Base Salaries in Lockstep Firms
Fixing Partner Salaries
Many so-called ‘lockstep’ law firms have introduced variations and hybrid models to give greater flexibility to their profit sharing arrangements, to allow better management of partners, and to reward high performers. One fairly common variation is to introduce a three tier system. Under this, part of the total compensation package is made up of a base ‘salary’, part is a lockstep element and a further part is performance related. From the individual partner’s point of view, this gives the comfort and security of a fixed level of reward, a safety net which is not subject to the tides of personal good and bad fortune within the firm. Partners know that this fixed base will allow them to pay their mortgages and living expenses.
It is very important to fix these salaries at an appropriate level. If it is fixed too high, the fixed base element may give partners too much security and may also become a disproportionately high focus of attention in the compensation setting round. If fixed too low, it can become somewhat meaningless. The experience of a number of firms is that the aggregate level of such base salaries should be targeted to be around half of the total compensation package, thus leaving a realistic proportion of total compensation subject to both performance related and proprietorship aligned factors.
How do you fix such salaries?
A number of different models can be employed to arrive at the appropriate amount for these base fixed salaries, although many firms do not have any systematic methodology in place, and some firms will consider combining a number of these methods to arrive at an overall result. Once these base levels have been set, there is a trend not to reconsider them annually but regularly to apply an inflation element to them.
Here are some of the methods currently in use.
Method One – Conversion of Drawings
The first method in common use is to convert existing monthly drawings levels into a ‘salary’ sometimes grossed up for tax purposes (although only the net sum would of course be paid). This has the advantage of providing only a minimal change but, depending on the firm’s drawings policy, may not necessarily draw fair distinctions between partners. Some firms have a flat drawings policy under which all partners receive an equal monthly sum irrespective of seniority or performance, whilst others adopt a very conservative monthly drawings policy which bears no relation at all to the sort of fixed or flat base sum upon which partners would expect to rely for their basic needs.
Method Two – Converting part of Compensation Package
Another method sometimes used is to convert a part of the overall compensation package from the previous year into a fixed base salary for the current year. This has the advantage of preserving the existing differentials between partners and also forms a small and therefore uncontroversial change.
Method Three – the ‘Salaried Partner Plus’ model
Another method is to look at the market salaries and compensation packages currently paid to very senior lawyers and attorneys below equity partner level. New incoming equity partners or members would start at a base salary level around the same as the salary level as a salaried partner, and the base levels would rise proportionately from there for all other equity partners.
Method Four – Market Salaries
This method is not dissimilar to method three in that the firm makes an attempt to fix market salaries for all its equity partners or members, having regard to salary levels in both the private firm market and for in-house lawyers and general counsel. In theory, this sounds sensible and logical, but it can be quite difficult sometimes to obtain meaningful benchmark salary levels and even more difficult to set a level for, say, a generalist partner in his 50s. It is however an attractive way of differentiating between partners in high cost and low cost offices, particularly in a firm with international offices.
How do you pay Laterally Hired Partners?
Base level salary or compensation packages are brought into stark relief when considering the introduction of lateral hires whether at shareholder/equity level or as a non-equity partner. Firms will want to draw an appropriate balance between offering a seductive package (which therefore will often contain a high fixed element) and the creation of flexible compensation which is tied to the performance and success of the laterally hired partner. The overall package needs to be sufficiently attractive to persuade the partner to leave his or her current firm but the hiring should never be carried out without reference to those who – perhaps as a remuneration or compensation committee – have the responsibility for the firms partner remuneration and compensation setting for the whole of the firm. It is worth noting that the level of fixed or base salary set for the new laterally hired partner will ultimately affect the base salary structure for the rest of the partners – too high an introductory package can destabilise the firm and lead to key existing partners leaving the firm.
Furthermore, the possible introduction of a lateral hire can usefully test the viability and purity of the firm’s compensation system. If the system is quirky, inexplicable, over-complex or thoroughly outdated, it is unlikely to be attractive to a new joiner.
Paying and protecting those who manage
In order to attract the best internal candidates for positions of management, firms are finding that they at least have to match the compensation of top equity partners and in some cases to supplement it.
The financial cost of losing a partner from fee earning can be extremely high. In addition to the direct financial replacement costs, such as recruitment fees, the intangible costs at partner level should not be under-estimated. Core skills, knowledge and experience can be difficult to replace, and the extraction from a team of a key partner can threaten stability, morale and growth internally. Externally, key client relationships can also be put at risk. In addition, the loss of team or departmental management or leadership skills can create long-term problems.
Against all these expenses, the huge advantages of an internal appointment have to be weighed. The risk to the business in appointing an unknown outsider is, after all, considerable. Unlike an internal appointee, the external appointee will need to take time to understand the firm’s culture and behavioural characteristics. He or she will have to gain intimate knowledge of the dynamics of the business, its history, and its strengths and witnesses. Whilst the external appointee will bring objectivity, lateral thinking and advanced management competencies, he or she will have to earn the respect of the partnership, particularly after the honeymoon period is over. In contrast and from day one, the internal appointee will understand intimately the dynamics and politics of the Partnership, and will have detailed industry, market place and competitor knowledge. The internal appointee will also know the firm’s strengths and the opportunities to be exploited as well as being acutely aware of the firm’s weaknesses and the threats and challenges which need to be addressed.
It is somewhat easier to gain a balance between all these factors both culturally and economically in firms which have a lockstep background than in firms which have relied on individual fee-earning performance. Having said that, many firms are managing to provide fair packages for their managing partners and group heads that combine personal measurable performance related objectives with the attainment of group and firm objectives. It is however sometimes difficult to reward (or at least protect from penalty) the managing partner whose excellent work is let down by the rest of the firm or a group of underperforming teams and partners over whom the managing partner’s impact will be seen in the long term rather than in the current year’s profits.
The ultimate cost of re-integrating the managing partner at the end of his term of office must also be factored in, and some security has to be given as otherwise partners will not be attracted to take up the role of managing partner. This will involve re-training and the rebuilding of a client base, and the ex-Managing Partner’s remuneration and compensation arrangements should be protected for a reasonable period whilst this takes place. The ultimate cost of this should be taken into account from the outset of the appointment. Many firms are allowing at least a two or three year period for this protected re-integration. The exit package should also recognise the possibility that the ex-Managing Partner may no longer wish to return to full time fee-earning at the end of his or her term of office, and provision should be made for the possibility of an alternative career plan.