, client communications, and marketing cost effectiveness.

The right application can provide the best practices, training, support, functionality, workflows and analytics that can transform a firm’s marketing. A properly implemented and well-maintained marketing automation system can lift the performance of the average lawyer.

Firms that can offer their lawyers an automated and perfected marketing process coupled with an equally good procurement system will have the highest going concern value.

Cloud-based technologies that enable advanced workflow and document management, marketing automation, and practice specific applications are improving at a rapid pace. Technology can allow a firm to expand to virtually any place in the world with an internet connection. A distributed workforce enabled by technology can expand a firm’s reach and reduce overhead at the same time. New technologies can improve client service and enhance competitiveness.

Generating more going-concern value requires focusing on repeatable processes and institutionalizing as much knowledge as possible. Creatively adapting presently available cloud-based applications can transform a firm and increase going concern value. Firm’s that rely solely on the relationships and talents of their lawyers and staff have no real going concern value beyond a relatively minimal convenience factor.

financial-transition_Plan_Law_FirmsA law firm transition plan can span over several years, requiring substantial investments from the remaining partners. Quantifying the potential impact on the firm’s profits and, ultimately, the income of the partners, informs plan development.

Healthy firms that have the right information can expedite the process.  Firms that lack profitability and/or have weak financial reporting may need remedial action before committing to a transition plan.

The elements of a transition-oriented financial plan are as follows:

  1. Cash flow, debt and equity over the transition period
  2. Effect of transition comp on earnings for the firm and for assuming partners
  3. Profitability of transitioned work
  4. Effect of multiple transitions occurring simultaneously
  5. Scenario planning at various levels of transitioned work
  6. Exit costs in the event of a failed implementation
1. Cash flow, debt and equity

The capital structure of many firms is reliant upon a combination of trade credit, bank and other interest bearing debt obligations, and members’ equity.  Members’ equity consists of fixed or paid in capital plus any undistributed profits.

Depending upon the amount and duration of retiring partner payments, a firm may need to secure additional capital. Preparing partners for the eventuality of the firm incurring more debt, withholding current earnings, or requiring more paid in capital from partners ensures that sufficient cash is available to make retiring partner payments.

Firms that skip this step are asking for trouble and potentially inviting instability.

2. Effect of transition compensation

The effect of a retiring partner’s compensation is either borne by all partners or only those partners participating in the transition plan. In most situations, a hybrid is also possible that includes a share that all partners absorb and a share that the benefiting partners pay.

All remaining members typically underwrite retirement payments not tied to a transition plan.  Firms that link retiring partner compensation to the transfer of client relationships can either allocate transition costs to all partners or only to the benefiting partners.

As an example, a firm that uses a profitability driven compensation approach or considers originations in compensation may allocate a retiring partner’s transition costs to the partners receiving post-transition origination credit.

A firm may also withhold assigning client credit to any partner until the transition period is complete. In these instances, the partners benefiting from the client transfer defer any compensation increase until after the transition period.

Regardless of the approach, calculating a pro forma effect on the remaining partners’ compensation adds to the transparency of the process.

3. Profitability of the transitioned work

Understanding the profitability of a client relationship before a transition is useful, but it is more important to project profit post-transition.   Future profit models allow a firm to determine the amount of net income available for transition compensation.

Additionally, a firm must consider the impact of changes in the staffing mix. Assume that the retiring partner worked a high number of billable hours on a client account, but the replacement partner plans to use a more leveraged model. Client considerations aside, what is the impact of that decision?

What if the opposite were true and the replacement partner plans to work many of the hours that were performed by others in a leveraged model? What if the replacement partner is planning to staff the account differently altogether?  If the transition plan calls for a retiring partner to receive compensation based on client profits over a period, these considerations are important.

4. Effect of multiple transitions happening simultaneously

Depending upon the size to the firm, simultaneous transitions can overtax the resources of the firm. Additional factors include the term of any payout or return of capital. Some firms cap combined transition costs or retiring partners’ costs at a percent of net income.

When transitions are essentially agreements between individual partners, they are easier to accommodate. In these instances, the firm has an interest in ensuring that transition arrangements are well understood by the parties and are feasible.  A weak agreement will inevitably become a problem for the entire firm. We recommend partnership approval of all transition agreements.

5. Scenario planning at various levels of transitioned work

We recommend modeling a best and worst case scenario. Worst case planning prompts a firm to consider a process for managing a failing transition.  Several considerations become relevant including:

  • Who assumes the risk of a successful transition?
  • Is there a role for the firm if the transition is not working?
  • What monitoring tools are necessary to detect issues in a transitioning account?

Modeling or a best-case scenario is also important. Client relationships are fragile, and a firm may want to allocate additional short run resources to ensure that service levels remain high.  A firm may also incur higher marketing and training costs.  Recruiting fees may also apply.

In these instances, it is necessary to consider the costs of these additional resources in the transition plan.

6. Exit costs in the event of a failed implementation

Firms should also consider the possibility of failure.  This is difficult to do with such a forward-looking action as transitioning a retiring partner’s successful practice.

While the retiring partner will likely want compensation in a failing transition, the firm will not have the underlying economic base to make these payments.  Correspondingly, a firm or the assuming partner will not want to pay the retiring partner if the clients chose to hire another law firm. Basing compensation to the retiring partner on future receipts diminishes the cost of a failing transition.

Regardless of the approach, quantifying exit costs in the transition agreement is recommended.

 

A credible process

Transition plans can include several components and a substantial investment. Understanding these costs and adequately preparing for contingencies will add credibility to a firm’s practice transition process. A credible process that is repeatable is a competitive advantage.

 

Law Firm Orderly Transfer EquityTransferring equity interests is typically more challenging in smaller or first generation firms than those that are larger or more mature. Firms that include their founding members may have even more difficulty with transitioning a law firm.  Founding partners often want compensation for the start-up risks they took, along with their reduced income in early years and the the going concern value of the organization they helped to build.

As law firms fully allocate profits to current partners each year, younger partners frequently resist the notion that founding or senior partners should receive compensation for prior risks.

We believe that senior partner goodwill payments that are tied to real residual contributions (book of business) are best compensated as part of a transition plan.

Our experience is that each situation is different and much of the tension relates to the degree of compensation.  In practical terms, if the founding members want a payment level that is greater than the cost of starting a new firm, younger partners are then inclined to start a new firm.

Additionally, equity interests based primarily on tenure can leave highly productive partners without a comparable level of influence on firm priorities, which is a risk.  Law firms that can balance these realities with their long-term needs can ensure their most productive partners stay and can create advancement opportunities for talented younger partners.

How then can a firm transfer ownership to the right people in an orderly way? 

Consider the following recommended objectives for any systems that allocate membership units to members:

  • Ensuring that those partners who are consistently contributing profits to the firm have a commensurate influence on firm strategy, policy, and management;

 

  • Ensuring that units are available for new partners without a disproportionate impact on the productive partners;

 

  • To facilitate the transition of firm ownership from one generation to the next; and

 

  • To ensure that the most consistently productive partners have the votes to protect the culture of the firm.

Many firms decouple ownership from compensation to help ensure fair pay.  Typically, paying partners is accomplished using a bonus plan or some other formulaic approach.  Some firms consider management contributions when adjusting equity, but recommend compensating managerial with income rather instead of ownership.

 

New model firms view partnership equity from an investment perspective. In many instances, a single owner capitalizes the firm initially and owns all the equity. These firms concentrate on building value in their platforms that new partners, when invited, can purchase at am agreed upon valuation upon entry.

 

Inevitably, however, a traditional law firm structure requires a process for the orderly transfer of equity. While not the only approach, we believe that the best way to meet our recommended objectives is to transfer ownership based on a 3-year rolling average of contributed profits.  Our clients employ other viable methods for managing equity interests, but the most successful firms, regardless of their approach, recognize the relationship between consistent performance and ownership.

 

Smart senior partners realize that if they do not make room for others in a timely way, they risk partner defections and the eventual extinction of the firm. Ultimately, most partners want a positive legacy and do not want to be known as the person who presided over the demise of the firm.

Create a law firm operating agreement that addresses all the necessary retirement elements Updating or creating an operating agreement (operating agreement and partnership agreement are used synonymously) that supports long-term strategic objectives is necessary.  New partner entries, leadership transitions, future equity adjustments, addressing non-performing partners, changes in compensation, retirement and buyout provisions, and most other significant actions require changes to partnership agreements.

It is also important to support strategic initiatives with the weight of a legally binding agreement.  For example, if a transition plan requires the admission of new partners, a provision governing the orderly transfer of equity is necessary. Binding the most important elements of the transition plan with a written and legally binding agreement bolsters confidence in the firm’s ability to implement the necessary changes.

Operating and partnership agreements are mature documents, and much of their content is standard. Most of the accords we have read contain some references to retirement but mostly in the context of withdrawal.

Frequently, we see agreements that include outdated buyout methodology. Often these provisions contemplate a valuation of the firm that does not comport with reality, which can create unfunded liabilities that can result in a crisis for the remaining partners.

In some instances, partners leave to avoid paying an unrealistic retirement cost. Additionally, firms that do not have provisions allowing for an orderly transfer of equity can become stagnant if too much power in concentrated in the hands of partners with a short-term viewpoint.

To ensure that your operating agreement contains the right provisions that support the eventual transitioning of the firm, we recommend the following requirements:

Timing and Approach

  • Mandatory retirement age
  • Transition plans and timing
  • Qualifying for a transition plan

Depending upon the size of the firm, we recommend a mandatory age for surrendering equity ownership percentages. Retirement age equity partners may choose to continue practicing in an Of Counsel status, but an agreement as to role and client connection is necessary.

Inserting these types of policies into an operating agreement before actual retirements begin removes the difficulty of opening a dialogue with a senior partner at what may feel like an arbitrary time. For example, a firm may approach a senior partner about retiring when he is 65, which may offend him if he is planning to work several more years.

Mandatory retirement age, transition plan qualification, plan substance, and timing are necessary components of an operating agreement.

We recommend declaring an age that triggers a retirement planning process. For example, an operating agreement provision that requires all partners to indicate their retirement intentions (approach and timing) upon the attainment of age 60.

Creating a retirement window, for example, that enables a partner to entirely or partially retire between the ages of 65-70 can create a transition period that spans up to 5 years, depending upon any mandatory retirement provision.

Provisions to deal with underperforming partners who are close to retirement are also necessary. Transition plans may not apply to all partners. An expedited process for partners who have no clients or key client relationships or unique expertise is needed. For example, a firm may have an initial mandatory retirement age that is binding unless extended by a supermajority of voting interests.

Return of capital and net asset interests

  • Return of capital timing and amount
  • Payout of AR and WIP interests, if applicable

The capital a retiring partner may have invested in the law firm typically consists of fixed capital and undistributed earnings. As undistributed allocated income has been previously taxed or subject to tax in the current period, most firms pay undistributed earnings on an expedited basis. Depending upon the amount of fixed capital, the payout period can extend for several months or even years.

When the return of capital also includes an amount for a retiring partner’s interest in Accounts Receivable and Work in Progress, a valuation process and payment schedule are necessary.

A delayed payment that corresponds to the collection of accounts receivable and unbilled fees is typical. In some instances, however, firm members may agree to longer payment period to allow time to defray any retiring partner replacement costs.

Advance agreement regarding payments of amounts due to retiring partners enables a firm to plan and manage cash resources.

Post retirement liability obligations

  • Lease and debt guarantee policy upon retirement
  • Contingent liability agreement (if necessary)

Some obligations, especially those to third parties, may need special handling by the remaining partners. For example, a large bank loan that is personally guaranteed by all equity partners will require a release of guarantee for the retiring partner. Loan agreements that require a retiring partner’s net worth as collateral are particularly challenging.

Managing a bank guarantee can include several options, but may force a capital call or a pledge of additional collateral from the remaining partners. If the remaining partners are unable to capitalize the firm adequately, concern about the firm’s future viability can arise.

Additional complexities may arise when a contingent liability exists for an action that happened during the retiring partner’s membership. For example, an impending malpractice suit that may exceed the policy limits of the firm’s error and omissions policy.

Depending upon the magnitude of a contingent liability, a range of options may exist, but it is virtually impossible to plan for unknown liabilities in advance. The best approach is to recognize that the potential for contingent liabilities exists and if they arise, take steps to consider the impact on a retiring partner.

Post retirement compensation

  • Post retirement compensation options
  • Retiring partner buy-out provisions
  • Contingent case policy
  • Post retirement practice a law

Most law firm compensation systems are designed to pay partners contemporaneously, which results in little residual value accruing to retiring partners except for transitioned client relationships. While retired partner buyouts are difficult in any circumstance, it is particularly difficult to justify post-retirement payments to partners who were not able to transition clients to other partners in the firm.

Although less common in contemporary times, some firms may pay retired partners a stipend for a stated period post-retirement. Typically, these payments fractionally correlate to historical compensation or are based on a previously agreed arbitrary amount.

Transition agreements with retired partners that contain an economic foundation, which is most often related to client transfers, are preferable and easier for the remaining partners to underwrite.

If a firm does have a universal post-retirement compensation option, it is important to create an annual collar based on a percentage of cash net income. For example, limiting the total annual cost of retired partner buyouts to 5% of net income.

Depending upon the size of a partner retirement stipend, it is limiting the payment period to one or two years is recommend. Without a finite time and a material transfer of value(clients), it is hard for the remaining partners to justify reduced earnings for retired partner buyouts.  Eventually, the remaining partners will grow weary and may join a competitor or start a new firm.

Depending upon the terms of an operating agreement, retiring partners can sometimes force a liquidation, which is almost never preferable.

Firms that chose to pay all retiring partners a stipend would do well to ensure them the economic burden to the remaining partners is less than the cost to start a new firm.

Agreeing on the type of post-retirement practice of law is necessary. Retiring from one firm and joining another is difficult if a partner is still receiving compensation from a former firm.  Addressing post-retirement competition is recommended.

A compensation plan for paying partners who retire from the equity partnership but want to remain active on a part-time basis is necessary. Post retirement pay is typically based on a sharing of worked and generated fees, assuming there is not conflict with a transition plan.

We prefer a transition plan approach with partners who can transfer business. Some firms, however, prefer to pay all partners a retirement benefit and including these provisions in an operating agreement is necessary.

Finally, to the extent that a firm may have contingent cases in progress when a partner retires, a provision governing the distribution of any eventual recoveries is also required.

Orderly transfer of equity interests and capital requirements

  • New partner equity policy
  • Lateral partner equity policy
  • Capital requirements tied to ownership

An orderly process for transferring equity interests among members is beneficial and supportive of firm longevity and growth.  When ownership impacts compensation, transferring equity among members is more difficult. Concentrated ownership interests can make admitting new partners harder.

Untying all or a substantial part of compensation from equity percentage can also make it easier to reallocate a retiring or transitioning partner’s ownership units.  Performance-based compensation also allows a firm to employ a conservative approach to assigning beginning ownership levels to lateral partners.

We recommend tying capital retained by the firm to the equity interest of each partner. For example, if a firm maintains $300,000 in capital reserves a 10 percent partner will have $30,000 invested in the firm. Tying capital to equity ensures that influence and dollars at risk are aligned.

The orderly transfer of equity and sensible capital management provisions help to ensure that membership interests held by retiring partners are indicative of their current contributions to the law firm.

Firm valuation provisions

  • A valuation approach to firm assets
  • Interest in firm assets and liabilities

Valuing a law firm beyond book value is tough. Most law firms have no value beyond the lawyers and the clients.  The value of a going concern is one possible approach, but a more relevant approach may consider startup value.

For example, how much would it cost if the remaining partners were to liquidate the existing firm and start a new law firm?

Some of the nuanced law firms are creating platforms that may ultimately have value to successor owners. For example, an efficient overhead structure, cutting edge technology, top quality fee earners and staff, a marketing process, client binding mechanisms and proven leadership and management teams may have market value.

For most law firms, many these factors are not present, and book value concepts are most accurate. Provisions are necessary for valuing the firm if retiring partners are going to receive payments based on their equity interest in net assets.

Supporting Policies

  • Compensation policies
  • Partnership admission policies

Many firms include their compensation system as an exhibit to their operating agreements. We recommend including definitions and examples of formula based systems. Thoroughly documenting subjective pay systems where possible is also recommended.

Documenting compensation policies and including them in the firm’s operating agreement can promote stability and maximum predictability.

New partner admission standards and guidelines are typically not incorporated into an operating agreement, but referencing their existence is helpful. Most operating agreements do contain provisions that govern the admission of new partners as it relates to voting.

We recommend investing the time to create an operating agreement that includes all the necessary policies related to retiring partners. Retirement policies that are well thought out, financially sound, and practical can make a firm sustainable from one generation to the next.

Target_vector_IconLaw firms taking a progressive approach to considering the elements of a transition plan must have a sustained focus. This is often difficult for administrators and lawyers who must manage daily business demands and press client service issues.  To best ensure the planning process remains focused and deliberate, a law firm needs outside support to work in conjunction with in-house resources.

We have found that management personnel shares many of the concerns of younger partners, associates, and staff. Their awareness of the business continuity issues typically comes from their experience and direct input from the individual lawyers and other employees.

We see management and staff as participants in the process who also have a stake in the outcome of the process. Additionally, objective third party advice can enable a less risky communication process from not partner participants.

A typical transition planning process takes six months to a year to complete and involves an in- depth analysis of the following areas:

  • Work-life timelines and capacity planning;
  • Marketing;
  • Attorney development;
  • Recruiting;
  • Compensation and incentives;
  • Transition and buyout compensation;
  • Policy formulation;
  • Partnership or operating agreement;
  • Orderly transfer of ownership interests;
  • Technology;
  • Platform building;
  • Implementation timing and process; and
  • Staff Development.

Taken together, these areas of concentration inform a firm’s highest priorities. The broad purpose of each analysis as follows:

  • Work-life timelines provide a planning horizon;
  • Marketing effectiveness indicates the firm’s ability to meet revenue goals;
  • Attorney development is essential to skill set continuity;
  • Recruiting effectiveness enables a firm to address capability and capacity weaknesses;
  • Compensation and incentives can attract high-profit laterals, ensure partners practice profitably, and incent senior partner transitions;
  • Policy development is essential for promoting consistency and building trust among partners, associates and staff;
  • A partnership or operating agreement ensures that necessary actions have the weight of a legal agreement;
  • Perpetuating a law firm requires a process for transferring equity without controversy;
  • Technology can promote efficiency, provide a competitive advantage and bind clients to the firm;
  • Creating a platform that elevates the success of the lawyers and staff builds value;
  • A trained and motivated staff can support the knowledge transfer process; and
  • Ensuring that process moves from planning to implementation is vital to the long-term interests of the firm.

The goal of the transition planning process is to develop a set of thoroughly analyzed and ready-to implement priorities.

Concepts_Staffing_Transition_PlanningWork-life timelines for all attorneys within ten years of retirement age are necessary for indicating the future capacity needs of the firm.  It is our experience that many attorneys seriously consider retirement between age 68 and 70.

Practice areas are more likely to survive over a longer continuum than many client relationships. For this reason, transition planning ten years before an actual retirement is conceptual and primarily focused on the sustainability of the skill sets in any affected practice areas.

Preparing work-life timelines in advance forces aging partners to consider their successors. In our experience, introducing replacement lawyers into a client account at least three years before a partner retirement can improve client retention probability.

Choosing a successor from an existing account team seems logical, but is not always an optimal choice. In many instances, loyalty and emotional attachment can impair the judgment of the retiring partner. Law firm management can struggle to find a voice in these situations. The retiring partner may feel that a loyal and hardworking member of the account team deserves an opportunity to assume the lead role, which is fine if this person is the best choice.

Most small and mid-sized firms have a non-interventionist policy regarding partner and client relationships, and it’s hard to insert a successor lawyer into a client account without the full support of the retiring partner and key members the account team. As we have had better success with incentives rather than penalties, we recommend approaches that encourage retiring partner cooperation.

Capacity planning that includes a consideration of skill and experience levels is an essential element of any transition plan. The items considered in a capacity plan include the following:

  • Age;
  • Experience;
  • Unique skill sets;
  • Billable hours targets;
  • Skill development needs;
  • Marketing goals;
  • Bar and professional goals;
  • Pro Bono commitments;
  • Recruiting responsibilities; and
  • Administrative contributions.

These analyses are prepared, as relevant, at the firm, section, practice or by strategic grouping. For example, by client team or even by skill set such as trial experience.

Capacity planning is inexpensive but curing the indicated weaknesses typically comes at a cost. For example, hiring in advance of the need to allow for training can run into six figures during the ramp up period. Several benefits and risks come with this approach to capability and capacity management including:

Benefits:

Enables transition planning;

  • Guards against turnover;
  • Can contribute to the competitiveness of the firm;
  • Can create competitive peer pressure;
  • Helps ensure high client service levels; and
  • Can maximize profitability when work surges.

Risks:

  • Financial risk;
  • People don’t always work out;
  • Excess capacity can impact productivity of others;
  • Training objectives not achieved;
  • Clients may not cooperate;
  • Potential compensation implications; and
  • Partners who do not directly benefit may lose patience with the process.

Assuming a firm can get comfortable with the risks, staffing in advance of demand is a useful tool in transition readiness.

Another element of capability and capacity management is the concept of strategic staffing. This staffing approach seeks to align case assignments with skill development or client transition objectives. For example, assigning a senior associate who needs trial experience to cases that are going to trial, or working a successor lawyer into a client’s most important matters.

The largest impediment to this staffing approach is a workload imbalance (big case, new work, turnover, etc.) that causes immediate capacity needs to meet client demands. When this happens, the firm’s short-term needs come into conflict with long-term strategic goals.

Typically, short-term priorities win.  The pressure of the work and the immediate financial gains can create an overwhelming force. Unfortunately, these situations can result in unprepared associate lawyers, a weak transition posture, a bloated cost structure and challenging HR situation.

Ensuring the long-term viability of the firm requires a more thoughtful approach to staffing and a genuine interest in the careers of colleagues and co-workers. The risks to a disciplined approach to staffing are real, but the benefits can define a firm for decades.

Read more about effective law firm transition planning on PerformLaw’s Law Firm Best Practices blog.