Money. As professionals, we have seen the dollar break up many of our clients’ relationships. Unfortunately, it can hit a little too close to home when it threatens our own professional partnership.
It is imperative to the ongoing success of a professional service firm to create a fair and equitable system that rewards the individual for fee generation, but also encourages contribution to the overall firm goals. Although this issue is faced by a variety of professional service firms, including medical clinics and CPA firms, this article focuses on compensation systems for law firms.
Compensation systems in new law firms often follow a cycle. Initially, the partners will develop the system based only on objective factors. The compensation system will be based on fees collected, less an allocation of fixed and variable costs. This objective system can easily be transformed into a formula to compute attorney pay. Although this system may be sufficient if the firm’s real purpose is only to bring together attorneys to share overhead, it normally falls short as the firm matures.
As the firm matures, it develops long-term goals. The partners want to build a firm where work is cross sold; a firm where associates are being developed to become future partners; a firm that will continue beyond the current owners. Also, the attorneys in the less-lucrative practice areas start to feel their contributions to the firm are not being adequately rewarded.
At this point, the firm realizes its compensation system is not encouraging the partners to work toward the common goals. Overall, firm unity is not being encouraged. It is “eat what you kill.”
This is a very critical point for the firm. If a new system is not developed to address these issues, the firm will start a downward cycle. As in any business, a law firm cannot stay on a plateau. If it is not going up, it is coming down.
So, what is the perfect compensation system? There is not a single system that will work for every firm. In fact, the perfect system for a specific firm today will not necessarily be the best tomorrow. Every firm’s goals are different — and changing. The compensation system has to adapt to meet these goals. Also, the practice mix varies within law firms. A firm with contingent fee attorneys and hourly fee attorneys will have a different system than a firm with a singular practice.
However, there are certain common elements to the framework of a compensation system that successfully rewards the individual’s efforts in both fee generation and support of firm goals. First, there is an equal sharing element of income and expense. This recognizes the “we are one firm” concept. Second, there is an allocation element based on objective criteria. This rewards the finder, minder and grinder efforts, and allocates the associated costs. Finally, there is an allocation element based on subjective criteria. This rewards the efforts that do not immediately result in fee income, but are very important to achieving long-term firm goals.
The subjective allocation is normally the most troublesome for the firm. It is difficult to communicate, measure and allocate. As a result, many firms avoid a subjective allocation. However, there are certain important contributions to the firm that can only be measured subjectively.
Applying a quantitative methodology to the measurement and allocation of the subjective element will often encourage firms to proceed with the subjective element.
The following describes one such quantitative methodology. First, the subjective factors are identified. These might include associate development and mentoring, development of the firm in the community, firm “hygiene” (timely billing, firm meeting attendance, etc.), development of new practice areas, and general leadership. A numeric weighting is applied to the factors based on their current importance to the firm. This weighting may differ among the individual attorneys to accommodate different roles in the firm.
At the end of the compensation period, the managing partner, compensation committee or possibly the partner group numerically rates each partner’s success in meeting their subjective goals. This 1-to-10 rating is applied to each factor’s weighting and totaled to result in the partner’s subjective rating. Each partner is then allocated a share of the subjective element based on the proportion of their rating to total partner ratings.
This has been a brief outline of an issue every professional service firm faces at some point in its life. Although many firms are reluctant to undertake the task of developing a comprehensive compensation system, it is an investment in the longevity and harmony of the firm. Often, an outside advisor can be effective as an unbiased catalyst in the process. As professionals, we practice because we enjoy using our knowledge and talents to better our clients’ situations. We wish we only had to focus on providing the best service to our clients. However, we also want to be fairly rewarded for our efforts. The successful professional services firm will have an understandable compensation system that is viewed as being fair by those it governs.
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Tim Jacobsen is a Bainbridge Island-based CPA who, over the last 30 years, has consulted with professional service firms in the areas of compensation planning, tax planning and compliance and retirement plan selection. He can be reached at 206-842-8200 or tim@tjjcpa.com.
