Professional Services Accounting ARTICLE -
The pros and cons of having nonequity partners

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

If yours is like most law firms, your staff includes at least one partner who keeps stalling on the retirement decision or an associate who’s not quite partner material. On the one hand, the person is productive and likable, but on the other hand, he or she isn’t quite making the grade to be an equity partner. So, what do you do? Many firms have discovered that establishing “nonequity partners” can make everyone happy.

How does a nonequity partner differ?

While the criteria for becoming an equity partner vary widely, the most common characteristics of an equity partner are that the partner has capital invested in the firm, shares responsibility for the firm’s debt and has the ability to vote on partnership/ownership issues. In contrast, nonequity partners have no capital invested in the firm, aren’t liable for the firm’s debts and can’t vote on ownership-related matters.

Additionally, it typically takes a supermajority of existing partners’ votes to elect or dismiss an equity partner. Firm management, on the other hand, is typically given the authority to elect or terminate nonequity partners.

Nonequity partner compensation is set much as it would be for an associate, with a salary and performance bonus. But unlike an associate, a nonequity partner may attend partner meetings and even have access to firm financial information.

Why add the nonequity status?

Single-tier, full equity partnerships in a law firm are as old as the profession, but two-tier firms continue to gain popularity. For many years firms were governed by the old “up or out” rule. If an associate hadn’t made partner in seven or eight years, it was time for him or her to move on. One problem with this rule is that it has caused firms to get rid of some highly productive and profitable associates who probably didn’t make partner simply because they weren’t successful rainmakers.

Another reason for the trend toward nonequity partners is that partners have become more willing to pull up stakes and move their practices to another firm. Although the new firms are happy to have the additional billings, they’re often reluctant to make someone a partner if they haven’t practiced with him or her. At the same time, they realize they’ll be unable to attract these recruits without the promise of partnership.

Moreover, many law firms now have associates who don’t want full equity partnerships. Many younger lawyers see their tenure at a law firm as an opportunity to gain experience and training, earn a good living and then move on. The idea of a career-long “marriage” doesn’t interest them as much as it did preceding generations. These issues have forced firms to look outside the traditional structure for more flexible organizational styles.

What are the benefits?

The advantage of a two-tier partnership lies in its flexible organizational approach. It’s important for many people’s egos to have the title “partner,” and many clients need to see the word “partner” after their attorney’s name to have full confidence in him or her. Nonequity partnerships can help your firm hang on to that valuable associate who’s being courted by a competitor or provide a safe haven for a partner who, while winding down, isn’t quite ready to retire.

Two-tier partnerships also offer a way for partners from other firms to make a lateral move in. Joining a new firm as a nonequity partner for a period of a year or two gives both parties time to judge whether the fit is a good one.

This flexibility can, however, also work against you. For example, there may be numerous reasons why an associate will never become a partner. Making him or her a nonequity partner simply because he or she has been at the firm for a certain number of years will just make the situation worse. So while the criteria may not be quite as high as for equity partners, it’s still important to select nonequity partners carefully.

Think it through

Although setting up nonequity partnerships within your firm has certain advantages, keep in mind that making the switch to a two-tier partnership structure will create its own set of headaches. Make sure all the angles are thoroughly vetted before making any changes. 

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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