Law firms are cash operations. Like many of us in our personal lives, law firms exist month-to-month, or quarter-to-quarter. Live many of us, when times are tough, law firms rely on their credit lines to float the bills.
Just like many of us, law firms do not have a savings account for when times get tough.
For most firms, at the end of the fiscal or calendar year, the cash is added up, the bills are paid, the profits-per-point are assigned, and the profits per equity partner are split. If the numbers are up, capital improvements are considered. If the numbers are down a bit, the new computer system is put off for a year. If the numbers are way off, a new chair is elected. And if the numbers are really, really bad, the firm looks for a merger partner or votes to dissolve.
Today, another firm announced their intent to dissolve. According to their statement, Wolf Block voted to commence “unwinding the firm’s business:”
The decision to unwind was reached in view of a confluence of unfavorable factors: the economic recession, especially in the firm’s core real estate practice; the constriction of credit occasioned by the ongoing banking crisis; and the intended and anticipated departure of significant partners and practices.
I had a partner in my firm recently wonder why there were so many layoffs this month. It was an easy answer for me, as I had personal experience at a prior Big Law: Many law firms pay out their previous year’s compensation after the first quarter of the New Year.
In boom times, this is great. Firms live off credit for the first few months. Partners hold off on their new purchases until the Spring. Revenue comes in. Credit line is paid off. Business as usual.
But in a bust year …
Bruce MacEwen over at Adam Smith, Esq. wrote an interesting piece about how the imperative placed on profits is skewed in respect to the overall role of the equity partner. He defines three distinct roles for the equity partner:
- Workers/producers, in which role their job is to actually bill hours and perform client work. In this role, their appropriate compensation is what the firm would have to pay a non-equity partner to perform the same work.
- Managers/administrators, in which role they help run their practice groups or departments, manage staff, mentor associates, participate in firm committees, and so forth. In this role, their appropriate compensation is what the firm would have to pay nonlawyer executives to perform the same work.
- And last and only last, equity partners, which is to say, owners with a residual claim on the profits of the enterprise after all other expenses and claims have been satisfied–including, if you want to be rigorous about it (and some of us do), paying the first two sums listed above out of operating income.
Yet too many equity partners place all their focus on the third bullet point.
But of course, in wonderland, partners view themselves as wearing one and only one hat, namely the last one. This means they view their compensation as coming entirely from their role as equity owners. And given the current realities of law firm organization, finance, and accounting, they are entirely right to see it that way, however economically irrational that might be in the abstract.
Why does this matter? Only because, as we’re about to see, “profits” in law firm land have a special meaning, and that’s why they’re imperative.
If equity partners across BigLaw had been raised from 3L status on to understand, internalize, comprehend, and expect that their compensation would consist of those three different components, the last of which is highly variable, profits would not be as imperative as they are. But that’s not the world we live in.
In today’s economy, if a law firm partnership is going to survive, than the PARTNERS need to look beyond PPEP as the only measurement of the value of their personal and professional relationships with the firms. They need to return to the holistic dynamic of a partnership. That is you SHARE in both the PROFITS and the LOSSES of the firm.
For a lot of firms, there will be bad times in the year or two ahead. That is not to say that these firms cannot survive. And it’s not to say that profits are not important … it’s just to say that INCREASED profits, year after year, cannot be the only thing holding the partnership together. It just means that law firms, just like the rest of us, need to be willing to absorb the economic hit the best that they can.