Professional Services Accounting ARTICLE -
Why you must address partner compensation challenges

Target Audience: Legal Professionals, Professional Service Firms, Law Firm Partners

When the economy was thriving, most law firms had enough revenue coming in that they could afford to compensate each partner well, regardless of individual contributions to the firm. So underperformers and the biggest rainmakers and technical stars were all content with their pieces of the ever-growing pie.

But now, many firms are finding that their pie has stopped growing or even has shrunk. In such an environment, partner compensation can become a contentious issue — one that could threaten the firm’s viability. Don’t think that your firm is safe just because your compensation plan is merit-based. Many firms that have a merit-based plan on paper don’t have one in practice.

Plan Challenges

Partner compensation plans are facing many challenges. First, there’s less client work, and remaining clients are more cost conscious. So, there’s less revenue coming in.

Second, layoffs of associates and staff and other cost-cutting measures aren’t providing enough savings to make up for reduced business. So, firm coffers won’t be large enough to support the levels of compensation partners have been enjoying.

Third, banks are keeping an eye on law firms and are likely to be less willing to extend credit at the beginning of the year if they’ve seen large cash payouts at year end. So firms can’t simply maintain current levels of compensation and depend on credit to get by until the economy improves.

Fourth, other firms may try to lure away top-performing partners by offering better compensation. Losing top performers could lead to revenue losses that may be nearly impossible to recover from. So plans must sufficiently reward top performers.

All of this adds up to one conclusion: Many firms must re-evaluate how to divide up the compensation pie in a way that won’t negatively impact the practice.

Partner Challenges

Partner compensation involves not just finances but people — and that can prove to be the toughest challenge of all.

It’s hard enough to talk to employees about how poor performance is going to negatively affect their compensation; it’s even harder to discuss that subject with fellow owners. Often partners have been partners for years and in many cases they’re good friends. It’s difficult to tell a respected colleague that she isn’t contributing enough to the firm to deserve to get paid as much as the other partners. Or even worse, to tell a friend that he needs to improve his performance to remain a partner.

When times were good, many firms could afford to avoid having these tough conversations. Top partners often were earning enough that they didn’t mind if underperformers were also doing well — it was a small price to pay for firm harmony. But this avoidance strategy can create problems when revenues are down.

Top performers may become concerned that their compensation isn’t proportionate to their contributions to the firm’s success, especially if they feel they’re the ones keeping the firm afloat. They may become impatient with seeing money they’re bringing in being distributed to underperformers.

At the same time, underperformers may have grown to feel entitled to their compensation levels. These partners can be extremely resistant to any reductions, even if necessary for the health of the firm.

What to Do

To address these challenges, firms that aren’t on a merit-based compensation system should seriously consider switching to one. Firms that are on a merit-based system should review it to see if the behaviors they’re rewarding are still the right ones.

Volumes have been written on what makes an effective merit-based partner compensation plan. For many firms, an outside consultant can be invaluable in separating the wheat from the chaff — whether a firm is developing a new plan or evaluating an existing one. But here are a few considerations to keep in mind:

• Because the current economic reality is so different from what it has been, firms must focus on each partner’s recent performance, rather than on performance over the past several years.
• Rewarding nonfinancial contributions that are critical to the firm’s long-term success and client satisfaction, such as mentoring associates and fostering teamwork, must be balanced with rewarding contributions that immediately impact the bottom line.
• It’s critical to stick to the performance criteria; firms can’t continue to give underperforming partners another chance next year.

Bottom line: Top- and middle-performers must be committed to having an effective system and face having the hard conversations with underperformers.

Think Long-Term

Because of the recession’s severity, clients likely will be cost sensitive for years to come. So even as work increases, your firm may not be able to bring in the fees that were common before the downturn. This means you can’t apply a temporary fix to partner compensation plan changes; you must make changes that will be effective long-term.

Find out how our expertise in professional services accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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