Olmstead & Associates Law Practice Management Asked and Answered Blog

Law Firm Buyout Arrangements in a Contingency Fee Practice

Question:

I am a partner in a four partner law firm in Cleveland, Ohio. Our firm does class action contingency fee cases and all of our fees are contingency fee. We do keep time of our time expended on these cases even though we don't bill by time. One of our partners has announced that he will be withdrawing from the firm. We each have 25% ownership interests. How do we value the firm and determine his buy-out. Our partnership agreement does not address this nor do we have any precedent. Do you have any suggestions?

Response:

The real value component is the value of your unsettled cases and it will be difficult - if not impossible - to determine the value of these cases until they are concluded in the future. Some firms payout the capital account and the value of the hard assets upon departure or over a relatively short payout period and they have a future payout formula for the cases in progress as the cases are concluded.

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John W. Olmstead, MBA, Ph.D, CMC

 

Problem Law Partners

Question:

Our firm has been discussing how to handle one of our partners. We are are 12 attorney firm in Houston. One of our partners who is one of our highest fee producers and best business getter's simply won't follow firm policy or play by the rules. He won't turn in time-sheets in a timely manner, he is argumentative with others in the office, and not a team player. He is "me first" while the rest of the partners in the firm are mostly "firm first". We are trying to build a team based practice and this one partner is holding up our progress. Do you have any thoughts or suggestions on how we should handle this?

Response:

Dealing with "maverick partners" is always a challenge. Of course they seem to always be the heavy hitters and this makes it that much more difficult as often there are major clients and large sums of money at stake - at least in the short term. This can also be major issues and large sums of money at stake in the long term if you don't deal with the maverick partner as well. In addition you won't be able to achieve the vision and goals the firm is trying to achieve.

• For starters - if you have not already - create a well understood set of firm core values or code of conduct that governs behavior in the firm. For example, in most firms people are expected to work hard, be honest, and treat each other with respect.
• Partners as well as all other attorneys and staff should behave in a collaborative, cooperative, and team-orientated manner.
• Partners as well as all other attorneys and staff should comply with all firm policies and procedures.
• Enforce firm policies for all - no exceptions.
• Consider coaching, counseling or other forms of outside assistance if they could prove helpful.
• Lay down the law - confront and deal with the problem partner sooner than later - even if it means he or her leaving the firm.

Many firms have had to deal with the problem of a maverick "huge business generator" who just wouldn’t cooperate with firm policies and caused conflict and tension in the firm.  It is an unplesant task - but in the end - worth the investment. In the end he or she either conforms or leaves the firm. We have been advised by our clients that even though they may have struggled in the short term as the result of the loss of a major fee producer - in the long run the firm was better off and should have done it earlier.

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John W. Olmstead, MBA, Ph.D, CMC

 

Law Firm Estate Planning Practice - Increasing Summer Demand

Question:

Our firm is an estate planning firm located in the Chicago suburbs. We have three attorneys, four paralegals, and three staff support members. We have observed over the past three years a trend where our new matters and associated fee revenues starts a dramatic decline in April and continues to do so until August. In the past we have just remained in a state of denial and relied on hope and prayer. This year we would like to be more proactive. I would appreciate your thoughts.

Response:

You could try investing in some additional advertising designed to stimulate early demand for such services. However, short of a new tax or other regulation occurring this summer or a dramatic price reduction - i.e. get your will done and get your spouse's will for free - I doubt that such advertising will do much to create a reason to act now as opposed to the fall or end of the year. Then you would have the additional cost of the advertising and lower revenue as a result of the discount or special offer. I believe you might be better off focusing on cost reduction and cutting back on attorney and staff hours until demand picks up again in the fall.

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John W. Olmstead, MBA, Ph.D, CMC

Law Firm Mergers: The Importance of a Timeline and Project Plan

Question:

Our firm is a 4 attorney firm in Columbus, Ohio. Three of our partners are in their 60s and contemplating their exit strategies. We have a very profitable high profile practice and have been approached by a couple of very large firms concerning possible merger. We believe that this would be our best exit strategy. What mistakes have you seen other firms similar to ours make that we should avoid?

Response:

Mistakes can run the  gambit - from choosing the wrong marriage partner - to getting into a deal that does not make business sense. A common problem that I have sees is the lack of a timeline and project plan resulting in project drift and lost time. I just got involved with a small firm that had been working with the managing partner and a small team from a much larger firm. After a few months of  financial and other document exchange, informal gatherings, etc., these individuals advised the partners in the small firm that they believed all looked good and led the partners in the small firm to believe that a deal with eminent. However, after one year had passed the small team in the larger firm presented the matter to the full partnership for a vote on the merger and the partnership voted against the merger.

Lessons Learned

1. Don't assume that the managing partner or a small merger committee or team in a larger firm speaks for the firm or has the authority to approve a merger. Merger with another firm or extending partnership are usually decisions restricted to partnership vote in most firms.
2. The partnership dynamics in larger firms will always be a variable and in larger firms a great deal of time is often required for this to play out.
3. It is critical that you establish your timeline (goal date) and let it be known to the other firms that you are speaking with. Let them know that you are talking with other firms that will have to have a decision by a date certain.
4. Outline a step-by-step task or project plan based on the goal date to focus your efforts, keep you on target, and reduce project drift.

Don't invest a year with only one firm only to find out that they are not interested.

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John W. Olmstead, MBA, Ph.D, CMC

 

Law Firm Compensation - Associate Bonus - Fee Split

Question:

Our firm is a 12 attorney firm located in downtown Chicago. We have 8 partners and 4 associates. We are considering making a change to our associate compensation system. Currently associates are paid a salary plus a discretionary bonus at the end of the year. We are considering continuing to pay them a salary plus 60% of any business they bring in (origination). Does this plan make sense?

Response:

I would need to know more about your financial situation, your overhead, and profit ratio. You and your partners should expect to make a profit from your associates. I believe you should expect to realize a profit margin of 25% - 30%.  After factoring in firm overhead and associate compensation I don't believe you will be able to give away 60% and realize this goal. 20%-30% may be all that you should incorporate into a bonus system. Be careful that a bonus system such as this accomplishes what you are seeking to accomplish and that you don't create a lone ranger culture. 

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John W. Olmstead, MBA, Ph.D, CMC

 

 

 

Law Firm Growth and Reduction in Profits

Question:

Our firm is a personal injury plaintiff firm in Topeka, KS. Until two years ago we had two attorneys (both partners) and two support staff members. In early 2012 we added an associate attorney, increased our marketing investment, moved our offices and took on additional space, added five additional support staff members, and implemented a case management system. We currently have 500 open cases - up from 200 cases 2+ years ago. Revenues are up - but the two partners are each taking home $40,000 less than they were before the expansion. Our home grown office manager manages and runs the office. What should we be doing differently?

Response:

My first thought is that your revenues have not caught up with the overhead and the growth investments that you have made. (You should review your reports and verify this) Personal injury cases have a much longer revenue lag than does work that gets "time-billed" monthly. Some cases may be in progress for two years or so. So be patient but don't be complacent.

You do need to be proactive in managing your case pipeline and your team. Someone needs to mind and manage the store. You are a larger firm now and you can't assume that your team is working to maximum effectiveness and efficiency. Insure that you actually need all of these people and that people are working smart. Roles for each member of the team should be created and performance standards and expectations established. Goals (cases) should be created for each team member, metrics and measurements established, standard reports created - generated - and used, and team members held accountable for results. Use the reports that the new case management system provides to measure goal accomplishment and performance.

Evaluate whether your office manager has the leadership skills that the firm now requires.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Law Firm Capital - How Much Do We Need

Question:

Our firm is a relatively new firm. Several of us left a large firm in Dallas and started the firm last year. We have 17 attorneys - 10 of us are partners. When we started the firm we each put in a little cash and obtained a line of credit which we have used extensively and we are at our limit. Is this a good practice? Should the partners contribute more capital? How much? I would appreciate your ideas.

Response:

There are two categories of capital - short-term or working capital which is used to fund daily operations and long term capital which is used to pay for capital assets such as furniture and fixtures, computers and other office equipment. I guess I am old school but I believe that short term working capital should be funded as much as possible with partner capital and long term capital funded with bank borrowing or leases. I have more and more clients that are funding working capital with partner capital and have no bank debt at all. I have other clients that finance all working capital with their bank line of credit - these firms could find themselves in dire straits if bank credit should tighten in the future.

The amount of working capital needed by a firm depends upon your practice, billing and collection cycles, whether you do contingency fee work, and whether the firm is growing and adding attorneys and staff. As a rule of thumb I suggest that a firm have three times one month's expenses excluding draws in working capital. This would need to be increased if the firm has lengthy billing and collection cycles, does contingency fee work, and is in a growth mode.

Partner capital contributions are usually made proportionately based on partner earnings or ownership percentages.

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John W. Olmstead, MBA, Ph.D, CMC

 

Law Firm Succession - Client Transition

Question:

Our firm is a 24 attorney firm in Chicago West Suburbs. We have 10 partners - five of which are in their early 60s. We represent small to mid-size business clients. Recently we have been discussing the eventual retirement of the senior partners and approaches to client transition. We would appreciate your thoughts.

Response:

Client transition involves different challenges that have to be overcome in order to successfully transition client relationships. Consider the following challenges and hurdles:

1. Relationships take an investment of time and must be nurtured on behalf of the parties making the introductions and connections as well as the parties trying to form the  new relationship. Attorneys often want immediate gratification and the "quick fix" and are unwilling to invest time needed for longer term results. More than a "one-shot" simple introduction is required.
2. Clients hire lawyers not law firms.
3. Client transition requires trust on the part of all parties (introducers and new players). A high level of trust must exist within the law firm organization between the attorneys involved and within the client organization between the parties there as well.
4. There is potential risk of embarrassment for all concerned. The transitioning attorney in the law firm could risk losing the client if the other attorney does poor work for the client. Another issue is the loss of control over the client. The individuals in the client organization could also risk criticism (or even their jobs) if the new relationship does not pan out.
5. Many law firms are "lone ranger" rather than "firm first" or "team based" firms. As a result there is no inclination or incentive to invest the time and effort nor take the risk to refer work to others in the firm.
6. Lack of knowledge regarding other partners' practices.
7. Fear of losing clients.
8. Fear of losing client control.
9. Compensation systems in many law firms encourage hoarding of work and discourage the referring of work to others.
10. Communication systems in  some law firms do not facilitate relationship building among attorneys. Effective client transition is simply not possible without strong relationships and high levels of trust among attorneys in the law firm.

Effective client transition is not a one-time lunch or introduction event - it most go deeper to bind the new relationship. This takes time. Start early and allow ample time for an effective partner winddown.

I generally suggest five year client transition programs.

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John W. Olmstead, MBA, Ph.D, CMC

 

Managing Partner Non-Billable Time in a Law Firm - How Much?

Question:

I am a partner in a 17 attorney firm in Madison, Wisconsin. We are a business law firm and we have ten partners and seven associates. We are managed by a managing partner, one of my partners, and he also practices law. We pay him his standard client bill rate for his non-billable time spend on law firm management. For the last couple of years his non-billable hours spent managing the firm have been increasing to the point where he is now spending 50% of his total time - 1000 hours a year managing the firm. This has caused tension in the firm and my partners and I are concerned. I would appreciate your thoughts.

Response:

I would concur that this amount of time is excessive for a firm your size. Even if you stay with the managing partner model of governing your firm - most managing partners in firms your size are able to get the job done for around 500 non-billable hours a year - 25% or less of their total time. You may want to consider the following:

1. Put in place a budget for the total non-billable hours that the firm will pay the managing partner.
2. Clarify the duties, role, responsibilities, and projects that the managing partner should be spending his time.
3. Review the overall governance/management structure that the firm has in place.
4. Consider supplementing the Managing Partner with an Office Manager or Firm Administrator.
5. Consider whether the managing partner role is still the most appropriate approach for your firm.

I suspect that your managing partner is either not delegating to staff some of the day to day management tasks or he does not have sufficient billable work to stay busy.  At $275 bill rate - 1000 hours per year costing the firm $275,000 a year. I believe that a firm your size can handle this function more economically.

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John W. Olmstead, MBA, Ph.D, CMC

 

Law Firm Margin/Profitability Ratio - Net Income to Gross Revenue

Question:

I am the owner of an elder law firm in Boston. I recently closed out the 2012 books for tax preparation, I'm reviewing my annual numbers from what was my 4th year in solo practice and wondering how I'm doing.  Is there some kind of benchmark/goal or can you share any advice about an ideal ratio between gross income and overhead costs?

Response:

I usually say 35-45% margin (net income divided by total fee revenue) which is supported by most of the survey data. (Expenses used in the determination of net income defined as total expenses less owner/partner compensation). However, I have some law firm clients that have 20% margins were the partners/owner are taking home $1,000,000 per year. So margin is sometimes tells only part of the story. Depends upon the area of practice and practice/leverage structure. Solos operating virtually with no staff may have a margin of 80% but only taking home $40,000. ($40,000 net income divided by $50,000 fee revenue - only $10,000 in expenses.)

Be careful of using the term overhead as this often refers to expenses less all producer compensation. (partners, owners, associates, and paralegals) I assume that by the term overhead you are referring to total expenses less your compensation or draw.

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John W. Olmstead, MBA, Ph.D, CMC