By Jonathan A. Karp, Treasurer, Law Practice Management Section Executive Committee. Karp is a partner with the law firm of Reish Luftman McDaniel & Reicher, focusing on corporate matters for successful closely held companies, professional firms, and their owners. He can be reached through the firm's Web site at www.reish.com. The opinions expressed are his own.
The sharing of compensation among partners is one of the critical issues facing a law firm and, all too often, can lead to disagreement and, in extreme cases, the break-up of the law firm. There are different ways of looking at the purposes of compensation and how it should be allocated among the partners.
Oftentimes, when firms are formed, the simplest method of allocating compensation is sharing it equally among partners. However, that can often lead to resentment from one or more partners who feel that they are contributing more and/or that others are not carrying their full load.
Firms need to determine whether they are trying to motivate or encourage certain behaviors when establishing a compensation system: Does the firm want to encourage originations of new clients, billing large hours, or delegation to and training of associates, for example?
In addition to compensating partners for their services, compensation structures could be used to encourage desired behavior or discourage undesirable behavior. The compensation allocation method used by many firms -- equal payments to all partners -- does not motivate individual behavior but may encourage the financial success of the firm.
Another method of allocating compensation, which rewards desired behaviors, is setting up a formula or structure that rewards the three roles generally performed by partners in firms: "finders," "minders," and "grinders." A certain portion of the profits could be allocated among members of these various groups, or a formula can be developed that allocates a portion of profits to these various groups based upon their respective efforts. This rewards originations (finders), supervisors and delegators (minders), and those who simply want to work hard and long hours (grinders). How to allocate or weigh the contributions made by these respective groups must be addressed.
An extreme method -- contrasted to a formula based on objective factors -- is a purely subjective compensation arrangement. Some firms use a compensation partner or compensation committee to sit down each year and determine what each partner's salary and share of the net profits will be. Smaller firms may have a meeting of all partners at the end of the year to determine how profits will be allocated and what the salaries will be.
Since any change to a compensation formula or arrangement requires a transition, oftentimes a staged approach to a desired goal may be appropriate. For example, a firm switching from equal compensation for all partners to a formula method may want to stage the approach such that, for example, during the first year 75 percent of profits and compensation will be divided equally among the partners and 25 percent will be based on an agreed formula. In the next year, the allocation may be 50/50 and then the following year it may switch to the ultimate 75 percent formula and 25 percent equal.
The formula should be modified over time to reflect changing realities and different circumstances among the partners.
The foregoing examples are just some of the possible methods of allocating compensation and profits among partners. In general, the appropriate method is limited only by the imagination of the attorneys and their advisors. However, clearly defining the method of allocation and establishing a formula that is fair and acceptable to all partners will go a long way toward avoiding future disputes and events leading to dissolutions of firms, which are far more costly than any minor discrepancies in compensation and profit sharing.
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