As law firms increasingly move away from the traditional lockstep (seniority-based) approach to compensation, various alternative compensation methods are emerging. Some of these, however, are proving less effective because they emphasize revenue. Compensation should be aligned with your firm's short and long-term goals. Employing a profit-based approach is more likely to facilitate the achievement of these strategic goals.

Pushing Profits Forward

Focusing on revenues can present a distorted picture of a partner's contributions. For example, a firm has one partner who generates $600,000 in billable revenues, performing all of the work herself. A second partner generates only $450,000 in revenues at the same hourly rate, but also supervises four associates who each bill 2,000 hours annually. The second attorney clearly brings more profits to the firm, even though he personally generates less revenue. However, in this scenario, a revenue-based compensation model would reward the first partner more.

Moreover, a focus on revenues fails to account for the impact of overhead and collections. The partner who generates staggering billable hours but incurs a significant chunk of overhead may be less profitable in the end than one who bills fewer hours. And billed hours have no value to the firm if they are not collected — all they have done is increase overhead. (See the Sidebar "Ideas for Motivating Collections.")

Finally, revenue-based compensation can encourage a partner to focus on billable hours to the exclusion of other activities that would support the firm's strategic goals. If, for example, the firm wants to build from within, partners will need to spend time training and mentoring associates, but partners might be unwilling to do so if it eats into their billable time, and therefore, their revenues and compensation. If compensation instead recognizes contributions to profitability, partners are more likely to sacrifice their own billable hours to supervise a team of associates.

Finding Objective Metrics

If your firm chooses a profitability model for partner pay, your compensation committee can use one or several objective metrics, including:

  • Realization;
  • Collections, including both whether and how quickly bills are paid;
  • Work in progress; and
  • New business from new or existing clients (regardless of whether the partner ultimately handles it).

Customizing your System

Fortunately, your law firm should be able to adopt a profit-based compensation system without needing to completely overhaul your current compensation approach. Profit-based measures usually can be incorporated into the most common compensation systems. For example:

Percentages or Units of Participation — Many firms pay partners a share of the net profits by assigning each a percentage or units of participation. The assignment of percentage or units of production to each attorney should consider more than just ownership interests, seniority and billable hours. Profit-based metrics can play a role in the assignment by taking into account factors like consequential nonbillable time, accounts receivable aging, and write-offs or write-downs.

Reserve Systems — Some firms use percentage or units of participation plans that include a reserve of a set percentage each year. That reserve can be allocated using a profits-based approach by allocating the reserve based on the factors described above.

Formulas — A firm's compensation plan may distribute net profits based on a simple or weighted formula. A simple formula might account for originating work and producing work on a 1-1 ratio, while a weighted formula assigns increased weight to the most important elements, ideally according to the firm's strategic goals. Firms with these types of formulas can increase the weight for elements associated with profitability.

Lockstep — Even where the lockstep approach lingers, firms can incorporate profitability. Rather than advancing partners to the next level based on the number of years they have been partner, a firm could require them to first satisfy specific profit-based metrics.

As important as profits are, your law firm's ultimate survival also depends on functions such as management, administration and planning. An effective partnership compensation plan should also acknowledge contributions in these areas.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.