How should a law firm compensate equity owners * who manage the firm?

Answering this question seems easy enough. However, the answer is much more complex. A related challenge involves compensating management committee members for their service. To provide context, let’s consider the most common small to midsized firm managing partner* archetypes scenarios.

* equity owners and partners will be used interchangeably throughout

Relatable Scenarios for Managing Partners:

• “No one else can do it as well as I can.”
• “I have the most business, so it is only natural that I have the most power.”
• “Most management tasks fall to me, so I should have the title.”
• “I would rather practice law, but my partners want me to run the firm.”
• “My partners want me to manage the firm, and I like doing it.”
• “My partners appreciate my management talent but will not pay for it.”
• “We do not know how to value firm management.”
• “We need incentives to encourage partners to make meaningful contributions to firm management.” 
• "We must remove disincentives from our compensation systems for those who make non-billable contributions that benefit everyone.”
• “We want to ensure we do not concentrate too much power in one position.“

Choosing and Compensating a Managing Partner

Selecting a managing partner in small to mid-sized firms often depends on factors such as ownership, client control, leadership ability, managerial competence, temperament, and willingness to serve. These factors are crucial as they influence the structure and fairness of the compensation system. 

In first-generation firms, founding partners with majority stakes typically manage the firm, treating it like sole proprietors. In these cases, managing the firm is considered part of ownership, and additional management pay isn't applicable.

As firms grow and include more equity owners, the power structure becomes more distributed, and electing a managing partner becomes a political process often involving committees. Effective management benefits a larger group, requiring more time and effort to balance competing interests.

Where a firm is in its lifecycle is crucial in selecting and compensating a managing partner or group. The skills and temperament needed to manage a start-up firm differ from those required for a mature firm. Additionally, the financial resources available for management compensation vary at each stage. Each phase presents unique opportunities and challenges, necessitating different levels of management, which are critical considerations in compensation decisions.

Measuring Managing Partner Performance

Managing partners do not typically enjoy the level of power afforded to a corporation's CEO, and they have a different type of accountability. Their burden is often underappreciated and undervalued. Authority and accountability will vary with a firm’s management approach, ownership, and lifecycle stage, but the areas of responsibility of a typical managing partner include: 

The extent of a managing partner's responsibilities often depends on the firm's administrative structure. If the firm has a solid non-lawyer management team, participation by other partners, and outside support systems, the managing partner’s position is easier. Many managing partners practice law and manage client relationships, which requires a strong administrative team. We developed a helpful template to help evaluate a managing partner's contribution level. Here is a snapshot of our editable template, which you can download by clicking the link below: 

DOWNLOAD THE TEMPLATE

Compensation Strategies

Objective Systems

Paying a managing partner depends on a firm’s compensation system. Objective systems that rely heavily on timekeeper and origination performance measures need a feature that allocates compensation for non-billable contributions. We typically recommend a tiered approach to compensation that considers:

• Timekeeper productivity
• Originations
• Fees managed
• Managerial compensation
• Equity ownership
• Subjective contributions

 Each of these tiers should be weighted and allocated appropriately. Firms with a single managing partner often treat all or part of management pay as an operating expense, meaning it is allocated to the managing partner before the remaining income flows into the equity partner compensation pool. For example, if a managing partner earns 2% of annual revenue to manage the firm, and the firm has annual revenues of $10,000,000 and profits of $5,000,000 before considering managing partner compensation, the managing partner would receive $200,000. The remaining $4,800,000 would then be distributed among the equity partners. Managing partners also participate in the partners’ compensation formula unless they manage full-time. 

Fairly compensating full-time managing partners may require additional compensation, such as a larger revenue share or a base salary plus revenue share. It is advisable to include management committee and other committee services compensation in the formula rather than as a special allocation, as excessive above-the-line compensation can create risk for the firm and make the special allocations onerous in lean years. 

Subjective Systems

Subjective and equity ownership-based compensation systems often use a rough justice approach to reward managing partner service. For instance, if a managing partner owns the most equity in the firm, they may not receive additional compensation, as they benefit the most from their efforts. In most cases, managing partners do not lose ownership points during their term, so they do not suffer adverse economic consequences from their service.

Firms using base salaries as part of their compensation scheme consider managing partner service when setting the base salary. Some firms view management as a duty and do not include management contributions in their compensation formula.

Typical Compensation Plans

Compensating managing partners is particularly challenging for small and mid-sized firms that rely on the managing partner’s economic contributions to sustain profitability. The debate often centers on whether to improve performance first and then offer incentives or provide incentives first to create improved performance. This question often poses an obstacle for law firms.

Here are some approaches to compensating managing partners:

• A subjective bonus 
• A stated monthly amount
• A percentage of revenues
• Credits or reduced requirements in the firm’s compensation system
• A share of the pool dedicated to firm management in a tiered compensation system
• Hourly pay credits (typically capped) for time spent managing

Basic Steps to Evaluate and Design Compensation Plans

The best approach to making this decision and designing a compensation plan that fairly compensates firm management and leadership is to use a structured process to evaluate the contributions of a managing partner and, by extension, those who make managerial contributions.

Basic steps include:

1. Complete the managing partner template.

2. Create a job description/role definition.

3. Set expectations regarding controllable metrics (revenues, realization, growth (rates and clients), profits per equity partner, operating expense efficiency, technology goals, turnover and morale, brand equity)

4. Consider the roles, quality, and cost of supporting positions and the non-lawyer management team.

5. Set pay based on expectations and total management spending benchmarked to revenue and profit.

A good managing partner can significantly impact the firm's success, However, a system that creates accountability and rewards performance can make an even greater impact. A talented managing partner can make the critical decisions needed to unlock a law firm’s full potential, creating opportunities for talented and hardworking lawyers and staff.