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.

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.

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.

 

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 a 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.

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.

The main areas of concentration in a strategic plan should include:

 

Strategic Plan Development

Establishing clear goals and developing a plan for achieving these goals is best accomplished using a structured process. A law firm strategic planning process typically covers several areas including marketing, professional resource development, compensation and incentives, recruiting,  progression and admission criteria, capacity planning, transition compensation, technology, financial management  and leadership and management training.


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Process Management
Establishing clear goals and developing a plan for achieving these goals is best accomplished using a structured process. A law firm strategic planning process typically covers several areas including marketing, professional resource development, compensation and incentives, recruiting,  progression and admission criteria, capacity planning, transition compensation, technology, financial management  and leadership and management training.
Marketing Plan

A marketing plan is a fundamental component of a strategic plan. A strategic marketing plan typically includes the following elements: Firm-level plan; section or strategic group plan attorney plans; paralegal and support staff contributions to marketing; review of optimal client account staffing; competitive analysis; digital and inbound marketing strategy; branding; technology (CRM, marketing automation software); and  a budgeting and approval process.


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Attorney Development

The components of an attorney development system include an evaluation process, practice planning process, client staffing alignment, incentives for senior attorneys use junior lawyers, and capacity and capability evaluation.  A strategic approach to staffing (aligning client work with training needs) can speed up attorney development, but often requires collaboration with clients. Anticipating client concerns and creating incentives for clients to can make strategic staffing possible.


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Recruiting

Most firms do not have all of the talents they will need to effect a successful transition. Prospective recruiting and lateral hiring strategies are often needed. A well-communicated plan with incentives for those who actively recruit has the potential to transform a firm immediately. Recognizing recruiting contributions is an important part of creating a recruiting culture.


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Compensation and Incentives

Plans that address compensation issues and that incent the behaviors that are congruent with the objectives of the strategic plan are ideal. Remuneration and incentives tied to profitability coupled with clear origination policies will support collaboration and increased plan acceptance from all firm members.   A dynamic compensation approach includes rewards for producing profits, business development, recruiting, training and leveraging is most desirable.


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Policy Development

Clear progression partnership admission criteria are important long-term considerations for talented young professionals deciding to invest in the firm’s success or look elsewhere. These policies are equally important to top professionals evaluating a possible association with the firm.  Designing these policies to support the firm’s strategic plan helps to ensure that the right people advance and makes it easier to recruit suitable laterals.


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Worklife Timelines and Capacity Planning

Worklife timelines for all attorneys within ten years of retirement are necessary for determining the future capacity needs of the firm. Evaluating capacity before departure provides the firm more time to implement client transitions. Preparing worklife timelines forces aging partners to consider their successors. In our experience, introducing successor lawyers into a client account 2 or 3 years before a partner retirement significantly improves client retention probability.


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Transition (buyout) Compensation
Creating sensible buyouts helps ensure that younger partners are not incented to start a new firm to avoid paying senior partners a disproportionate share of current profits. Apart from accounts receivable and work in process, most law firms have no other liquid assets.  Given that most client relationships are tied to an individual and not to a firm, existing partner cooperation in a business transfer is necessary. Creating an affordable buyout structure can benefit everyone and is an important part of any strategic plan.
Partnership/Operating Agreement Revisions

Updating or creating a partnership agreement 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, etc. often require changes to partnership agreements.


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Technology
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 a firm’s competitiveness. Choosing to partner with the right IT resources can transform a law firm.
Financial Plan

Financial modeling to consider the potential impacts of the strategic plan, enhanced profitability reporting, a market competitive cost structure, pricing alternatives, capitalization, earnings management are all contemplated in the strategic planning process. Partners must understand the investment required to implement any proposed plan along with the potential risks and rewards.  A sound financial plan will support plan implementation.


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Implementation Support
Creating a strategic plan is a time intensive task. Firms tend to lose momentum after the written part of the process is completed. In too many instances implementation falters. Charging someone with the responsibility to implement early in the process is recommended.
Retreat
At the completion of the strategic planning process, a retreat to consider and adopt the plan is most helpful. A setting away from the office without the routine interruptions can result in a deeper commitment to the firm’s goals greater plan acceptance.

In our experience, trying to address all of these areas at once ends up in a lengthy document with little time remaing for implementation. We recommend that our clients start with their highest priorities and begin implementing early in the process. Immediate successes are critical to building momentum.

For many firms, especially first-generation firms, admitting new partners at the right level can be a challenge. Whether it is a new partner from their current ranks or a lateral partner from another firm, placing a new partner at the right level is much easier if compensation does not depend on equity share and the firm has a process for routinely adjusting ownership.

Recall from our previous posts on our Best Practices Blog that we discussed systems for compensating partners based on contributed profit and changing equity based on a rolling average of that added profit. If you missed those posts or you would like to review, we have provided links here.

The considerations for admitting a new partner often depend on the firm’s compensation system and the proposed partner’s ability to thrive in at the partner level. One initial hurdle for most newly admitted partners is the transition to owner from employee, which often includes a change in payroll status and a continuing guarantee of firm debt.

Compensation independent of equity

When compensation and equity are not dependent, we recommend a nominal equity percentage (1%) initially that is adjusted after a period. We recommend the first adjustment period span three years and then annually after that using a prior three-year rolling average of contributed profits.

We like this approach for new partners for following reasons:

  • Making new partners is much easier and typically does not by itself create a material shift in equity interests among current partners;
  • New equity partners often rely on origination sharing with current partners, which may change post admission;
  • Increased equity comes with a greater financial commitment, and new partners frequently need time to afford the applicable capital contribution; and
  • It allows time for the firm to implement any strategic initiatives such as transitioning senior partners and the process of reshuffling clients.

Although less preferable, some firms may have a solid three-year track record with an attorney and may choose to include those results into the ownership alignment process immediately. As a result, no three-year adjustment process is necessary, and equity continues to adjust annually.

While we are not discussing laterals until our next post, it is also possible to use this same approach toward lateral equity considerations.

Compensation dependent on equity

Firms that base a material part of compensation on ownership can implement other alternatives to immediately offering a high-value initial equity position. Slotting new partners based on a factor of their pre-partner compensation effectively equates compensation and equity. For example, assume a firm’s policy for new partners is to ensure that partnership does not result in a pay cut. In this instance, a person currently making $215,000 annually (salary and benefits) would rate a 10.75% share a firm that generates an annual profit of $2,000,000.

It becomes even more complicated if the firm’s policy is to ensure that equity partnership results in a raise in income after considering any benefit differentials. Regardless of these complexities, we do encounter these situations and typically evaluate the feasibility of following options:

  • Creating tiers for timekeeping and origination contributions;
  • Creating a transitional compensation plan for new partners that includes a partial guaranteed payment;
  • Including the previous three-year’s results when calculating the new partner’s initial equity;
  • Creating an income reserve in new admit years as a safeguard against an over or under slot; and
  • If necessary, amending the operating agreement to include a process for regularly adjusting equity.

Tying equity to compensation is more complicated and requires consistent and thoughtful consideration of partner contributions to ensure that partners are fairly compensated, and the ownership structure of the firm is supportive of a highly productive culture.

Sum up

As mentioned throughout, our default recommendation is to adjust new partners to an appropriate level after a three-year period, which is only possible if compensation is independent of ownership. We do encounter very successful firms that do not formally have a process for adjusting, but typically these firms are highly profitable and can pay above market. Our next post will consider admitting new Lateral partners.

For more on these topics and great resources, please visit our best practices blog and resources pages at performlaw.com.

A system for regularly transferring equity interests among law firm partners is most prevalent in mature firms. Many first-generation firms only change ownership percentages when admitting a new partner or after a partner exits.

Transfers of equity interests that result in a change of control are particularly stressful. Considering that the founding partners may still be practicing and that the firm name often bears their namesake, relinquishing power is typically a challenging process.

We are not discussing buyouts in this post, but often there are no or only nominal buyouts related to a surrender of equity, which can create additional tension. An objective 3rd party can help facilitate communication, propose solutions, and manage expectations.

Smart partners, however, 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.

How then can equity be transferred in an orderly way and to the right people? If you regularly follow this blog or our best practices blog, it should come as no surprise that we recommend allocating units based on contributed profits over a sustained period of years.

The most common adjustment period is three years, although firms that tie compensation to equity may need a two-year duration to align ownership and contributed profits adequately.

Allocating equity based on contributed profits is beneficial for several reasons including:

  • Ensuring that those partners who are consistently providing 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. Firms that do not compensate based on equity can remove some of the pressure to adjust equity, but inevitably, ownership interests must change to reflect the economic realities of the partner contributions and to grow the firm.

Additional considerations may include considering managing partner equity and ensuring that the operating agreement contains adequate voting safeguards.

For a detailed example of changing ownership based on contributed profits, please see our law firm best practices blog.

In our next post, we will review the concepts for admitting new and lateral partners.

 

 

 

Market-aware law firms realize client can globally analyze billing data and draw statistical conclusions about the appropriateness of lawyer billing. For example, it would not be hard to determine the number of hours charged to a client’s matters and perform competitive comparisons and reasonableness tests. Imagine the potential consequences of a poor showing in the testing process.

In the firms we support, litigation practices tend to generate more billable hours than transactional practices, although not always. Within these litigation practices, the ability to produce billable hours also differs. Firms that impose caps on billable hours are usually trying to mute the temptation of billing clients for low value work.

The usual disincentive for exceeding the production cap is to not count toward bonus consideration any billable hours over the annual limit. I understand the point of a cap, but it does seem unfair not to reward someone who, for example, worked on an extensive trial or is a highly sought after specialist.

As most caps are arbitrary (i.e. not dictated by a client), how then are they set? Are they market based? Are they created based on subjective norms and beliefs about reasonableness? Should the type of work dictate the cap? Are short-term waivers a good idea? What about specialists who work in select practice areas? What if clients demand particular a lawyer or group of lawyers? Creating a workable policy requires answering these questions.

 Apart from addressing the billing concerns, a typically overlooked by-product of a policy that sets an upper limit on billable hours is that it can force a long term approach to staffing. If hours incentives are too robust, partners and other timekeepers can be reluctant to add staff or delegate. Not adding staff can lead a firm to an unsustainable economic model and a stagnant workforce.

 Some of the consequences may include one or more of the following:

  • Partners and senior lawyers performing lower level work, which can result in diminished value to clients;
  •  A lack of time for developing better client relationships and more profitable work;
  • Reduced opportunities for individual and team lawyer development;
  • Burnout and frustration related to heavy workloads and limited compensation;
  • Diminished profitability as timekeeper pay increases faster than billing rate; and
  • Too much reliance on one or a few individuals.

Alternatively, a firm can institute a planning process that provides incentives and capital for growth when actual billable hours approach a targeted range for a sustained period. A good planning process can work in concert with a collar on billable hours. Firms can also temporarily relax a cap during periods of sudden increased demand or unanticipated turnover.

Having a firm-wide cap may prove difficult to enforce, but the idea has merit.

*Read more relevant articles on law firm billing, compensation, succession planning on PerformLaw’s blogs:

  1. Law Firm Best Practices
  2. Law Firm Management Concepts

What would you do if a client called you today and proposed to increase the current volume of work sent to the firm in exchange for a blended hourly billing rate all attorneys? How quickly could you respond and how much confidence would you have in your answer? Would your answer change if the client placed fewer restrictions on staffing?

Assuming the client is only trying to save money is possibly an oversimplification of their motives. Recall that the client relaxed their staffing restrictions, which means that the firm is reasonably free to change case staffing.

Could this client’s motivations also include a limitation the top tier rate because they believe that the firm is staffing their cases with too many partners? If so, then it follows that limiting the partner rates will result either in a more cost-effective staffing mix or shifting the cost of the inefficient staffing mix to the firm.

Answering the following questions are will help create the right response:

  • Will the increased associate rate offset the rate decrease to the current partner billing rate?
  • Will the increased volume result in enough profit to compensate for the changes in rate?
  • What is the planned post-proposal staffing solution? Moreover, can the firm offer an optimal staffing solution?
  • What impact does the increased volume have on payroll and overhead costs per hour?
  • Are there profit opportunities or will the new volume create staffing issues that result in a more expensive staffing solution?
  • What overall (applicable to all clients) impact does the increased production and overhead absorption have on payroll and overhead cost per hour?
  • If the cost per hour impact is favorable, are the incremental profits from other clients enough to offset any lost profit resulting from this proposal?
  • What are the intangible effects of the post-proposal staffing solution?
  • What are the ramifications if this client finds a competitor to accept their proposal?
  • Is there room for a counter-proposal, and if so, what is reasonable?
  • What other client opportunities are in the pipeline?

Several other questions are relevant, but answering these will go a long way toward creating a proper solution. In has been my experience that most firms do not get past the fear of losing work or the allure of increased business. Firms that struggle with marketing have no practical choice but to meet client demands. Lack of new opportunities erodes confidence and discourages any pricing dialogue.

client-profitability-law-firm-analytics

Having the relevant data quickly accessible to answer these questions allows a firm to respond intelligently to client requests. Consider the following sample analysis borrowed from our last post. In this format, it is easy to update the existing rate data, alter staffing mixes and create several post proposal scenarios.

What about performing these types of analyses on a proactive basis and informing clients of your plans to stay efficient? Elevating client relationships to this level ensures that you are not caught off guard and is certain to put pressure on less informed competitors.

If you are interested in reviewing a detailed example of using hourly profitability in strategic decision making, please see our Law Firm Best Practices Blog.

CLICK HERE FOR THE ARTICLE

Email_Analyze_Performance_Per_HourWhen it comes to professional services, we all sell time. Lawyers certainly sell time, and in a defense practice, it is almost always valued hourly. Lawyers who bill using fixed fee or percentage of recovery methods may choose not to track or to consider time spent in hours, but the same 24-hour clock is doggedly present.

Whether a firm uses hourly or non-hourly billing methods, there is an underlying cost structure that can be evaluated and often improved. While a simple cost per hour analysis using firm or group totals is easy enough to prepare, it will provide limited insight. For anyone interested in the limitations of averaging, I recommend reading The End of Average by Todd Rose.

An attribute of successful firms is that they make better choices, and making better choices is much easier with good data. A few examples include:

  • Determining where to focus marketing investments;
  • Determining whether a practice area rate and overhead structure is a good fit;
  • Determining if the return on a particular type of case is worth the effort;
  • Determining if a telecommuting model is feasible;
  • Determining if staffing is efficient;
  • Determining if rate increases are warranted; and
  • Determining the salary structure within practice areas.

This list could go on, but the point is that making choices based on consistently applied data is a much better bet than the all too often politically expedient and perception-based methods. Imagine a system that promotes accountability, is transparent, is used consistently, and supports efficient decision making. What is the value of a tool that could reduce decision time from months to minutes?

Analyzing performance per hour is a fundamental part of a data-driven decision-making process. For an in-depth analysis of return per hour best practices, please read our post companion post:  CLICK HERE

Law Firm Data Profitability AnalyzeAs someone who has provided clients with this information for more than 15 years, I have witnessed many law firms transformed by the data produced from a client profitability analysis.  Yes, most lawyers are usually not trained in financial management.  And while their day jobs doe not allow them much time to learn new disciplines, they can quickly understand the elements of client profitability.

Better decision making is supported when leaders are provided with quality information about the impact of billing rates, case staffing, support staff costs, lawyer compensation, marketing, write-downs and write-offs, and other overhead costs on the profitability.

Consider, for example, that you have a client who refuses to grant a billing rate increase. The client believes or knows that she can buy these services from a competitor for the same or better price. The client also perceives that law firms are inefficient and that a billing rate increase is the law firm’s way of covering the cost of these inefficiencies.   How then do you deal with this situation?

For starters, you need to test the client’s assumptions. Depending upon the type of work and the competitive environment in this circumstance, determining if a competitor will step in is not hard. What takes a little more work is determining if you are practicing efficiently. I should add that knowing how efficient you are is an exercise better done before asking for a rate increase.

How does client profitability help determine if you are practicing efficiently?

Borrowing from our Law Firm Best Practices blog, here is an example of a client profitability analysis with matter level detail.

client-profitability-law-firm-analytics

 

The first question is whether a 35.03% return is fair given the supply and demand factors for this client’s work. If there is sufficient competition to provide these services (supply) and there are no real barriers to entry, a 35.03% return will make most firms happy. In this situation, asking for a rate increase is risky.

Improving profitability may require a review of less obvious factors. Consider the table below that compares results to years of experience.

law-firm-analytics-profitability-client

In this example, profit per hour declines with seniority. As many clients manage top rates more closely, an experience related decline in profit per hour is not unusual.

A consideration of future staffing mix is warranted. As the lawyers in this staffing mix mature and assuming the payroll and overhead costs are not held constant, profits are going to decline. All too often, partners ignore the staffing considerations until profitability is unacceptable.

Left unchecked, clients become conditioned to a staffing mix that is unsustainable. When this occurs, the risks associated with changes in the staffing mix or rate structure increases substantially.

Providing partners with these tools and empowering them to make necessary changes quickly is the transformative part. Our example is just one of the many analytical tools available from the data provided by a client profitability analysis.

So yes, we believe it is worth the trouble to prepare these analyses. If you would like more information on the mechanics of client profitability, please see our posts at our Law Firm Best Practices Blog.

CLICK HERE TO VIEW CLIENT PROFITABILITY POST.