Olmstead & Associates Law Practice Management Asked and Answered Blog

Law Firm Compensation Committee

Question:

For years our14 attorney firm has operated under a formula based eat-what-you kill system. We are moving toward a more subjective-based system. We have been advised that we will need a compensation committee. What are your thoughts regarding compensation committees?

Response:

The components of your compensation plan and partner buy-in will be important to the success of your program. However, how you setup and constitute your compensation committee will be crucial. In a subjective system trust is paramount. How the members are selected, who serves on the committee, how the committee operates, and other matters must be spelled out and communicated to all partners. Here are a few ideas:

1. Consider a three member compensation committee.
2. Elect members to staggered three year terms. On the initial election elect the individual with the most votes to a three year term, the individual with the second most votes to a two year term, and the individual with the least votes to a one year term.
3. Hold elections annually to fill vacancies for the upcoming year.
4. Consider adopting a policy of requiring a partner whose term has expired to remain off the committee for one year before being able to run for another term.
5. Incorporate procedures for removal of members by majority vote of the partners. Specify the voting requirements.
6. Outline the general flow of the compensation review process, how it will work, specifically what performance factors will be considered, etc.
7. Outline the approval procedure of the partnership. Suggested that the partnership only be able to disapprove the recommendation in total - not pick apart and change. If the proposal is disapproved by a majority vote - the compensation committee starts all over.
8. Specify appeal rights and procedures.

The key ingredient of a successful subjective compensation system is that partners perceive the system as fair and have faith and trust in the compensation committee. The process is as important as the outcome.

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

Client Origination Credit and Importance in Law Firm Partner Compensation Systems

Question:

Our firm is a 18 attorney insurance defense firm located in Chicago. We are in our second generation and none of the original founders are still working in the firm. The majority of our insurance company clients have been with the firm for decades and were inherited. Our current crop of partners are primarily "worker bees" and have not developed "rainmaking" skills. We have not added a new client to our client roster in years. In the past two years we have lost several clients due to mergers, consolidations, and partner defections. This concerns us. Currently partners are rewarded and compensated totally on "working attorney" fee collections. We are considering changing our compensation system to including a credit for origination of new business. What are your thoughts regarding client origination credit?

Response:

All law firms need a mix of finders, minders, and grinders. Finders (client originators) are needed to provide sufficient work to keep the workers busy. Minders (responsible matter attorneys) are needed to manage the portfolio of client work. Grinders (working attorneys) are needed to service and produce client services. While there are exceptions, in most firms partners must hit on all three of these cylinders. In other words, most of the partners must do well at finding, minding, and grinding. Partners may perform some of these roles better than others, however overall they should be competently performing each of the roles. Very few firms can afford the luxury of having several senior partners only bringing in business without being required to maintain personal production levels as well. Partner compensation research concludes that the most a law firm can afford to pay a rainmaker - over and above his or her own billable hours (fee collections) is the marginal profit derived from the associates the rainmaker can keep busy, regardless of how many partners he or she occupies. The most valuable partners are those who offer a balance of skills: worker, delegator, supervisor, and rainmaker.

Since origination of new clients is the lifeblood of any firm it is a key factor that should be recognized in any compensation system. The exact weight that it is given will depend upon the firm and how dependent it is upon constant client replacement, only a few institutional clients, turnover of clients, leverage ratio, etc. A firm that has a well diversified base of institutional long time clients will typically weigh client origination much lower than a firm that has to constantly replace individual clients.

Actual approaches to implementation will depend upon whether your system is a subjective or a objective (formula system). However, the pitfalls are the same. Actual assignments of origination credits to partners can be difficult to initially determine. When and how should origination credits be shared between partners? Who determines and monitors such determinations? How long should the credit be awarded?

Origination credit becomes counter productive when it encourages senior partners to become comforable on the income received from origination credits from clients they brought in 20 years ago to the extent that they no longer develop new sources of business nor generate working attorney fees.

For this reason we believe origination credit should have a sunset expiration provision and that a firm should set time limits on origination credits - say five years on a reducing schedule - and have partners share origination credit with other members of the firm who develop business by cross-selling the firm's services to clients whose accounts were originated by another partner. In addition, offer "maintenance credit" as long as the originating partner continues to perform tasks that reinforce the relationship between the client and the firm.

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

Reducing Law Firm Employee Benefits

Question:

As the administrator of our 14 attorney firm I have been asked to present a plan to the partners for reducing employee benefits. We have had a difficult time during this recession. So far we have not had to reduce our employee headcount - but this could change in the future. It is our hope that if we can reduce the cost of benefits we won't have to layoff or terminate any employees. What is the best way to handle/manage this difficult discussion and process?

Response:

As an "at-will" employer you have the right to change benefits whenever you please. However, you must be careful as employees will perceive a reduction in benefits as a reduction to their overall compensation package.

If you do decide to cut benefits it is advisable to plan carefully and communicate as much in advance of the changes so that people know what is coming in time for them to allow for changes in their lives. It is also a good idea to be prepared to clearly and concisely share comprehendible reasons for making these changes. If implementing this type of change will save jobs, present it this way. If you believe that you may again provide benefits that have been cut once the economic environment is better, that knowledge will make it more palatable to employees.

A key point here - do an overall examination of your benefits and cut once and be done with it -don't keep reducing benefits every month or so.

You might want to examine your overall benefit costs - especially medical insurance - and strategically think about best approaches. It might make sense to cut here rather than a day of sick time or vacation.

Food for thought - According to a Society for Human Resource Management Poll taken in March of 2011 in the last six months 20% of employers reported that they had reduced benefits - the highest level since the fall of 2008. "Employees continue to scale back on health care coverage for employees (91%) and dependents (89%), and the amount of leave that an employee can accrue (54%).

So proceed with caution - but go for it if it makes strategic sense for your firm.

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

Does Law Firm Partner Compentation Make a Difference in Motivation and Actual Performance

Question:

We are a 21 attorney firm in San Francisco. Recently we have been considering overhauling our partner compensation in order to foster leadership and more of a team environment. Currently many of our partners are operating and functioning as if they are in separate law firms rather than part of a firm. What are your thoughts? 

Response:

With thinner profit margins firms can no longer carry unproductive partners. Law firms are demanding more from their partners and asking everyone to think outside the box to help the firm innovate for the future and obtain/retain a competitive advantage.

This has renewed discussion and debate on the topic of partner compensation and in particular whether compensation can make a difference in motivation, actual performance, and contribution.

We are receiving many more inquiries from firms looking to overhaul and redesign their partner compensation systems. Based upon these inquiries we believe that many firms are expecting miracles from their compensation systems and are asking and expecting more than they will ever be able to accomplish. They are not just seeking to align pay with performance – but have far higher expectations. For example:

• Dramatically improving a partner’s worth ethic.
• Changing a partner from being a lone ranger to a “firm first” team player.
• Resolving maverick partner “lone ranger” behavior and getting them to follow firm policy and play by the rules.
• Getting partners on board with new strategies and getting them to actually implement them.
• Getting partners to take on leadership roles and become effective leaders.

Expecting a compensation system to perform miracles such as these may be expecting more than any system can deliver.

Compensation does not drive behavior – it maintains the status quo. It serves as a reinforcing agent. Motivation requires leadership which can have a greater impact upon a firm than anything else. 

An effective compensation system serves as a strong messaging and reinforcement agent that helps you obtain and retain top partner talent and helps align their goals and activities with the strategies and goals of the firm.

A well designed compensation system should provide:

• A system that is aligned with the firm’s business strategies, culture, and personality.
• A reduction in partner dissatisfaction.
• A system that rewards performance and contribution as well as other behaviors that the firm desires to reinforce.
• A system that is perceived as fair by the partners.

While you must get partner compensation right in order to acquire and retain top partner talent as well as reward performance and reinforce desired behaviors, the starting point is hiring and retaining the right people to begin with. Jim Collins in his book Good to Great sums it up well with the following comment: “get the right people on the bus, the wrong people off the bus, and the right people in the right seats. People are not your most important asset. The right people are.”

“Your compensation system should not be designed to get the right behaviors from the wrong people, but to get the right people on the bus in the first place, and to keep them there. Your compensation system should support that effort.

I believe that the following three pronged approach is needed to strategically manage and motivate partner talent in your firm:

1. Get Maverick and Unproductive Partners off the Bus (Deal with Problem Partners)
2. Get the Right People on the Bus and in the Right Seats (Hire Right and Retain)
3. Insure that the Partner Compensation is Reinforcing the Right Behaviors, Rewarding the Right People and Keeping the Right People on the Bus

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

Year End Staff Bonuses and Raises

Question:

Our firm is meeting later this month to discuss year end bonuses and raises for our staff personnel. Due to the economy we did not give raises and bonuses last year. While we have been holding our own with the present economy we have been trying to watch our overhead very closely. However, we want to be fair to our staff and we don't want to lose key employees to our competitors. We are a five attorney firm and have four staff members that have been with us for many years. Do you have any ideas for us?

Response:

Your situation sounds quite familiar. Many law firms deferred raises and bonuses last year and are wondering what to do this year. Here is what we are seeing:

• Many firms that deferred raises and bonuses last year are doing something this year - raises, bonuses or both.
• Typically raises are in the 3% range.
• More firms are examining ways to hold the line on base salary and shift a larger component of compensation into variable pay based upon performance based bonuses.

We are recommending to many of our clients that they use 2010 raises and bonuses to launch new performance base systems for 2011. They are awarding traditional raises and holiday bonuses for 2010 to clear-the-deck - and advising staff of new programs going into effect January 1, 2011 consisting of goal achievement bonuses where specific firm and personal goals are established at the beginning of the year for each staff member and annual performance reviews.

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

Partner Compensation Metrics - What Is Important - What Matters

Question:

I am the managing partner of a 14 attorney law firm located in Nashville, Tennessee. We have 8 equity partners. The firm represents business and other institutional clients and handles transactional work as well as litigation. Each partner over the years has accumulated "partnership interest" percentages and these interests are used totally to determine annual compensation as well as ownership in the firm. The only numbers that matter in our firm are billable hours - not dollars and billable hour reports are all that we have ever looked at when reviewing associate performance or partner contribution. We are now beginning to question the wisdom of this approach and we should be considering more than hours?

Response:

Billable hours alone is a poor indicator of associate or partner performance and you should include more measures/metrics in the analysis. More and more law firms today realize that partner contribution and value goes beyond and involves much more than “billable hours” and their compensation systems incorporate other factors into the analysis. Billable hours is just one metric in the overall equation. Many law firms focus on various measures of revenue dollars - fees billed, fees collected, etc. The next question is what kind of fee dollars - working attorney, responsible (managing) attorney, or originating attorney. Fees collected by working attorney seems to be the primary focus of smaller law firms. Origination (attorney that brought in the client) attorney fees collected is often part of the mix as well. Very seldom do we see responsible attorney fees collected considered. We believe that more firms need to include this measure as well.

As attorneys evolve from associates to partners - roles and responsibilities changes and so must the scorecard. If you want partners to build teams, delegate, and leverage the work of others - working attorney fees collected used by itself no longer makes sense. A measure of matter and team management is needed as well as a measure of individual production.

A focus totally on billable hours or working attorney fee collections places little, if any, emphasis on client origination, responsibility for matter management, or any other factors such a mentoring, associate management and training, marketing, and firm management which are critical to the long-term success of the firm.

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

Characteristics of Successful Law Firms - Basic Building Blocks - Block 4 - Partner Compensation

For the past three weeks I have been discussing the characteristics of successful law firms and introduced the following basic building blocks that successful firms typically have in place:

• Partner Relations
• Leadership
• Firm Management
• Partner Compensation
• Planning
• Client Service
• Marketing

Partner relations, leadership building, and management blocks have been discussed. 

The fourth basic building block is partner compensation. Successful firms have a good partner compensation in place. Partners frequently advise us in confidential interviews that they are more dissatisfied with the method used to determine compensation than with the amount of compensation itself.

How much and how partners are paid are probably the two most challenging management issues that law firms face. Many law firms are struggling with compensation systems that no longer meet the needs of the firm and the individual partners. Failure to explore alternatives to failing systems often result in partner dissatisfaction leading to partner defections and disintegration of the firm.

In many law firms compensation systems have been counter-cultural and failed to align compensation systems with business strategies. As more law firms move toward teams many are incorporating new ways to compensate partners in order to develop a more motivated and productive workforce. Team goals are being linked to business plans and compensation is linked to achieving team goals. Such systems reinforce a culture that significantly advances the firm’s strategic goals.

People tend to behave the way they're measured and paid.

What gets measured and rewarded – is what gets done.

However, be advised that compensation does not drive behavior – it maintains status quo. Motivation requires leadership which can have a greater impact upon a firm than anything else.

Compensation systems should do more than simply allocate the pie – they should reinforce the behaviors and efforts that the firm seeks from its attorneys. Many firms are discovering that desired behaviors and results must go beyond short term fee production and must include contributions in areas such as marketing, mentoring, firm management, etc. to ensure the long term viability of the firm.

Click here to read my article on the topic

I will address each of the other building blocks in upcoming postings.

John W. Olmstead, MBA, Ph.D, CMC
www.olmsteadassoc.com

 

Law Firm Partner Compensation - Should We Change Our System

Question: 

We are a three attorney law partnership that does primarily business transactional work. My partner and I have been in practice together for four years. We are equal partners (50% each) as far as our partnership interests and we use these same interests for determining partner compensation. In other words we receive the same compensation. We recently have been discussing whether we should look into a different method for determining partner compensation. Currently we produce about the same level of fee revenue. What are your thoughts?

Response:

I could write a whole book on compensation systems - but here are a few thoughts:

1. Over the past 30+ years I have seen just about every form of compensation system that there is - from "even steven" systems such as yours to "eat-what-you-kill", other formula systems, profit center systems, objective systems, etc. No particular system is better than another system. It depends upon the firm - the culture - strategic goals - and the environment.
2. If the system is working - sometimes it is better to leave it alone. There is nothing wrong with an "even steven" system as long as the contributions (fee generation, fee origination, firm management, and otherwise) made by both of you to the firm are perceived as equal. Frequently, partners start out making even contributions and down the road contributions change (often due to life or family changes) and are no longer in alignment.
3. When perceived contributions get out of alignment partners are reluctant to have the candid discussions that need to occur as well as changes in the arrangement or compensation system. It could be the system - percentage interest is fine - but as contributions have changed the percentages need to change.
4. Resist the temptation to look at financial contributions in a single year. Look longer term - say the past three years.
5. Consider not just the compensation as to whether people are happy with what they are getting - but consider whether the system in encouraging the behaviors that you need to achieve firm goals? For example - management of the firm, marketing activities, mentoring and training associates and others in the firm, etc. Often we discover that firms that are not realizing their strategic goals (those firms that have such goals) - for example growth - are victims of their compensation systems. The systems are motivating "lone range behaviors" rather than firm strategic goals. Often this is the primary reason that firms decide to change their system - to transition from "long ranger" to "firm-first" team-based firms.
6. Consider bonus pools and other methods of supplementing the base system.
7. Start slow.

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

Law Firm Eat What You Kill Partner Compensation Systems

Question:

We are current using an “eat what you kill” compensation system in our firm. Is this appropriate method for our firm to use?

Response:

 It depends. You must ask yourself what kind of firm you want to be – team-based firm or group of space sharers or partnership of individual firms. Such systems are not appropriate for law firms that want to build a firm and create a team-based practice since such compensation systems typically reinforce “lone ranger” behavior resulting in a “me first vs firm first” orientation. It is hard to build a team-based firm with such an orientation. However, some firms do not want to practice as team-based firms – they want to practice as groups of individuals. For these firms such a system may be appropriate. The challenge will be to nail down a method of allocation revenue and overhead that is fair and equitable to all members concerned. Compensation systems should do more than simply allocate the pie – they should reinforce the behaviors and efforts that the firm seeks from its attorneys. Many firms are discovering that desired behaviors and results must go beyond short term fee production and must include contributions in areas such as marketing, mentoring, firm management, etc. to ensure the long term viability of the firm. Eat-what-you-kill systems discourage these behaviors.

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

Should Time Spent Managing the Firm Count in Partner Compensation Systems

Question: I am one of the founding partners in a 25 attorney law firm in the northeast. We have three equity partners, six non-equity partners and sixteen associates working in the firm. We focus totally on litigation. Each of us three equity partners have equal ownership percentages and since day one (20 years) have divided firm profits equally along those lines (1/3, 1/3, 1/3). We each put in the same amount of effort and work - but since I am managing partner - my fee collections are much lower than those of the other two equity partners and I am concerned that they may feel that I am not carrying my weight since my fee collections are lower. How should this be handled in our compensation system?

Response:

This is a common question that we hear often. It sounds like you are still allocating income in the same manner that you did when the firm first started. Often when a firm grows the partner compensation system needs to be reexamined when and if partner roles or contributions change. As the firm has grown I suspect that your time spent on management activities has grown as well. I, as well as many other legal management consultants, believe that firm management (running the business) is as important as generating client fees and should be so considered in partner compensation systems.

We have numerous law firm clients where at least one or more of the equity partners "run the business" and do not provide billable client services at all.

Management time should not be used as a non-billable time category (excuse) to simply "dump" time. Your partners have a right to expect results that improves the bottom line and the size of the pie for all.

Here are a few suggestions:

• Develop a budget for management time and have it approved by the partnership.
• Create a job description for the management partner and have it approved by the partnership.
• Recognize that administrivia (day-to-day office management) and management (higher level concerns) and not the same thing. Hire an office manager or administrator for administrivia - focus your time on the higher level management concerns.
• Insure that you are using your management time wisely and obtaining results for the partnership.

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