Why law firms are re-examining profit sharing structures

Why law firms are re-examining profit sharing structures

A number of influencing conditions or factors in the market place are persuading firms to abandon their previous more egalitarian model of equal profit sharing and to move towards a structure which has at least some performance or merit element.   The first influencing factor is that firms can no longer rely on a captive set of loyal clients and referrers who can be counted on to provide them with work on a consistent and enduring basis.  Clients have become more sophisticated and ready to move their work to firms which can provide them with the right mix of expertise, industry knowledge and experience at competitive prices.  Partners at law firms have had to develop and improve their business development skills as well as their expertise, and this places a premium on high flyers and those who are skilled and successful at building business.  Second, partners themselves have become more mobile and prepared to cast aside traditional loyalties in order to practise in a firm where their skills will be appreciated and rewarded, and where the reputation, credibility and infrastructure of the firm will help them further their personal aspirations.  Third, the law firm market is steadily becoming more corporate in style and structure, and many firms are seeking to align their systems for partner rewards to the structures prevalent in many corporate enterprises.  This leads to partners being paid a ‘salary’ with bonuses then based on performance.  Fourth, the law firm market is steadily consolidating.  More and more firms are merging and this often leads to a re-examination of the new firm’s compensation and profit sharing systems.  In some jurisdictions we are also seeing law firms floating, embracing alternative business models, or gearing up for flotation.  In such firms, share options will be available, together with capital growth in shares held – realised when shares are sold.

There is a further and more recent worry.  The legal profession’s golden era of consistent expansion in comparatively benign market conditions has now come to an end. Expansion and growth will not be as easy to achieve in the next ten years as in the last decade or so.  At the same time, firms are still finding that scale is an issue.

I was talking recently with an environmental law partner from an eighty partner commercial law firm.  He told me that he felt his firm was just about the minimum size necessary to support a two partner environmental team; for him, scale was definitely an issue.  This conversation is similar to many which I have had with law firm partners over the last year or two.  Except for the perfectly formed specialist practices, the question of size is increasingly on the agenda.  For clients, size is seen, amongst other things, as a safety or comfort factor.  For law firm partners who wish to pursue better work (whatever that means for them), increased specialisation needs to take place in the context of a firm which is large enough to warrant deep teams across all the heavy-lifting core commercial areas.  For the recruitment market, especially at senior level, the incoming lawyer wants to board a vessel which is capable of travelling safely but speedily through the water.  Additionally, potential law firm investors will only be interested in firms which have strong track records in managing fast and sustainable growth over reasonable timeframes.

The majority of law firm managing partners have appreciated for some years now that mergers – or even growth generally – are not strategies on their own but form the means to a strategic end.  Size for size’s sake is not the relevant point.  The strategic question on the lips of many is ‘What might we need to look like in three to five years time to attract and retain the best lawyers, to continue to serve our best clients and to attract both better clients and better work?’. For some, the answer may be to continue steadily on the course which has already been chosen and is tried and tested.  For many, however, profitable growth – carried out strategically in a consolidating market-place – will be an inevitable part of their plan.  Such strategically directed growth needs to consider at least four imperatives which are all closely linked with the firms strategic positioning. First is the growing client-driven need for depth of expertise – smaller and more general practices with skin-deep expertise are finding themselves most exposed to the client driven demand for greater specialisation and deeper levels of expertise.  Second, the more sophisticated clients also expect increased depth of service – the ability to progress larger matters quickly and efficiently with the work being done as a team effort and at the right level.  Third is the need to increase depth of resource – the increasing imperative for investment capacity and management capability to develop and maintain a supportive infrastructure.  Fourth, depth of brand is also important to give the profile and market perception necessary to provide a winning business recipe.   In this context, many firms are striving to cast off their image as local firms in favour of a regional profile; at the same time, regional firms are seeing the need to become national, whilst national firms are striving to extend their reach internationally.

In the light of these trends, we are already seeing a growth in the number of strategically generated merger discussions, and the momentum is expected to increase. Such discussions are never easy, particularly in the case of international mergers where very different profit sharing systems have traditionally applied.  To ensure that that the right links are forged requires strong leadership, a clear strategic focus and the ability to take a long term investment perspective.  The pressure to continue to grow in a contracting market-place will undoubtedly lead some firms to rethink both their business models and their partner reward and compensation structures.