Searching for the True Meaning of Equity Partnership

It is interesting to note two recent trends in large law firms across the world. First, there was the now notorious demise of the US firm Dewey & LeBoeuf in which back bench partners appear to have been left powerless, uninformed and disenfranchised as the firm’s leadership cabal drove the firm onto the rocks. In the last few years in that firm, newly hired laterally hired partners seem to have been prized more for the capital they introduced than for their skills or acumen. Second has been the recent tendency for large firms to streamline their equity structures, often ending up with so-called “all-equity” partnerships, in which the classes of partnership are significantly reduced and the funding needs of the law firm are met by the introduction of more partner capital.

These two seemingly unconnected issues have caused me to puzzle lately about the real meaning (if any) of equity partnership in the modern law firm. In return for joint and several liability and the introduction of fixed capital, the equity partner often has the somewhat dubious return of merely a vote in serious matters and the hope of a higher income. In this respect the new equity partner is often placed entirely in the hands of a powerful remuneration committee to assess his or her profit share and is at risk of a drawings freeze if the firm runs into cash problems. In other words, the modern equity partner in a mid-sized firm or larger often has very little authority or control over the firm’s management and destiny, and yet bears a huge amount of responsibility and risk.

The lockstep system of partner remuneration has been much derided recently as backward looking and a disincentive to high flyers, but – as essentially an equal sharing model – it at least endorses the spirit of true partnership as opposed to a system of rewards based on the subjective judgement of a powerful and sometimes unelected committee. One former partner of a large international firm told me that he regarded himself as no longer a partner but as a freelance contractor on a short term contract, with no employment rights and little control. As an extreme example, the history of Dewey &Le Boeuf has shown how a firm can be hijacked by a small self-serving oligarchy leaving the backbench equity partners little more than ciphers. Hence, it could be argued that the only real difference between equity and non-equity partners in many big law firms is the assumption of risk. It therefore has to be asked – as many younger lawyers are now doing – why anybody sensible would want to be an equity partner in such a firm.

Not every law firm is a partnership however. Some firms have gone down a more corporate route, in which the law firm’s equity owners have real stake in the firm’s real value (if it has one) represented by shares.

The equity options to considered by law firm leaders are more complex, however, than a binary choice between a corporate model and a true and egalitarian partnership in which partnership rewards are based on the principles of equality and in which partners have more than a token voice in the firm’s direction and management.

There are three questions that any leadership group should consider before making profound changes to their equity structure

First, there is a philosophical or cultural question to answer, which should be based on the firm’s values. Unless the firm truly considers all the so-called equity partners to be true owners and stakeholders in the firm, it is hard to justify the opening up of equity for financial motives alone. If the raison d’etre is for the firm just to become a short term vehicle to maximise earnings, and if the main reason for becoming an equity partner is simply to earn more, it will be difficult for the firm to become or remain enduring institutions.

Second the firm should consider equity with a view to issues of succession and stability. The question here is around the best equity structure to help the firm to develop and grow in substance as opposed to size. Finally, the firm should only promote to equity those who are likely to make a sustainable and valuable contribution to the firm’s strategy, directions and goals.

Just as it is wrong for a firm to change its legal structure just for tax reasons, so it also seems to me to be wrong for a firm to change the traditional partnership model into a structure that is dressed up as a partnership but has few of the egalitarian facets of such a structure – such as sharing, collegiality, and collaborative autonomy. If it is no longer strategically desirable or managerially practicable to maintain the firm as a true partnership, then a truly corporate structure might prove to be a more honest solution.
Ironically, however, the change from a partnership structure to a corporate one is usually a decision on which all equity partners have a vote, and many partners seem unwilling to trade their partnership status, however limited it may be, to become an employee and a shareholder.