Law Firm Partnership – Partnership Structures
For many lawyers, securing Partnership remains the holy grail of their career in the law, and in most cases, for good reason too. Despite the knocks that the law firm Partnership model has taken in the more chastened post-Global financial crisis economy, it is still, if achieved with the right firm, the best route to playing a key role in the running of your firm and earning handsomely at the same time.
Nonetheless, it pays to be informed about what you are getting into. For all of the high-flyers drawing several hundred thousand pounds (and more) annually, there are a small number who have had their fingers burnt, most famously in the bankruptcies of Dewey & LeBoeuf, Halliwells and others. Knowledge of the firm, its financial footing, its future prospects, and its expectations of you, are essential to making an informed decision.
In future articles we will address some of these other more complex points but here we introduce the basics of the Partnership model, starting with the different levels of Partnership employed by firms and recent market trends relating to the Partnership structure.
Status of Partnership
Law firm Partners typically fall into one of the following three categories:
1) Full Equity:
A full Equity Partner will be rewarded entirely on the basis of the firm’s profitability. Equity Partners may hold a number of points which determine how their share of the partnership profit pool is calculated. These points were traditionally accrued through a lockstep model which allowed Partners to climb the equity ladder on the basis of time served with the firm. Things have changed however, and with a few notable exceptions firms are now allocating equity points, at least in part, on merit. An Equity Partner will have full voting rights, shared responsibilities for the running and compliance of the firm, and will be required to make (sometimes substantial) capital contributions. Equity partnership can of course be highly lucrative with the right firm but it requires some due diligence to ensure that the firm is on a sound footing and that your investment (i.e. your capital contribution) is secure.
2) Fixed Share Equity (FSE):
This level of partnership has become increasingly common as firms have moved away from a salaried partnership model, originally motivated at least in part by significant cost savings (in the form of tax and national insurance) to both the firm (assuming it operates as an LLP) and the Partner. FSE partnership means different things in different places but it will typically come with limited or no voting rights and compensation will be comprised largely of a basic salary or guaranteed drawing, plus a smaller percentage that is determined by the firm’s profitability. There is some confusion at present due to HMRC’s efforts to close the loophole and categorise an FSE Partner as an employee (thus requiring firm and individual to pay tax/NI accordingly). The result looks like being a greater requirement for capital contributions from FSE Partners in order to maintain their HMRC eligibility status as Partners rather than employees. For firms, this has the side benefit of an injection of cash and whilst it may in turn lead FSE Partners to gain some additional influence, this remains to be seen as firms adapt to the changes. FSE Partnership is typically seen as a step towards Full Equity and allows the individual time to build their business case within the confines of the firm, and the firm time to assess the suitability of that Partner for the potentially long-term commitment of a full equity holding.
Until recent years Salaried Partners represented a significant portion of the market with many firms fielding greater numbers than they did at Equity level. Numbers have declined significantly, largely due to the cost savings of using FSE Partners (identified above) in an LLP model but also in part due to the perception that they were Partners only in title and little else. As the name suggests, a Salaried Partner is paid a salary much like an Associate would be, although they may be eligible for larger bonus elements. Where it still exists, it is typically seen now as an interim step between Associate and ‘proper’ Partnership, much like the Counsel title that (along with FSE Partnership) has replaced it.
Two trends have characterised the market in recent years:
1) A movement away from large tiers of salaried partners towards an ‘all equity’ or more specifically ‘full equity’ plus ‘fixed-share equity’ arrangement.
This has been largely explained above. It was fundamentally motivated by HMRC recognition of FSE Partners as Partners rather than employees, making it instantly favourable for firm and individual, from a tax/NI perspective, to switch from salaried to FSE status. Recent HMRC amendments have now brought this into question once more, although at present it looks like most of the larger firms will address this by requesting capital contributions from FSE Partners at the level required to satisfy the new HMRC requirements for individuals to be treated as Partners.
2) A movement away from pure lockstep towards a more merit based system whereby advancement is determined by performance alone or by some combination of performance and length of service.
This trend has had far greater impact on the market, at least from a recruitment perspective. Slowly but surely, firms have begun to jettison the long-held lockstep method that rewarded Partners for their longevity of service and replaced it with more meritocratic assessments that might (although not all do) still account for seniority but also allow the flexibility to offer high-achievers a higher share of the profit pool.
This has added fuel to the lateral hire market with successful Partners no longer worried about losing their place on the lockstep ladder when they are being enticed by high-drawings elsewhere based on their previous success, and acquisitive firms far more able to attract high-performers now that they do not have to be shoe-horned into a lockstep system.
Naturally it has also caused consternation among some longer serving but less effective Partners. It is perhaps for this reason that so few firms had taken the leap before the financial crisis and yet so many did during and have since. Whatever its critics might say about the dissolution of the true partnership ethos, most accept the commercial reality that in a larger firm, Partners need to justify their earnings with their performance if it is to maintain a competitive level of profitability. If it doesn’t, the dangers of the best Partners leaving for more profitable competitors, in turn causing the firm’s profits to spiral downwards, are all too evident in recent high-profile failures.
To discuss this or for a copy of our Guide to Moving as a Partner, please contact Jason Horobin at [email protected]egal.co.uk