law-firm-compensation-small-mid-sized-firmsThere are a lot of small and mid-sized law firms that rely on relatively few clients.  These client relationships are typically consolidated among an even smaller subset of top performing lawyers. It is not unusual for us to  encounter a firm of twenty lawyers serving less than 20 or 30 clients that are managed by three or four partners. We have also worked with firms of more than 50 lawyers working for 6 or 7 groups of clients controlled by as many partners. In these instances, the loss of a client or a partner is potentially a destabilizing event.

Compensation Challenges

Compensation in these environments can present real challenges. Many of these firms, despite their longevity and history, are one or two client losses away from instability. This insecurity can permeate the thinking of law firm partners, causing them to have a short-term approach to organizational development and compensation.

Dominant Instincts

The dominant instincts present in many of the top performers in these firms include the following:

  • Business development is a priority;
  • Business development carries the highest reward;
  • Personal billable contributions are important but secondary to attracting new work;
  • Attorneys must maximize compensation while they have the clients;
  • Disruptions in client relationships can cause more stress than the legal work;
  • Others don’t appreciate the effort it takes to develop, keep and grow a client base;
  • As attorneys, we feel threatened all the time; and
  • With so many incomes reliant on relatively few books of business, it is difficult to relax.

Top Performer Power

As a means of survival, a firm’s culture often bends around the immediate needs of a small but powerful group. As a result, unintended consequences can occur. For example, top performers may appreciate that another partner is succeeding, and even might take less short-term compensation to support their growth, but also might not like the potential shift in the future balance of power.

Small entrepreneurial firms that were created by a few high energy producers can pay better than market compensation for many years. By staying lean and making only long-term investments that support the practices of the top performers, these firms can generate high profits. Managed properly, the partners in these firms can amass a nice retirement, and some even become wealthy. In many ways, partners in these firms accomplished what they set out to do when they took the risk of starting the firm.

Law Firm Transition Process

At some point, however, small firm partners reach retirement age or their practice starts to diminish and many begin to focus on transitioning the firm or creating a more viable institution. Because of their immediate profit generation focus, these firms generally do not have the infrastructure or the necessary junior partners who are capable of perpetuating the firm.  And when there is a transition path, splitting the origination portion of the compensation pool becomes a challenge. If the compensations issues are not addressed, any attempt to transition or transform a firm may be derailed.

Forward-thinking partners start the transition or transformation processes well in advance of retirement or foreseeable client losses. A transformation process starts when the current partners who make up the power structure of the firm desire to change or transform the firm’s strategic vision and operating model. Since most clients buy first from lawyers and then from firms, it is easy to understand why most  firms find it difficult to transform from a collection of individuals to a branded offering . Most successful small and mid-sized firms focus compensation on keeping originators happy first, followed by high producing lawyers and those with unique skills sets, with everyone else falling to the third tier.

Stability Factors

Organizational development that includes advanced compensation concepts comes from stability.  This requires time and means that high producers must embrace the transformation. A firm can find itself in between what is good for current profits and what is best for the long term. Highly productive partners (enabling partners) are called on to invest more income into a strategic initiative than under-performing or new partners. As the new partners or previously under-performing partners become more successful and demand more in the compensation formula, the enabling partners’ incomes can decline, and their prior strategic investments of current income are potentially lost forever.

Analysis and Tools

One way to deal with this is to use a rolling average of results in the compensation formula. For example, a firm that uses a 3-year rolling average of results can allow productive partners to participate in the future uptick in earnings resulting from a successful strategic plan implementation. Some of our clients refer to this as a “slow up/slow down” approach. The slow up/slow down approach is not without issues. Declining partners can “hide” in the formula for a couple of years. While these declining partners deferred income in previous years, it often creates tension when nonperforming partners draw a disproportionate share of current year earnings.

Recognition of where a firm is in their life cycle is also essential. A compensation plan for a young firm that has not fully passed through their start-up phase is likely to differ from a firm that is approaching the transition stage. In our experience, there are several best practices that support stability at all stages, but variations of the application of these best practices is often required. For example, moving from a one-year results approach to a rolling two or three-year results approach.  Another example includes the level of profits apportioned to objective, equity, and subjective pools.

Putting It All Together

Properly designing and administering small and mid-sized law firm compensation systems requires a process-oriented approach, experience, analysis and tools, and an understanding of the factors that contribute to stability. A sense of the firm’s economic, political, and market factors contributes to the development of an effective compensation plan. The capability, capacity and commitment of the firm’s revenue-generating staff to achieve strategic goals and produce a market competitive profit are equally important.

Read more about developing a more effective compensation system at your law firm.

 

CLICK HERE

 

law firm, transition planning, succession plans, retirementWith an estimated 65% of equity partners approaching retirement age over the next decade, most attorneys currently working in a law firm will be affected by the challenge of transition planning. While this statistic is notable, most law firms pay little attention to partners’ plans for retirement.

Without careful planning, the investment and hard work you have put into your firm could end up benefiting your competitors. In this post, we review 10 key steps to prevent this negative possibility by developing a transition plan that works.

 

1. Prepare work-life timelines for all attorneys who are within 10 years of retirement age.

Work-life timelines provide a planning horizon for a firm. Law firms should prepare work-life timelines for all attorneys who are within ten years of retirement age. It is our experience that most attorneys seriously consider retirement between age 68 and 70.

Preparing work-life timelines in advance forces aging partners to consider their successors. Introducing replacement lawyers into a client account at least three years before a partner’s retirement can significantly improve client
retention probability.

Most small and mid-sized firms have a non-interventionist policy regarding partner and client relationship. 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. Since we have found firms to achieve more success with incentives rather than penalties, we recommend approaches that encourage retiring partner cooperation.

2. Be strategic with staffing.

Smart competitors will seize any possible opening in a client relationship. A firm that is ready for these challenges has a definite advantage. Strategic client staffing ensures that younger lawyers build the essential relationships among the
firm’s current clients, which will make competitive challenges more difficult.

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.

Senior partners should evaluate their client staffing assignments at least three years before any planned transition. If no existing resources are available, we recommend a targeted recruiting process.

 

3. Focus on attorney development.

When a law firm focuses on developing its attorneys, it can better determine who is best suited to serve a client’s needs and identify those would perform better in another role. In addition to billable expectations, developing a quality lawyer
requires time commitments in the following areas:

• Client service fundamentals;
• Personal development;
• Marketing competence;
• Training and mentoring contributions;
• Professional profile and peer recognition;
• Skill development;
• Leverage and supervision;
• Recruiting; and
• Basic law firm economics.

A quality attorney development system enhances a firm’s ability to operate more profitability and can also ready lawyers for future leadership and management positions.

4. Develop an efficient recruiting process.

Most good laterals have several opportunities. The firm that can evaluate a candidate quickly and offer a transparent economic deal has an edge.

When considering potential lateral hires, firms should be able to efficiently address questions involving:
• Opportunity costs and benefits;
• Impact on revenue and cost and profit per hour;
• Compensation, and equity slotting if appropriate; and
• Impact on cash flow and current year earnings.

Creating a streamlined process that can simulate compensation post admission (equity is essential) is ideal. Smart laterals want to see current compensation levels of current partners with similar levels of profitability. Having all data readily available will help a law firm to secure the best candidates.

5. Ensure attorney compensation is market competitive

In addition to promoting profitable behaviors, a market sensitive compensation plan can produce a very competitive firm, one that is ready to support a transition process for their most successful attorneys.

A data-driven compensation plan that pays at competitive market levels can reconcile the perceived and actual value of a lawyer’s economic contributions. There is no better gauge of value than what a competent competitor will pay. Accomplishing this level of acceptance will remove a large obstacle inherent in the practice transition process.

With a market-based compensation system, a transition compensation feature, and a process for the orderly transition of ownership interests, firms can will significantly increase their ability to pass from one generation to the next.

6. Be objective with buyout pay decisions

Many personal reasons motivate people to continue working rather than retiring. One significant factor for this is the lack of of remuneration for a senior partner’s income generating asset. Removing the economic disincentives for senior partner retirements increases the chances of a successful transition.

Using an objective process-oriented approach to arrive at a buyout price and structure removes much of the emotion from the negotiation. Firms that have the data to complete the recommended analyses can set expectations early in the
process and create a model for future buyouts.

The keys to setting transition compensation include an objective process oriented approach; setting expectations early in the process; and a model to ensure consistency.

7. Be disciplined in policy development and implementation.

If law firms wish to ensure client business continuity, a disciplined approach to policy development and implementation is necessary. Policy development is essential for promoting consistency and building trust among partners, associates and staff. Firms should identify areas that may impact a smooth retirement process and create policies to ensure
the provisions accomplish the firm’s objectives. Policies can cover areas such as :
• Associate progression criteria
• Partnership admission criteria
• Mandatory retirement with/ without a transition
• Transition period incentives and requirements
• Origination sharing policy
• Basis for transferring equity between partners
• New partner and lateral partner equity policy
• Capital requirements tied to ownership
• A valuation approach to firm assets
• Post retirement compensation

8. Understand the costs associated with transition planning.

A 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.

For example what are the costs associated with transition compensation? And how will remaining partners be affected? What are the projected profits of particular client work post-transition? What effects will potential changes in staffing have on client work post-transition?

Healthy firms that have the right information can expedite the process and answer these questions. Understanding these costs and adequately preparing for contingencies will add credibility to a firm’s practice transition process.

9. Know the firm’s actual value.

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:

  • Book Value of Equity
  • Platform Value (going concern value)
  • Value of any transitioned business

Book Value of Equity is a simple calculation the includes subtracting total liabilities from total assets. Determining platform value (going concern value) requires a careful analysis and comparison with the benefits and costs of starting a new firm. Finally, when paying retiring partners for the clients that a firm retains, firms should have individual agreements between retiring partners and those benefiting from the transitioned client relationships.

10. Continuously build the firm’s going concern value

A firm’s going-concern value includes is the value of the the firm’s various systems, processes, procedures, trained staff, reputation and any unique distinctions. Building going concern value requires modernizing the firm’s business processes to the point that they become a platform. This platform can transcend the reputation and referral network of the senior partners.

To build going concern value, firms should adopt cloud-based technologies and software applications to provide needed structure. Such applications include; Client case management software;Cloud-based email and Office; Automated Forms and Electronic Signature Application; Integrated Document Management with Secure
Email Transfer; CRM Software; Marketing Automation Software.

This technology will promote efficiency, provide a competitive advantage and bind clients to the firm.

 

law firm, transition planning, succession plans, retirementCLICK HERE to Download “10 Key Steps to Law Firm Transition Planning” as an eBook

 

Law Firm Best PracticesCLICK HERE to Receive More Information About PerformLaw’s Transition Planning Services and to See if We Can Help Your Law Firm

The topic of transition planning is not the most enjoyable or easy topic around law firms. But it is critical, especially with a significant number of equity partners set to retire over the next decade. So why is transition planning so difficult for law firms?

The list of challenges to transition planning is a long one. Our eBook “Is It Possible to Transition a Small Law Firm” highlights 12 of the most significant ones we have found in working with small and mid-sized law firms. Some of these obstacles include:

  • Compensation Issues
  • Poor Firm Profitability
  • Inadequate Time
  • Greed and Selfishness
  • Client Reluctance
  • + 8 more obstacles

The only way to survive these challenges is to prepare for them and begin to address them now.  This eBook describes some of these challenges and outlines ways to mange and overcome them.  Of most importance, the book calls out to law firms to start the transition planning process early, to start it NOW.

Download the eBook Here:

Law Firm Transition PLanningWho is PerformLaw?

PerformLaw is a management consultancy based in New Orleans, LA. PeformLaw regularly assists law firm clients with transition planning, marketing and business development, contracted business services, compensation, lateral vetting, performance and process improvements,  and practice planning. For a complete list of services and helpful resources, please visit performlaw.com.

 

PerformLaw law firm consultant

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.