Compensation is a reflection of value, but also has the purpose of motivating workers. Where compensation is a fee split, make sure that your offer is accomplishing both of these objectives.
I work predominantly with small to medium-sized law firms in Canada, so my comments here reflect that particular marketplace. And within that market, over the past five years, it has become increasingly common for law firms to compensate Associates through a fee split: paying the Associates with a percentage of their collected revenue instead of a salary. This appears to have started due to the challenge in finding and keeping Associates. In an effort to find a warm body to fill those roles regardless of experience, law firms sought to protect their interests by limiting compensation to a percentage of actual revenue, rather than paying out salaries for lawyers who might not be worth those salaries. This has evolved into a common practice, with fee splits that can be 50% or higher. Unfortunately, what started with the best of intentions to protect law firms is instead (in my opinion) damaging law firms and Associates alike.
Before all of this craziness, fee splits where originally limited to senior members of the practice in the process of transitioning into retirement. These practitioners were listed as Associate Counsel, and allowed to set their own hours with the understanding that in the last five or ten years of their career, they would eat what they killed while slowly transferring their practice to someone else in the firm. Part of their percentage compensation reflected their efforts to mentor, delegate existing files and clients, and build new work which they would then hand over as well. That was worth a higher-than-average fee split, and was usually worth 50-60% of collected billings.
This was higher than average because it has long been held that law firms require a 40/60 split to actually make money.
Running a law firm requires a lot of fixed costs. Premises, furniture, hardware, software, staff, management, marketing, training, hiring costs…these don’t really change regardless of what the lawyers bill. In order to ensure a law firm can handle its fixed costs, most law firms set revenue targets for their lawyers. These revenue targets generally count on the lawyers producing 2.5 of their compensation (salary) in revenues (or a 40%/60% split with the firm). This tends to satisfy costs, and also leave a bit of money for Partner profits. Why should anyone care about leaving money for profits? Consider it from these three perspectives:
- The values of ownership need to outweigh the investment in time and risk for existing Partners or they will leave and the firm will collapse.
- Firms need to entice Associates to want to move toward Partnership so that the firm can carry on. But this also helps the firm’s during the process, because in their run-up years, the Associates will be motivated to build the skills needed to get to Partnership. These include increasing their revenue production toward Partner-level, building their marketing and business development skills, efficiently managing their practice, effectively delegating, taking on some leadership roles within the firm, etc. Without the enticement of Partnership and if they already getting 50% of their revenues, there’s little incentive to develop these business skills.
- If the firm aspires to attract lateral Partners, the role has to make sense by balancing remuneration with workload and risk. Outside parties aren’t attracted to the role by firm loyalty or history. Joining the Partnership has to makes business sense for them.
It’s in everyone’s interest to ensure that the Partnership is at least somewhat profitable.
During the very difficult market for Associates in the past three years, firms have been forced to entertain fee splits as a normal compensation model. And increasingly, that split is becoming 50/50, even for the most junior of lawyers. Keep in mind that most lawyers under five years of call do not make the law firm money. When you deduct their pay, hiring and training costs, they tend to be an expense until year five. If, on top of this expense, they are also receiving a 50/50 split, they have an inflated view of their own value, and law firms are hiring them at a more significant loss than normal.
Firms have added to this dysfunctional and non-sustainable trend by neglecting to provide those lawyers with targets. About 10% of these lawyers have a natural inclination to produce as much revenue as they can, with steady inclines over the years. The other 90% are content to work as hard as they feel like working at a given time. So not only are they getting a 50/50 split, but they might be pulling in under $250K/year. This makes them of even less value to their firm. Imagine a lawyer generating $225K in revenue. At a 50/50 split, they are earning $112 for their firm. But in return, they are costing the firm $112 in compensation, and probably around $80K or more in their share of overhead.
What Should Compensation Look Like?
We need to balance fairness with business goals and motivation. For me, that means that Associates start on a salary (within the range of their marketplace standard by year of call) with expectations set for productivity. By third year, Associates should be producing at 2.5 of their compensation. Each year, their base target must go up.
I’m all for providing Associates with bonuses, but firms must be able to point to the reason for the bonus. There can be a productivity bonus, and a performance bonus. The productivity bonus is based on any revenue over target, which provides a good motivator for growth. This is where I’m fine with fee splits. Obviously, the split would need to be higher than what the Associate is already getting (40% of base target earnings). Most firms offer a 50/50 split at this point. Here’s what it would look like:
Alison is a third-year call earning $120K with a target of $300K. If she collected $350K this year, she would be paid $120K + ½ of $50K = $25K for a total of $145K. For this the firm would get $350K.
Your firm may also wish to have a bonus available for extraordinary effort and accomplishment in other skills such as marketing and BD, work delegation, participation in leadership (serving on committees), and other contributions to the firm. This takes me to the other problem about paying someone on a pure fee split. Too often, those lawyers see no value in doing anything other than legal work because they don’t get paid for those other activities. And they are right: their relationship with the firm has been completely formed around pay for collected billings. So, these lawyers don’t learn to marketing, they don’t cross sell or otherwise try to build business for the rest of the firm, they don’t like to delegate, they don’t like to sit in non-billable practice group meetings, they don’t like to sit on committees or task forces, etc. They miss out on a critical component of training for a legal career, which is just as much a business as it is a profession. They certainly have no preparation for Partnership. I’ve had a number of firms come to me, desperate to create a more collaborative environment after they’ve established quite the opposite with their purely split fee compensation structure.
This isn’t to suggest that firms with salaried lawyers have great skills development and non-billable participation by all of their Associates. If you haven’t established job descriptions that identify training and expectations in all of these areas, it’s hard to expect that behaviour. And it’s difficult to point the finger at your Associates and complain that they just aren’t ambitious enough. They have NO IDEA what it takes to be a great lawyer. They need to be directed and managed, into that role.
A final note on bonuses. Most Associates hear that law firms take all sorts of factors into account when determining bonuses, but when the time comes, firms point to revenue and state the resulting bonus. No Associate truly believes that their non-billable efforts have been taken into account. This is why I like to two-bonus program. It separates the rewards, clearly identifying the value of each. Does it cost more to give a second bonus for non-billable skills and participation? Yes and no. For example, a lawyer who has implemented on an aggressive marketing plan, and sat on the student committee might be given a $3K-$5K bonus for those efforts. So yes, it’s a bit of an added investment by the firm. But it’s more than worth it in lawyer skills development and active engagement with the firm. Their skills will land more work, their delegation will keep others busy, and their engagement will encourage others, and all boats will lift in a rising tide.
With some exceptions, Associates don’t tend to be long-term planners. They live for today. They see, and judge, what is in front of them. Their trust is low that law firms will guide them unselfishly. They need to see the game plan, the pathway, the playing field. They need to learn the value of a more fulsome training ground for their profession, but also to be acknowledge and even rewarded for doing those things that will help them to become great lawyers. A 50/50 split might be easy to understand and feel like it limits cost exposure to the firm, but it doesn’t train the lawyer, it doesn’t prepare them for partnership, and it doesn’t keep the firm sustainable. Your Associate compensation system should demand and provide for all of the types of growth needed in a younger lawyer. It should balance fairness, business goals and motivation. The most important 50/50 should be the amount of effort both the firm and the lawyer put into that lawyer’s development.