It’s the Money, Stupid!

Why the new breed of law firms is moving from point- to math-based compensation models.

By Jim Meadows | April 20, 2018

Much has been written about the importance of “culture” in companies and in law firms. Building it. Encouraging it. Enforcing it. In law firm partnerships, culture is as widely discussed as the concept of “meaningful work” and “prestige.” But behind closed doors and in compensation committee meetings, what really matters (if we are being honest) is compensation—the engine that drives most law firm partnerships.

At the end of the day, it’s the money (stupid) that makes the practice of law possible. But how a law firm or its executive management choose to allocate that money can make the difference between a law firm that fosters a culture of cohesion and collaboration or where the battle for a bigger share of a finite pie promotes a culture of “me vs. them” competition.

Lawyers and management committees complain that the conventional “eat what you kill” law firm compensation model (with its negative connotations and resulting divide-and-conquer culture) creates silos and fosters less collaboration among law firm partners (equity and non) and future partners (associates). The “I am only as good as my book of business” mentality has been the end result of how some firms calculated their compensation formulas—often in secret.

This doesn’t mean that all attorneys care only about who is making more money than whom. Rather it’s the lack of transparency that creates more internal competition. Attorneys inside a firm are as likely to battle one another for their piece of a finite pie than to battle members of competing firms for a bigger share of an infinite universe of clients. It is one thing to compete against other firms for client business. Internecine warfare is another—a management challenge that has brought about the dissolution of many longstanding firms.

Increasingly law firm management committees are exploring compensation models beyond the traditional “point” system (i.e., subjective percentage of the whole—1 point equals 1 percent). They are looking at mathematical formula-based compensation models that clearly and transparently outline who earns what for what. Because these formula-based compensation structures provide members with a clear sense of how one will be compensated, this knowledge goes a long way toward boosting productivity and morale firmwide. In fact, many firms find that implementing a transparent, formula-based compensation structure can yield significant benefits, including increased cross-selling and collaboration—the two things all law firms claim to want most.

What’s the difference between point and math models?

Historically, law firms have operated on a 1/3-1/3-1/3 model: one-third of each attorney’s revenues would go to salary, another third to overhead and the final third to the equity partners as profit. In the name of “paying their dues,” a law firm’s associates work hard for a number of years, earning a guaranteed salary, comfortable, but relatively low in relations to that of the equity partners. Their goal, the big pay-off at the end: partnership.

However, at large law firms, not all partners are treated equally. A large number have traditionally split the partnership hierarchy into two: nonequity and equity partners. And the trend has been to invite fewer attorneys into the equity ranks, increasing the firm’s “leverage” and its coveted “profit per equity partner” figure (a large law firm’s “stock price”). Partnership decisions (who’s in and who’s not) are often shrouded in mystery, a tabulation of “points,” subjective opinions and a great deal of internal politicking in closed-door meetings. Excluded from the process, associates at these firms continue to work hard never knowing whether the big equity partnership payoff will ever be within their grasp, and for most, it will not.

This traditional associate to nonequity partner to equity partner model sets the stage for intense internal competition among the many (associates/nonequity partners) for the few equity spots—where the real money at these firms is made. Associates pay their dues to become nonequity partners. Those who make the cut frequently get three years (sometimes with training) to become a rainmaker for consideration as an equity partner. But even among equity partners, there is competition. Rather than collaborate and even cross-sell or delegate, each competes against all others for their piece of the equity pie available. This can be complicated further by senior attorneys attempting to “hold on” to their piece of the pie as compensation for “dues paid” (i.e., past contributions while they were climbing the ranks), thus increasing the level of competition.

Is “eat what you kill” bad?

Most firms have long avoided a transparent, formula-based model of compensation. Management committees believed that a straightforward, mathematical model compensating partners for what they bring in, and the work they do, would be even more divisive than the current, more subjective point + committee review system. Perhaps that would be the case for some models and at some firms. But it doesn’t mean that all formulas create silos and internal competition. Done properly, it can accomplish the opposite.

A growing number of executive committees are exchanging their traditional “point” compensation model for a completely mathematical-based compensation formula. Because the numbers are the numbers, these systems are free of internal politics and backroom dealing. Moreover, these models build in rewards for sharing the business (originating partner and account management partner and working attorney), encouraging cross-selling and the concept of actual equity among partners based upon the contribution of each. Transparent, math-based compensation works because it offers:

(1) immediacy in the compensation the attorney is awarded—because they know how the compensation is calculated, income is easy to calculate; and

(2) transparency in the way it is calculated—compensation is strictly formula-based.

Managed properly, a transparent, and objective compensation formula can incentivize cross-selling. Originating partners and other partners involved are both compensated and incentivized to work together on client matters. In a formula-based system, partners know exactly how much they will earn from other partners working on their client matters. This is unlike conventional compensation models where partners are incentivized to make their own practices look bigger by holding all engagements close to their vests.

Some firms have experimented with hybrid compensation models. Attorneys receive a base salary based on the traditional 1/3-1/3-1/3 model until they showed a profit. Once they reach that benchmark, they begin to earn a percentage based on the profits accrued.

Another less visible factor in compensation formulas is the role played by a firm’s overhead costs. When firms can reduce overhead (the second 1/3 of the traditional associate compensation model), they can distribute additional income back to their attorneys—a win-win scenario. (Culhane Meadows operates on this principle. Its structure incorporates very little overhead and a proportionately high-profit distribution.)

The benefits of formula-based compensation are many. Not the least is the fact that such a system is completely merit-based and neutral—blind to gender, age, race, religion, etc. When subjectivity is eliminated in partnership decision, so is the glass ceiling.

The original impetus behind the notion of partnerships in law firms is that when a group of attorneys joins together, the collective practice will be more productive (and remunerative) than it would be if each practiced solo. Compensation systems should support that collaboration, not undermine it. One attorney’s climb up the point sheet, should not mean that another is forced down or out. The key, in the end, is transparency.

Jim Meadows (jmeadows@culhane.law) is one of the co-founders and managing partners of cloud-based Culhane Meadows PLLC (www.culhane.law), the largest, woman-owned national full-service law firm in the United States. Founded in 2013, the firm has grown through recruiting nearly 60 former Big Law attorneys who continue to serve sophisticated clients in seven major business markets (Atlanta, Austin, Chicago, Dallas, Houston, New York, and Washington, DC).

Reprinted with permission from the April 20, 2018 edition of the New York Law Journal © 2018 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 – reprints@alm.com.