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Good Compensation System Reflects Firm's Goals
by Barbara Lewis MBA and Dan Otto MBA

Law firms use various methodologies to compensate equity partners. Some firms divide revenues equally among the partners, some use a compensation committee and others have devised a compensation formula. Surprisingly, research indicates that nearly 40 percent of law firms have no written compensation system. The lack of a fair written formula can strain partnerships and eventually cause their demise.

When attorneys form a law firm, they generally compensate all partners the same. They assume that all of the individuals will expend the same effort and enthusiasm and so they divide the revenues equally. However, eventually firms realize that all partners are not motivated to work in the same way. Some may focus on their careers and enjoy working long hours, while others have a family orientation and prefer a less intense workload during a specific time in their lives. The amount of work performed by each of the partners is not the same. Eventually, the partners who are putting in more hours begin to view the compensation as inequitable.

Nearly half of all law firms participating in a survey acknowledged that they used a compensation committee. Oftentimes, the committee allocation of compensation is more subjective than objective. The lack of well-defined metrics may fuel dissatisfaction among partners who believe they deserve more compensation than they are paid.

Many law firms reward their partners for all the wrong reasons. Some reward partners for their seniority in the firm, although the partner may not bill adequate hours or generate business any longer. Law firms that maintain this type of compensation system have found themselves in a lot of trouble, especially when the younger partners begin generating business for which they are not paid.

Before a compensation formula can be developed, the partners should define the strategic goals of the firm. For example, whether the firm’s goal is to increase revenues, hire associates or develop new services, the compensation formula should be designed to accomplish that objective.

A good compensation formula should be easy to understand, should be written and accessible for partners to review and should be explained and shared with potential lateral partner candidates as well as with senior associates.

There are several basic factors that should be included in the compensation formula. One, of course, is the billable hours. Attorneys need to bill hours and be rewarded for doing so. But it is not just the billed hours, which should be rewarded. The true reward should be for collecting the money that is billed. Yet, many law firms compensate attorneys for billable hours and not collections. Compensating for billed hours and not for collections can pose an enormous problem if major fees are not collected.

The second important factor in a compensation formula is a reward for originations. By going out and bringing in new clients, a partner is growing the firm and should be rewarded for doing so. Yet many firms only compensate partners for billing or collections and not for originations.

A third important area of compensation is delegation. In order to expand a firm, partners need associates and paralegals to assist them. If the firm has not linked reward to the objectives of new business development and delegation, then the key ingredient of motivation is absent and the chances of success are diminished.

A fourth compensation area is for administration work. This includes work done by the managing partner, who supervises the administration of the firm, the marketing partner or the partner in charge of continuing education. Those types of responsibilities should be rewarded, because it is time spent away from new business development and billable work. No attorney will be motivated to manage the firm if there is not some type of reward for doing so.

Another factor of the compensation formula is client and case responsibility. Partners should be rewarded for managing work that they may not have originated or for billing hours. The partner may oversee other attorneys’ work and should be compensated for the supervision.

A comprehensive compensation formula should not be set in stone. The formula should always be tweaked and reevaluated to determine, if it is motivating the partners to achieve the firm’s goals. Take a look at your firm's objectives and analyze whether or not your compensation formula encourages your partners to achieve your firm’s goals.

 

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